Would you buy Blockbuster? Well what if you had lent money to Blockbuster? Would you buy it then? We said it before, and we’ll say it again, inside the Blockbuster business is a Netflix waiting to get out. All it needs is a way of taking the business out of its retail footprint and it has the film rights, the DVD stockpile, the brand and the technology to challenge Netflix. It’s just that no-one, except the companies that have already allowed it to borrow money, believe in Blockbuster right now.
So a group of them ‘ have formed a new company to bid for Blockbuster, called Cobalt Video Holdco, formed by funds managed by Monarch Alternative Capital, Owl Creek Asset Management, Stonehill Capital Management and V’rde Partners, each of which is a secured noteholder of Blockbuster.
But it’s not a conventional bid and there’s two ways of viewing it. The first is that these companies would like to buy Blockbuster and run it until it looks more like Netflix, and starts to have that kind of immense consumer appeal, and then they would like to sell it. They want to do the deal before Blockbuster runs out of cash, and want to offer as little as possible. So they have come up with a scheme whereby they offer $290 million, and unless another bidder comes forward a deal can be done. This way instead of the court feeling that it has to get back more of the $1 billion plus of debt that the company has run up, it feels that a decaying asset has to be sold quickly to the highest bidder. So perhaps this consortium wants to be the highest bidder. We don’t think so.
That brings us to the other alternative. This group of lenders wants their money back and the only way they can see it happening is if the court is forced to sell the company off quickly, by using this ‘Stalking horse’ approach, which is meant to be the first bid, and trigger higher bids. It relies on just what we have said about the company ‘ that some of the Netlfix sheen needs to rub off on it.
Given that Blockbuster has already run up $250 million of debtor in possession debt, which is where the company takes goods but they remain the property of the supplier until paid for, any value lower than this bare bones offer might scare suppliers.
The court would want over $1 billion so all debt gets paid off, but won’t get it, so Blockbuster must therefore be worth somewhere between the two figures, $290 million and $1 billion.
If we look at the value attached to Sonic Solutions when Rovi acquired it a few weeks back, we see that it was sold for $720 million, and that this had an online only video store, and didn’t have thousands of store property leases around its neck, as Blockbuster has. Sonic also had a couple of perfectly good other businesses including its DVD manufacturing business and the recently acquired DivX, which provided around 80% plus of its revenue. So if you believe it was bought to help Rovi’s offerings to become Netflix-like, that was a huge premium on what was about $16 million of revenue per year out of a run rate of around $100 million.
With Blockbuster still having revenues closer to $3 billion, what does that say about its relative value? We would say that it’s much the same, and that Rovi might even consider a bid, even though it supplies the technology behind the online store at Blockbuster, which shares virtually the same content as its own. A low-ball bid of $300 million to keep it from another rival might make sense, especially if it can come up with a way to dispose of the retail offering.
But it might make more sense to let this consortium strangle their own assets, trying to re-organize a company that has had 5 years of re-organizations, than to take on the task itself. So it would be a mistake for Rovi to do that. Rovi now lives or dies on helping operators into the OTT market, lock stock and barrel with end to end technology. If other independent operators come into the market on the back of after a Blockbuster purchase, Rovi would rely on its own differentiation ‘ its EPG intellectual property, its cloud search capabilities, its deliver platform software and its content ‘ not just content rights.
But there could be hundreds of other companies out there that might feel that $300 million or even $500 million, was a price worth paying to get itself into the online OTT film business, and given that Rovi is its technology provider, it should be every bit as good as the Rovi film service.
The right buyer will need to be someone who cannot only go up against Netflix and Amazon, which has recently entered this business internationally, but also who has another service which consumers are happy to pay for, so that it can virtually give away the online films. Amazon has just announced that it will give away film rights to anyone buying its Amazon Prime free delivery service costing $79 a year, roughly $6.50 a month, a little less than the paid online offer of Netflix, at $7.99 a month.
Back in September we wrote ‘The truth is that the cost of entry into this market is prohibitive, because someone has to swallow the content costs, and produce a partly or mostly free service ‘ and in order to license enough content to make a serious stab at competing with Netflix, that cost will run to around $1 billion a year today (that was the annual Netflix cost of subscriptions which has now risen to $2 billion) in order to reach a similar number of homes to Netflix, and substantially more tomorrow.’
So the buyer would need to be able to swallow the price of Blockbuster and around another $1 billion in licensing costs if it wants to make any service it offers nearly free, and it needs to be sure it can get that back from some other source. The banks which funded Blockbuster are NOT that organization. There ARE private equity groups out there, who have properties that might fit alongside Blockbuster, who might buy it from the stalking horse bidders, if they are successful, the day after such a deal is done. But that plan would be ruined by the emergence of a single second bid for Blockbuster, and we think there will be some.
We asked back in September is anyone would have the guts and presence of mind to enter the bidding to buy Blockbuster, but given the incredible growth of Netflix someone, even if it is just Wal-Mart or another retailer, will have to at least investigate the possibility of harnessing the blockbuster brand.
We don’t have sight of all the property portfolio that the company is saddled with, nor do we know the prevailing price and time to sell such retail properties, but that must be the big obstacle to breaking even, that and staffing them all while they are open. Someone has to take the brave decision to transfer the Blockbuster business model to one that either uses no retail or only retains the currently profitable outlets, but somehow transfers the relationship where it closes a store from a retail relationship to an online one. If that can’t be managed then everyone that stops going to Blockbuster is potentially a new Netflix customer. Another issue is whether or not the rest of the world, outside of the US, might continue with the existing Blockbuster model for quite some time, in which case the international operation could be sold off right after a buy-out transaction, to produce further funds.
But we know there will be rivals emerging to Netflix apart from Amazon , we would have said about two or three more nationally within the US, simply because of the revenue pie that’s at stake, and also there’s the rest of the world to chase. It’s hard to consider that if you have to begin the content licensing process, from scratch, now.
So we reckon that the price for Blockbuster will go a fair bit higher, and that with the right detail about the condition of its property lease and ownership portfolio, one of these will have enough confidence to outbid the Stalking horse.
Blockbuster will now invite competing bids from both strategic and financial investors, which will bring a library of 125,000 titles, in both DVD and streaming, but they have to come forward in the next 30 days. Our bet is that the only groups who can move that fast will be private equity groups, who plan to re-align the customer offering and then sell the business on, so even after we know who has won the bidding, it may not tell us very much about Blockbuster’s future right away. The final sale hearing will take place no later than April 20, 2011.
The big imponderable remains how Apple or Google can intercept the Netflix model from the point of view of their devices and a free or close to free offering, which neither have looked like trying so far.