Courtesy of Chris Pavese
The risks To Blockbuster are well publicized today. The company is fighting off competitors on all fronts with Netflix, Redbox, and OnDemand steadily eroding share from brick and mortar competitors. But Blockbuster’s senior subordinated notes maturing May 2012 are trading below twenty five cents on the dollar today. Investors with an above-average level of risk tolerance may want to give these bonds a closer look. If management can simply execute on its strategic plan, investors stand to make a substantial profit in a very short amount of time. We note that the days of Blockbuster Domination are clearly over, but investors only need a few quarters of stabilization and a briefly extended survival timeline to earn outsized returns.
Downside appears limited from here. The company recently made an important interest payment to bond holders during the first quarter – BBI’s largest seasonal drain on cash. Quarters two and three are generally cash neutral while the fourth quarter, which includes the important holiday season, is the largest generator of cash. The company appears to have cleared their biggest near term hurdle, especially when one considers recent deals with major studios for new payment terms which reduce working capital, freeing up additional cash flow.
Upside is substantial when one stops to consider the potential for positive surprises:
- Roughly one third of domestic stores generate more than three quarters of cash flow (see company illustration below). With store leases on average one to two years (according to management), rapidly closing stores should leave a very profitable core store base.
- New releases represent almost two thirds of revenues. Recent deals with major studios provide Blockbuster with a “monopoly” on new releases giving the company an exclusive rental window and a head start over nimble competitors. Studios want Blockbuster to survive.
- Hollywood Video bankruptcy eliminates the largest competitor in the industry. Reduced capacity through thousands of store closings (Hollywood and local video retailers) will ultimately bring supply back in line with demand. Take a look at same store comps at Best Buy in an ex-Circuit City world.
- Blockbuster’s strong brand and brand awareness provide a key competitive advantage. Management should be successful in leveraging these assets across various forms of distribution – by mail, kiosks and electronically.
We stress the word should only because it is not apparent that shareholders have the right team on the bus today. We appreciate the tremendous value in this franchise, but question management’s ability or incentive to unlock this value. Blockbuster CEO, James Keyes, is saying all the right things. But he’s been saying all the right things for years now. Jim, if you’re listening, we’d offer up the following words of advice first – “Well done is better than well said.”
It’s pretty clear that this old boy’s club may need a fresh set of eyes on the inside. Or better yet, a fresh pair of shoes, to “walk the walk” since they seem to have no problem “talking the talk.” We didn’t get a chance to ask him when we spoke yesterday, but I’m guessing our new friend Gregory Meyer is walking around in some pretty comfortable running shoes. We urge interested investors to take a look at Greg’s recent letter to stockholders and his original letter to the Blockbuster Board of Directors in 2005. And Jim, if you’re still listening, we’d urge you and your Board to carefully consider what Greg might have to offer. The guy did hand you Redbox on a silver platter five years ago . . . he just might know a thing or two.
Disclosure: At the time of publication, the author was long Blockbuster Senior Subordinated notes, although positions may change at any time.