Blockbuster, Inc. Class B Shar BBI/B
December 19, 2008 - 10:19pm EST by
rasputin998
2008 2009
Price: 0.47 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 94 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

At 47 cents per share, the Blockbuster Class B’s are currently priced for bankruptcy despite clear evidence that 1) a companywide operational turnaround is well underway; and 2) the overall business can hold its own, if not prosper a little more, from the dramatic economic downturn we are currently experiencing (i.e. the business may be considered slightly counter-cyclical).
 
An investment in the B shares couples significant financial leverage with tremendous operating leverage.  Current levels value the enterprise at less than 3.7 times 2008 EBITDA, and Blockbuster’s equity market cap at less than one times 2009 free cash flow.  The leverage on these shares is illustrated by the fact that no operational improvements and a tweaking of the company’s valuation up to a modest 5.0 times trailing EBITDA gives us a share price of $2.50 per share – a 400% return from the current price.
 
Moreover, we believe the current management team has the experience and vision to take advantage of Blockbuster’s vast, underutilized bricks and mortar presence to grow its top-line while at the same time continue to slice down the company’s relatively high cost structure.  Management has communicated that the company has earnings power in excess of $500mm in EBITDA as 1) it moves towards a media convenience store model to take advantage of selling merchandise to regular traffic and 2) identified cost-reduction initiatives are implemented.
 
With $60mm in term loan amortizations and a $135mm revolver maturing in August 2009, bankruptcy is indeed a possibility.  However, the company’s operating cash flow and other sources of cash should prove more than ample if their bank group proves unwilling to extend.  While there is some possibility of a donut here, it is small enough to offer a very attractive risk/reward relationship given the tremendous upside from the market price.  Management has communicated to investors a fairly detailed “Plan B” that they anticipate implementing if lending conditions maintain their frozen state.  Inventory reductions, minimalist capex, and lease renegotiations offer sources from which the company can harvest over $200mm in excess cash to accommodate these near-term obligations.
 
Interestingly, there is also a dramatic Class A/Class B arbitrage available in this name.  The Blockbuster Class A shares currently trade at over twice the price of the Class Bs. Both classes offer the same economic rights, but the Class Bs have superior voting rights, at two votes per share versus only one vote per A share.  The As are somewhat more liquid - well over 1mm A shares trade on a typical day, while the B shares see volumes ranging from 50k to 500k on most days.  We have not looked into the borrowability of the A shares as we are not in this for the arbitrage but rather for the multi-bagger potential on the B shares as a long-only investment.  There has been talk between management and some of the larger Class B shareholders about “collapsing” the A and B shares, creating a single class of common stock.  On the most recent conference call the CFO responded to a question about this by saying, in effect, that he doesn’t see how the company benefits from the dual class structure.  While we don’t sense that collapsing the shares is a current priority, we do think it will occur eventually.  Obviously, the huge price discrepancy between the two classes offers a “bonus” potential catalyst as a decision to collapse the classes would likely cause the B shares to trade more in line with the A shares and converge to the higher A share price as implementation approaches.

History/Overview
 
Blockbuster Inc., headquartered in Dallas, Texas, is a leading global provider of in-home rental and retail movie and game entertainment. The company operates almost 4,000 stores in the United States and 2,000 stores abroad. It also has about 1,500 stores operated by franchisees.
 
Founded in 1985 by David Cook, the company was bought by Wayne Huizenga in 1987 when it was a chain of just 20 stores.  Mr. Huizenga expanded the enterprise to 3,600 locations and $2bb in revenues before selling it to Viacom in 1994. Viacom IPO’d Blockbuster in 1999, and fully divested its ownership in 2004 by allowing its shareholders to exchange each Viacom share for 5.15 Blockbuster shares (thus giving rise to the Class B shares that are the subject of this writeup).   After several years of increasing customer dissatisfaction, operating losses and destruction of brand value, Carl Icahn accumulated 10% of the company’s shares and launched an activist campaign to oust John Antioco, the company’s egregiously compensated CEO.  Jim Keyes, who brought in his own team in July 2007, replaced Antioco with Icahn’s support.  Notably, when Mr. Keyes was hired he was granted 7.8mm stock options with strike prices ranging from $4.50 per share to $6.80 per share.  He was also required to buy $3mm worth of stock in the open market, for which he paid approximately $4.50 per share at the end of July 2007.

Management/Strategy
 
The bear case on Blockbuster reasonably considers a broken brand name and an industry steadily whittled away by technologically superior distribution methods.  A long investor must therefore believe in management’s ability to execute on the top and bottom line in the near-term, and transition the business in the long­-­term. A look at Jim Keyes’ background gives us comfort that we have the right captain at the helm.
 
From May 2000 through November 2005, Mr. Keyes served as President and CEO of 7-Eleven, Inc., which operates or franchises almost 6,000 stores in the United States and Canada, and licenses almost 23,000 stores worldwide.  During 2004, 7-Eleven stores worldwide generated total sales of approximately $41 billion.
 
Mr. Keyes is credited with an impressive turnaround at 7-Eleven.  His merchandising strategy involved analyzing point-of-sale data to understand and cater to customer trends within each market.  He also focused on partnering with suppliers to bring new or enhanced products into his distribution system.  Under his stewardship, 7-Eleven maintained remarkably consistent same-store sales growth throughout its footprint.  At the end of 2000 when Mr. Keyes was appointed CEO, 7-Eleven’s equity traded at approximately $8 per share.  In November 2005, a Japanese franchisee tendered for the entire company at $37.50 per share.
 
Mr. Keyes brought Tom Casey, his banker from his 7-Eleven days, to Blockbuster as his CFO. Mr. Casey is a graduate of the Harvard Business School, and had been a Managing Director at Deutsche Bank.
 
Management’s strategy involves significant top-line initiatives as well as taking advantage of opportunities to reduce the company’s significant fixed-cost base without compromising the customer experience.  Top-line initiatives include 1) revitalizing the brand with significantly improved new release stocking and appealing store format upgrades, 2) offering a broader and more fulfilling consumer experience through alternative delivery methods, including digital vending kiosks and in-home download applications, as well as through their existing mail-subscription and bricks and mortar channels, and 3) broadening the merchandise available to its prodigious store traffic, including CDs, magazines, games and game consoles, as well as convenience store snacks and beverages.  Results are encouraging so far. The 3rd quarter of 2008 represented Blockbuster’s sixth consecutive quarter of improved same-store sales and its third consecutive quarter of video rental revenue growth.  Domestic same-store revenues increased 5.1% during the quarter as a result of a 30.7% increase in same-store merchandise revenue and a 0.8% gain in same-store rental revenue.
 
Management is taking advantage of a range of opportunities on the cost front as well.  In addition to closing underperforming stores, significant savings can be realized from lease renegotiations and optimizing its Total Access online/in-store product.  The company has closed 326 stores since the 3rd quarter of 2007 – resulting in not only improved EBITDA but also improved liquidity, as the letters of credit securing those leases were freed up.  Blockbuster is in a strong negotiating position in reducing its lease expense.  As the anchor tenant on many of its properties and with an average 2.5-year lease across its network, management believes that a number of landlords would be willing to lower their lease charges by well over 10 percent.  Finally, management believes that their Total Access program is costing the company $80mm annually by requiring excess inventory.  They believe this can be managed down significantly through pricing and program adjustments.
 


Capital structure on October 5, 2008

Current Debt:

Revolver                       135.0

Term Loan A                 27.9

Term Loan B                 37.3

Capital Lease                   9.0

                                    -------

                                    209.2

Long Term Debt:

Term Loan B                314.8

Senior Sub Notes         300.0

Capital Lease                 30.3

                                    -------

                                    645.1

Total Debt                    854.3

Preferred Stock            150.0

                                    -------

Sr. to Common            1,004.3

Less:

Cash                            95.3

Net Sr.                         989.0

There are 125.4mm Class A shares and 72mm Class B Shares outstanding.


Valuation

The latest balance sheet is arguably a very conservative view of the company as 1) the third quarter is seasonally high in working capital cash drain, and 2) significant additional DVD and other merchandise stocking investments have just been made. 
 
Using $1BB in net senior claims and 200mm shares priced at the Class B price of 47 cents, we have a total enterprise value of $1.1BB.  It now seems very likely that 2008 EBITDA will comfortably exceed $300mm, and management believes they have many levers to drive EBITDA toward $500mm over time.  Through the Class B shares, the enterprise is therefore trading below 3.7 times a conservative, growing EBITDA estimate.
 
Using a 2009 EBITDA estimate of $315mm and defining free cash flow as EBITDA less interest, preferred dividends, cash taxes, and maintenance capex, we get a forward free cash flow estimate of $315mm less $70mm less $11.5mm less $28.5mm less $75mm, or $130mm. With the B shares trading at 47 cents, the company’s equity market cap of $94mm is valued at significantly less than one times next year’s free cash flow.
 
 
Risks
  
1.      Business falls off a cliff with other retailers, the expected positive cash flow in the 4th quarter doesn’t materialize, and the banks refuse to refinance next August.
 
2.      Alternative delivery technologies are adopted faster than expected, and management doesn’t have enough time to complete transition plan.
 
3.  The company’s “Plan B” strategy is either insufficient to cover the cash drain on the business or impacts the consumer experience to the point of doing long-term damage to the brand.  

Catalyst

1. Liquidity concerns dissipate. 2. Same-store sales improvements continue, reducing concerns about secular decline. 3. Potential of transition plan becomes more apparent. 4. Potential “collapse” of the A and B shares
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    Description

    At 47 cents per share, the Blockbuster Class B’s are currently priced for bankruptcy despite clear evidence that 1) a companywide operational turnaround is well underway; and 2) the overall business can hold its own, if not prosper a little more, from the dramatic economic downturn we are currently experiencing (i.e. the business may be considered slightly counter-cyclical).
     
    An investment in the B shares couples significant financial leverage with tremendous operating leverage.  Current levels value the enterprise at less than 3.7 times 2008 EBITDA, and Blockbuster’s equity market cap at less than one times 2009 free cash flow.  The leverage on these shares is illustrated by the fact that no operational improvements and a tweaking of the company’s valuation up to a modest 5.0 times trailing EBITDA gives us a share price of $2.50 per share – a 400% return from the current price.
     
    Moreover, we believe the current management team has the experience and vision to take advantage of Blockbuster’s vast, underutilized bricks and mortar presence to grow its top-line while at the same time continue to slice down the company’s relatively high cost structure.  Management has communicated that the company has earnings power in excess of $500mm in EBITDA as 1) it moves towards a media convenience store model to take advantage of selling merchandise to regular traffic and 2) identified cost-reduction initiatives are implemented.
     
    With $60mm in term loan amortizations and a $135mm revolver maturing in August 2009, bankruptcy is indeed a possibility.  However, the company’s operating cash flow and other sources of cash should prove more than ample if their bank group proves unwilling to extend.  While there is some possibility of a donut here, it is small enough to offer a very attractive risk/reward relationship given the tremendous upside from the market price.  Management has communicated to investors a fairly detailed “Plan B” that they anticipate implementing if lending conditions maintain their frozen state.  Inventory reductions, minimalist capex, and lease renegotiations offer sources from which the company can harvest over $200mm in excess cash to accommodate these near-term obligations.
     
    Interestingly, there is also a dramatic Class A/Class B arbitrage available in this name.  The Blockbuster Class A shares currently trade at over twice the price of the Class Bs. Both classes offer the same economic rights, but the Class Bs have superior voting rights, at two votes per share versus only one vote per A share.  The As are somewhat more liquid - well over 1mm A shares trade on a typical day, while the B shares see volumes ranging from 50k to 500k on most days.  We have not looked into the borrowability of the A shares as we are not in this for the arbitrage but rather for the multi-bagger potential on the B shares as a long-only investment.  There has been talk between management and some of the larger Class B shareholders about “collapsing” the A and B shares, creating a single class of common stock.  On the most recent conference call the CFO responded to a question about this by saying, in effect, that he doesn’t see how the company benefits from the dual class structure.  While we don’t sense that collapsing the shares is a current priority, we do think it will occur eventually.  Obviously, the huge price discrepancy between the two classes offers a “bonus” potential catalyst as a decision to collapse the classes would likely cause the B shares to trade more in line with the A shares and converge to the higher A share price as implementation approaches.

    History/Overview
     
    Blockbuster Inc., headquartered in Dallas, Texas, is a leading global provider of in-home rental and retail movie and game entertainment. The company operates almost 4,000 stores in the United States and 2,000 stores abroad. It also has about 1,500 stores operated by franchisees.
     
    Founded in 1985 by David Cook, the company was bought by Wayne Huizenga in 1987 when it was a chain of just 20 stores.  Mr. Huizenga expanded the enterprise to 3,600 locations and $2bb in revenues before selling it to Viacom in 1994. Viacom IPO’d Blockbuster in 1999, and fully divested its ownership in 2004 by allowing its shareholders to exchange each Viacom share for 5.15 Blockbuster shares (thus giving rise to the Class B shares that are the subject of this writeup).   After several years of increasing customer dissatisfaction, operating losses and destruction of brand value, Carl Icahn accumulated 10% of the company’s shares and launched an activist campaign to oust John Antioco, the company’s egregiously compensated CEO.  Jim Keyes, who brought in his own team in July 2007, replaced Antioco with Icahn’s support.  Notably, when Mr. Keyes was hired he was granted 7.8mm stock options with strike prices ranging from $4.50 per share to $6.80 per share.  He was also required to buy $3mm worth of stock in the open market, for which he paid approximately $4.50 per share at the end of July 2007.

    Management/Strategy
     
    The bear case on Blockbuster reasonably considers a broken brand name and an industry steadily whittled away by technologically superior distribution methods.  A long investor must therefore believe in management’s ability to execute on the top and bottom line in the near-term, and transition the business in the long­-­term. A look at Jim Keyes’ background gives us comfort that we have the right captain at the helm.
     
    From May 2000 through November 2005, Mr. Keyes served as President and CEO of 7-Eleven, Inc., which operates or franchises almost 6,000 stores in the United States and Canada, and licenses almost 23,000 stores worldwide.  During 2004, 7-Eleven stores worldwide generated total sales of approximately $41 billion.
     
    Mr. Keyes is credited with an impressive turnaround at 7-Eleven.  His merchandising strategy involved analyzing point-of-sale data to understand and cater to customer trends within each market.  He also focused on partnering with suppliers to bring new or enhanced products into his distribution system.  Under his stewardship, 7-Eleven maintained remarkably consistent same-store sales growth throughout its footprint.  At the end of 2000 when Mr. Keyes was appointed CEO, 7-Eleven’s equity traded at approximately $8 per share.  In November 2005, a Japanese franchisee tendered for the entire company at $37.50 per share.
     
    Mr. Keyes brought Tom Casey, his banker from his 7-Eleven days, to Blockbuster as his CFO. Mr. Casey is a graduate of the Harvard Business School, and had been a Managing Director at Deutsche Bank.
     
    Management’s strategy involves significant top-line initiatives as well as taking advantage of opportunities to reduce the company’s significant fixed-cost base without compromising the customer experience.  Top-line initiatives include 1) revitalizing the brand with significantly improved new release stocking and appealing store format upgrades, 2) offering a broader and more fulfilling consumer experience through alternative delivery methods, including digital vending kiosks and in-home download applications, as well as through their existing mail-subscription and bricks and mortar channels, and 3) broadening the merchandise available to its prodigious store traffic, including CDs, magazines, games and game consoles, as well as convenience store snacks and beverages.  Results are encouraging so far. The 3rd quarter of 2008 represented Blockbuster’s sixth consecutive quarter of improved same-store sales and its third consecutive quarter of video rental revenue growth.  Domestic same-store revenues increased 5.1% during the quarter as a result of a 30.7% increase in same-store merchandise revenue and a 0.8% gain in same-store rental revenue.
     
    Management is taking advantage of a range of opportunities on the cost front as well.  In addition to closing underperforming stores, significant savings can be realized from lease renegotiations and optimizing its Total Access online/in-store product.  The company has closed 326 stores since the 3rd quarter of 2007 – resulting in not only improved EBITDA but also improved liquidity, as the letters of credit securing those leases were freed up.  Blockbuster is in a strong negotiating position in reducing its lease expense.  As the anchor tenant on many of its properties and with an average 2.5-year lease across its network, management believes that a number of landlords would be willing to lower their lease charges by well over 10 percent.  Finally, management believes that their Total Access program is costing the company $80mm annually by requiring excess inventory.  They believe this can be managed down significantly through pricing and program adjustments.
     


    Capital structure on October 5, 2008

    Current Debt:

    Revolver                       135.0

    Term Loan A                 27.9

    Term Loan B                 37.3

    Capital Lease                   9.0

                                        -------

                                        209.2

    Long Term Debt:

    Term Loan B                314.8

    Senior Sub Notes         300.0

    Capital Lease                 30.3

                                        -------

                                        645.1

    Total Debt                    854.3

    Preferred Stock            150.0

                                        -------

    Sr. to Common            1,004.3

    Less:

    Cash                            95.3

    Net Sr.                         989.0

    There are 125.4mm Class A shares and 72mm Class B Shares outstanding.


    Valuation

    The latest balance sheet is arguably a very conservative view of the company as 1) the third quarter is seasonally high in working capital cash drain, and 2) significant additional DVD and other merchandise stocking investments have just been made. 
     
    Using $1BB in net senior claims and 200mm shares priced at the Class B price of 47 cents, we have a total enterprise value of $1.1BB.  It now seems very likely that 2008 EBITDA will comfortably exceed $300mm, and management believes they have many levers to drive EBITDA toward $500mm over time.  Through the Class B shares, the enterprise is therefore trading below 3.7 times a conservative, growing EBITDA estimate.
     
    Using a 2009 EBITDA estimate of $315mm and defining free cash flow as EBITDA less interest, preferred dividends, cash taxes, and maintenance capex, we get a forward free cash flow estimate of $315mm less $70mm less $11.5mm less $28.5mm less $75mm, or $130mm. With the B shares trading at 47 cents, the company’s equity market cap of $94mm is valued at significantly less than one times next year’s free cash flow.
     
     
    Risks
      
    1.      Business falls off a cliff with other retailers, the expected positive cash flow in the 4th quarter doesn’t materialize, and the banks refuse to refinance next August.
     
    2.      Alternative delivery technologies are adopted faster than expected, and management doesn’t have enough time to complete transition plan.
     
    3.  The company’s “Plan B” strategy is either insufficient to cover the cash drain on the business or impacts the consumer experience to the point of doing long-term damage to the brand.  

    Catalyst

    1. Liquidity concerns dissipate. 2. Same-store sales improvements continue, reducing concerns about secular decline. 3. Potential of transition plan becomes more apparent. 4. Potential “collapse” of the A and B shares

    Messages


    SubjectNew Writeup
    Entry12/19/2008 10:19 PM
    Memberrasputin998
    Description:
    At 47 cents per share, the Blockbuster Class B’s are currently priced for bankruptcy despite clear evidence that 1) a companywide operational turnaround is well underway; and 2) the overall business can hold its own, if not prosper a little more, from the dramatic economic downturn we are currently experiencing (i.e. the business may be considered slightly counter-cyclical).
     
    An investment in the B shares couples significant financial leverage with tremendous operating leverage.  Current levels value the enterprise at less than 3.7 times 2008 EBITDA, and Blockbuster’s equity market cap at less than one times 2009 free cash flow.  The leverage on these shares is illustrated by the fact that no operational improvements and a tweaking of the company’s valuation up to a modest 5.0 times trailing EBITDA gives us a share price of $2.50 per share – a 400% return from the current price.
     
    Moreover, we believe the current management team has the experience and vision to take advantage of Blockbuster’s vast, underutilized bricks and mortar presence to grow its top-line while at the same time continue to slice down the company’s relatively high cost structure.  Management has communicated that the company has earnings power in excess of $500mm in EBITDA as 1) it moves towards a media convenience store model to take advantage of selling merchandise to regular traffic and 2) identified cost-reduction initiatives are implemented.
     
    With $60mm in term loan amortizations and a $135mm revolver maturing in August 2009, bankruptcy is indeed a possibility.  However, the company’s operating cash flow and other sources of cash should prove more than ample if their bank group proves unwilling to extend.  While there is some possibility of a donut here, it is small enough to offer a very attractive risk/reward relationship given the tremendous upside from the market price.  Management has communicated to investors a fairly detailed “Plan B” that they anticipate implementing if lending conditions maintain their frozen state.  Inventory reductions, minimalist capex, and lease renegotiations offer sources from which the company can harvest over $200mm in excess cash to accommodate these near-term obligations.
     
    Interestingly, there is also a dramatic Class A/Class B arbitrage available in this name.  The Blockbuster Class A shares currently trade at over twice the price of the Class Bs. Both classes offer the same economic rights, but the Class Bs have superior voting rights, at two votes per share versus only one vote per A share.  The As are somewhat more liquid - well over 1mm A shares trade on a typical day, while the B shares see volumes ranging from 50k to 500k on most days.  We have not looked into the borrowability of the A shares as we are not in this for the arbitrage but rather for the multi-bagger potential on the B shares as a long-only investment.  There has been talk between management and some of the larger Class B shareholders about “collapsing” the A and B shares, creating a single class of common stock.  On the most recent conference call the CFO responded to a question about this by saying, in effect, that he doesn’t see how the company benefits from the dual class structure.  While we don’t sense that collapsing the shares is a current priority, we do think it will occur eventually.  Obviously, the huge price discrepancy between the two classes offers a “bonus” potential catalyst as a decision to collapse the classes would likely cause the B shares to trade more in line with the A shares and converge to the higher A share price as implementation approaches.

    History/Overview
     
    Blockbuster Inc., headquartered in Dallas, Texas, is a leading global provider of in-home rental and retail movie and game entertainment. The company operates almost 4,000 stores in the United States and 2,000 stores abroad. It also has about 1,500 stores operated by franchisees.
     
    Founded in 1985 by David Cook, the company was bought by Wayne Huizenga in 1987 when it was a chain of just 20 stores.  Mr. Huizenga expanded the enterprise to 3,600 locations and $2bb in revenues before selling it to Viacom in 1994. Viacom IPO’d Blockbuster in 1999, and fully divested its ownership in 2004 by allowing its shareholders to exchange each Viacom share for 5.15 Blockbuster shares (thus giving rise to the Class B shares that are the subject of this writeup).   After several years of increasing customer dissatisfaction, operating losses and destruction of brand value, Carl Icahn accumulated 10% of the company’s shares and launched an activist campaign to oust John Antioco, the company’s egregiously compensated CEO.  Jim Keyes, who brought in his own team in July 2007, replaced Antioco with Icahn’s support.  Notably, when Mr. Keyes was hired he was granted 7.8mm stock options with strike prices ranging from $4.50 per share to $6.80 per share.  He was also required to buy $3mm worth of stock in the open market, for which he paid approximately $4.50 per share at the end of July 2007.

    Management/Strategy
     
    The bear case on Blockbuster reasonably considers a broken brand name and an industry steadily whittled away by technologically superior distribution methods.  A long investor must therefore believe in management’s ability to execute on the top and bottom line in the near-term, and transition the business in the long­-­term. A look at Jim Keyes’ background gives us comfort that we have the right captain at the helm.
     
    From May 2000 through November 2005, Mr. Keyes served as President and CEO of 7-Eleven, Inc., which operates or franchises almost 6,000 stores in the United States and Canada, and licenses almost 23,000 stores worldwide.  During 2004, 7-Eleven stores worldwide generated total sales of approximately $41 billion.
     
    Mr. Keyes is credited with an impressive turnaround at 7-Eleven.  His merchandising strategy involved analyzing point-of-sale data to understand and cater to customer trends within each market.  He also focused on partnering with suppliers to bring new or enhanced products into his distribution system.  Under his stewardship, 7-Eleven maintained remarkably consistent same-store sales growth throughout its footprint.  At the end of 2000 when Mr. Keyes was appointed CEO, 7-Eleven’s equity traded at approximately $8 per share.  In November 2005, a Japanese franchisee tendered for the entire company at $37.50 per share.
     
    Mr. Keyes brought Tom Casey, his banker from his 7-Eleven days, to Blockbuster as his CFO. Mr. Casey is a graduate of the Harvard Business School, and had been a Managing Director at Deutsche Bank.
     
    Management’s strategy involves significant top-line initiatives as well as taking advantage of opportunities to reduce the company’s significant fixed-cost base without compromising the customer experience.  Top-line initiatives include 1) revitalizing the brand with significantly improved new release stocking and appealing store format upgrades, 2) offering a broader and more fulfilling consumer experience through alternative delivery methods, including digital vending kiosks and in-home download applications, as well as through their existing mail-subscription and bricks and mortar channels, and 3) broadening the merchandise available to its prodigious store traffic, including CDs, magazines, games and game consoles, as well as convenience store snacks and beverages.  Results are encouraging so far. The 3rd quarter of 2008 represented Blockbuster’s sixth consecu
    Catalyst: 1. Liquidity concerns dissipate. 2. Same-store sales i

    Subjectjriz1021
    Entry12/22/2008 01:11 PM
    Memberrasputin998
    Hi jriz -

    Thanks very much for your comments.

    I agree with you that the Term Loan B is unlikely to be impaired and will benefit from a bankruptcy filing, making the risk/reward there very interesting.

    You mention a 40% yield. I assume that is the yield to the 2011 maturity. However, with the coupon at L+375, what is the current yield (i.e., coupon divided by mkt price)? One of the problems with the bank loan market, other than the obvious technical one of universal deleveraging, is that Libor is so low. Bank loans are designed for levered investors and currently most of us that are still standing are unlevered guys, and we care about more about current yield than about spread.

    Even so, I would submit that even with 40% yields on the senior securities the equity makes sense if the company is a survivor. This company was written up on this site at $10 and at $3.50 (both also at significantly higher EBITDA multiples than the current level and with less evidence of a turnaround - interestingly, the higher the price, the higher VIC members rated it...). Yet even if it trades at the $2.50 I propose, you're looking at a 5-bagger.

    I guess I disagree with your assessment that survival is only 50/50 and that the shares only double if it survives (simply trading to where the Class As are now is well over a double).

    The multiple expansion does not have to be large to garner a huge return on this - yet even with no multiple expansion, at a free cash flow multiple below 1 times, the unlevered long-term investor (the guys we used to call "value investors" in the old days) sees his intrinsic equity value more than double and compound each year.

    I also don't think collapsing the A/B is a matter of managers having too many things on their plate, as the effort to complete that would not really be overly distracting.

    Based on our conversations, management's real reluctance is more a matter if losing their NYSE listing, since the reference price is where the A shares trade. Management fears that collapsing would result in a stock price somewhere between the current A price and B price, and they don't want to risk it trading below $1 for enough time to trigger a delisting. I understand that the NYSE is making more and more exceptions to the $1 rule in the current environment, so if management were convinced that they would not lose their listing I think they would likely move forward with the collapse sooner than later.

    SubjectRE: jriz1021
    Entry12/22/2008 03:17 PM
    Memberjriz1021
    Yes, that 40% yield is the yield to maturity assuming the bank pays on its current amortization schedule (Which is ~2.5% of principal paid back per quarter and then approximately 20% of principal paid back per quarter the last 4 quarters. That's what drives the hefty yield, even with low Libor. The bank debt trades in the high 50s. So say you buy $1000 of bank debt. Your cost basis is 600 (for round numbers). In one year you'll get $52.5 in annual interest and another $100 back in principal. That's a current yield of ~25%, not shabby. I agree with you completely that the shares will do well if the company survives its impending maturity schedule. The question is 1) what's the probability BBI makes it? and 2) what do the shares do if it does make it? I'm assuming the shares go to zero if the company files. I think you and I could come to some reasonable agreement on the probability of survival - 40-50-60% - whatever it is. However, it sounds like there is some disagreement as to what will happen to the shares in the event they do make it. In prior cycles I would agree with you, they could triple or quadruple perhaps. In the current environment, even if the company makes it through August 2009, I don't think the shares will trade well. I sincerely hope I am wrong (for both of our benefit). It sounds like you have better insight on the A/B share collapse, but I still maintain my bet that management won't deal with it in 2009.

    SubjectRE: RE: jriz1021
    Entry12/22/2008 10:16 PM
    Memberrasputin998
    Thanks very much for your response.

    We'll disagree about where the stock goes if they they meet the amortizations, but that's what makes a market. My view is that the multiple is too low to stay here without very significant clouds on the horizon. I do hear you about investor sentiment in the current environment. Sentiment can change too, and predicting sentiment is a subtler art than many who predict it are willing to admit.

    Just a quick clarification on the Term Loan. You mention a $600 investment receiving a $52.50 annual interest payments and a $100 principal paydown for a 25% current yield. I'm not sure why the full $100 principal payment should be considered part of your yield numerator. Wouldn't the current yield be more properly calculated by adding $40 (i.e., the full accretion of your purchased discount from par at paydown) to the $52.50, for a total of $92.50, divided by $600, for a 15% yield?

    I do agree that the term loan is interesting in any case.

    SubjectRE: RE: RE: jriz1021
    Entry12/23/2008 12:47 AM
    Memberjriz1021
    I mean the math I'm doing (and I don't have the amortization schedule in front of me but something like: 1/15/2009 - 2.5% principal, 5.25%/4 Interest 4/15/2009 - 2.5% principal, 5.25%/4 Interest 7/15/2009 - 2.5% principal, 5.25%/4 Interest 10/15/2009 - 2.5% principal, 5.25%/4 Interest So assuming no default, you're going to get 1/6th of what you paid back in one year (i.e., 10% of par amount, or 100, and you paid 600), and 5.25% of interest, or 52.5 (actually slightly less because of the quarterly paydowns). I'm not sure what you want to call that in terms of current yield.

    SubjectRE: RE: RE: RE: jriz1021
    Entry12/23/2008 09:29 PM
    Memberrasputin998
    I wouldn't think of principal paydown as part of my yield as that part is a return OF capital, not a return ON capital.

    If I plunk down $996 for a juicy 1-year t-bill and I receive $1,000.00 in a year, I don't calculate my yield as equal to that full principal paydown divided by my initial investment, or 100.40%. My yield is merely the accretion from my purchase price to the par paydown, or 40 bps.

    So in the case of the loan amortization, you are receiving $40 of the $100 in annual principal payments as a return ON capital, and $60 of that $100 as return OF capital (having paid only $60 for the $100 principal payment). So for current yield you would include that $40 plus the $52.50 in in interest for that year.

    SubjectRE: RE: RE: RE: RE: jriz1021
    Entry12/24/2008 09:09 AM
    Memberjacob828
    Given that the bank debt appears to lack any real security or collateral (it is only secured by the equity of the domestic and foreign subs it seems) isn't it simply pari with the trade claims and rejected leases in the event of any restructuring (esp with the company eager to get out of a large amount of its leases), which would likely be a huge claims pool? I am new to this one but it seems that the bank debt is trading where it is to reflect a lack of effective seniority (no lien on working capital, pp&e, etc) except against the bonds, and security is unlikely to be granted at this stage. Any thoughts?

    SubjectRE: RE: RE: RE: RE: RE: jriz10
    Entry12/30/2008 11:23 AM
    Memberjriz1021
    I think I overstated the case for the BBI TLB slightly. The reality is in a nightmare/bankruptcy scenario I think it's actually worse than you put forth in terms of the TLB's seniority. I agree with you that the collateral for the TLB is simply the equity in the opcos. Given that, I don't think the bank debt would be pari with the trade claims. I think the bank debt would be subordinated, as the trade claims would be unsecured claims at the opco level (i.e., ahead of the TLB's equity interest).

    SubjectRE: Profile to windup
    Entry12/30/2008 09:56 PM
    Memberrasputin998
    I think the equity will not survive if you believe this liquidates over the next 5 years.

    My view is that this business will last much longer than a lot of investors believe. I think the disappointment experienced by investors with Blockbuster over the last few years has more to do with prior mismanagement and brand value destruction than with technological cannibalism. The souring of the customer experience allowed a smart competitor to come in. But now I think their offering offers more value than Netflix. People have the mail convenience, but many like to browse if the store is nice to be in.

    I recall being asked by a Sanford Bernstein analyst when I was in business school to review his research on how video on demand would soon destroy the rental industry, as well as cable and broadcast television. That was in 1992.

    In a recent interview with the Motley Fool, Jim Keyes was asked whether Blockbuster was a melting ice cube, and his response was that it is a melting glacier.

    My bet is that Keyes will be able to execute the migration to a broad media convenience store, but also that he has plenty of time and that he will do it so incrementally that it will hardly be noticeable.

    Subjectkirkland ellis
    Entry03/06/2009 04:42 PM
    Memberpat110

    rasputin998,

    Thanks for the idea....  they did anounce positive 4th qtr comps and that EBITDA for 08 will be above $315 million...  but hiring Kirkand Ellis has overwhelmed that news i guess...

    Wondering if you know what incentives the new CEO has to keep the common alive versus restructure in BK and have more cash flow for him to play with after reducing debt.

    Here is Bloomberg report for any did not see it.  The company later put out a release saying hired Kirkland only to explore refinancing options.

    Bloomberg report really scared mkt creating a great opportunity in b shares if you believe they will survive in current form... Also volume in B shares has exploded... maybe someone wants control?

    ABBI 0.38, -0.06, -13.6%) is seeking legal counsel to explore the possibility of bankruptcy filing, Bloomberg reported Tuesday on its Web site, citing a person familiar with the situation. Kirkland & Ellis LLP was asked to evaluate restructuring options for the movie rental company, which may include a "pre-packaged" or "pre-arranged bankruptcy," the news agency said. Blockbuster shares were down 76% to 23 cents before trading was halted. 

     

     

     

     


    SubjectRE: kirkland ellis
    Entry03/07/2009 06:28 PM
    Memberpat110

    I answered my own question re Jim Keyes.... from a recent Wedbush report..... Jim Keyes invested $3 million of his personal funds to purchase Blockbuster stock at around  $4.00 per share in mid-2007.    I am glad to see he has lot of incentive to keep it afloat!


    SubjectWho will buy?
    Entry03/16/2009 07:29 PM
    Memberrasputin998

    I think it would be a homerun for Netflix to tender for the stock at $1.50 using its own overvalued stock and eliminate the competition for $300mm in inflated currency.  Heck, it would be worth it for them to do that, not assume the debt, and let their equity in Blockbuster evaporate along with everything else in a liquidation.  Listening to Netflix's conference calls, though, I don't think they'd consider anything like that.

    A number of analysts have suggested that Blockbuster should be taken private, but I don't see the advantage that a private buyer would have with the debt markets shut down. 

    I'm sure you've seen the Pali research speculating that they've delayed the earnings release so they can announce a completed revolver deal at the same time.  Pali states that it's likely to be expensive (> 15%) but the additional interest is not hugely material relative to their free cash flow.  I have no additional insight there, but I do believe that if the company does file, it won't be until very near the August deadline.  I also believe they will be able to use cashflow and negotiations to eliminate the nearterm bankruptcy risk if they can't get a bank deal. 

    Call me a conspiracy theorist, but I actually think it's possible that the bloomberg headline regarding bankruptcy was planted by a selfserving fund that was either short the stock or seeking liquidity and a price collapse to cover its long A-share/short B-share position.


    Subjectcorrection
    Entry03/16/2009 07:40 PM
    Memberrasputin998

    Er - sorry - I meant the other way around.  The unscrupulous fund would be collapsing it's short A-share, long B-share position.


    Subjectpat
    Entry03/16/2009 11:52 PM
    Memberrasputin998

    agreed - anyone remotely conscious would be short the A's and long the B's - hence my corrected post.


    SubjectResults
    Entry03/23/2009 02:24 PM
    Memberrasputin998

    Results were as expected given the updated guidance.  Note that free cash flow for the QUARTER exceed the market cap as measured through the B share price.  The flat 2009 ebitda guidance vs. 2008 seems incredibly conservative given the anticipated $200mm in SG&A cuts (though this is a run-rate number that should be achieved by year-end).  They alluded to a weak first quarter on uninspiring releases but expect an uptrend as the strong box-office titles move to DVD during the year.

    The financing terms are out per the 8-K .  Although the nominal L+10% pricing was better than most expected, it includes an 8% fee, which is egregious given that rapid paydowns effectively make the duration of this loan approximately 9 months (one-year final).  The wiseguys that engineered the bankruptcy headline clearly hurt the company and its loan negotiations.  While this is a strong negative from a sentimental point of view, the fee effectively costs the company $20mm, which hurts but is not backbreaking in the context of 300mm+ in EBITDA and bankruptcy fully priced in.

    Wattles' involvement can't hurt, but I'm not hanging any hopes on it.  Pali has gone from bullish to neutral on the name, seemingly on the short leash and cap-ex limitations that accompany the financing deal.  Personally, I'm happy to see the cap-ex held down.  The tidal wave of cash flow is what interests me.


    SubjectInteresting writeup
    Entry03/23/2009 04:02 PM
    Memberedward965

    I was shocked to see such a low rating at what seems to be an interesting risk/reward, not a poorly writen piece of trash.  VIC members tend to love sure deals and not this expected value stuff. I also suppose this company has burned many a folk over the years and so evokes a visceral reaction, and for good reason.

    I like to invest in what I know well, and I use Netflix and Redbox almost exclusively. In my mind Blockbuster stores are overpriced and not fun to be in.

    That said, there is a definite need for a last minute, full service offering and if someone could offer it somehow/someway, I know there would be demand.

     

     

     


    SubjectEdward
    Entry03/23/2009 04:37 PM
    Memberrasputin998

    Appreciate the kind words.  The Bs were actually up 100% within 2 weeks of my writeup and I was tempted to trumpet this on the board and pooh-pooh those that gave me such a poor rating.  Glad I didn't given the subsequent selloff to 12 cents...

    I think you'd be pleasantly surprised at the value proposition that Blockbuster offers relative to Redbox and Netflix.  I'm a Total Access subscriber, and for $20 a month I get 3 movies out at a time by mail and can take the returns to the store to get free rentals.  I like to browse in the store and get immediate satisfaction, so this plan offers the same mail program as Netflix, plus the in-store convenience all for the same monthly price.


    SubjectPat
    Entry03/23/2009 09:17 PM
    Memberrasputin998

    Well I think you got in at the right price.  I agree that the 8% "fee" is a nice piece of hide, especially with the average life of the loan under a year.  It does seem with this deal they'll have no choice but to manage the business for cashflow, and I do think that is what we want here in any case.


    SubjectRasputin
    Entry03/25/2009 10:16 AM
    Memberedward965

     

    Rasputin,

    I reread this and looked at BBI/NFLX work I had done two years ago.  I think this idea would be better served if read also in conjunction with the zeke NFLX writeup - which directly addresses the 800 lb gorilla in the room - why will this company last more than 5 years?   I liked your writeup and bought some because I'm confident that BBI will be around in 10 years, but without that foundation this idea is much harder.

    Without a full rehash, zeke convincingly argued than DVDs aren't going anywhere for a long while.  People will absolutely stick with something that is easy and familiar (eg AOL's current 10 million + subscribers), and many people aren't that tech saavy and downloading high def movies is something that half of Americans won't be doing anytime soon. Mark Cuban made a great case why movie downloads will continue to be a niche product.

    That said, the second part of the idea is that the current CEO can manage a slightly declining business, which is super hard. I enjoyed how you laid out the case. I'm quite familiar with his (Keyes) days at Southland Corp (7-11) and think he's the right guy for the job.  I hadn't looked at this idea since Antioco so I enjoyed the opportunity to revisit it.  Antioco didn't get it at all and hence my previous pass on this idea, but I'm encouraged by all the recent action, including the one a couple of weeks ago to redo Total Access, which I imagine will kick out the unprofitable customers (to avoid so called double dipping by customers).  I'd love to see some analysis on before vs. after profitability in Total Access, because shifting channels from store to mail server has been a disaster to date from a profit standpoint, although perhaps great from now having a good mail order service which can be tweaked to find a good price point for the offering.  

    Also, blockbuster has a quasi monopoly in its niche: stores + mail rental combo. No one is opening a new video store chain, and Wal-Mart and Amazon's failures have proven that mail service DVD is super tough to break into, as again zeke showed.  Only BBI can offer what I'm looking for - the price of mail order but the convenience of a store, and $3 extra for the ability to use the store is okay in my mind. I'd say that is close to a monopoly/strong competitive advantage.

     I don't like Netflix because I like to pick last minute, and I sometimes dislike Redbox because of their movie selection.  I dislike blockbuster stores because of the price, but with Total Access I can get advantages of all.

    The trick will be to manage for cash and not growth, as you say.

     


    SubjectEdward
    Entry03/26/2009 02:54 PM
    Memberrasputin998

    Thanks for the additional comments and insights.  With regard to the difficulty in managing a slightly declining business, I agree that it is a huge challenge and requires constant focus on the cost side.  I would add though that some of the best investments in my career were in declining businesses that were levered but survivors bought at the right price - Arch Wireless and Metrocall come to mind.


    SubjectFees for VOD
    Entry04/04/2009 10:40 AM
    Memberedward965

    Maybe everyone has seen this, but I heard a lot about this yesterday since slashdot posted an article and all the techies went up in arms. 

    Basically, Time Warner (and AT&T and Comcast) are capping downloads, and making a "pay per GB" beyond that.  Someone said a HD movie would cost $8 to download, but I didn't check their math.

    http://www.businessweek.com/technology/content/mar2009/tc20090331_726397.htm

    I never thought High Def downloads were an issue for BBI to begin with, but maybe helps the sentiment for the stock if high def VOD basically becomes cost prohibitive for the forseeable future.

     

     

     

     


    SubjectNote offering
    Entry09/14/2009 03:55 PM
    Memberrasputin998

    Blockbuster announced a $340mm secured bond deal this morning.  I am hearing that the deal will be well-subscribed and the coupon is in the low to mid teens.  With the final maturity on these notes out to 2014 and an extension on their term loan facility to May 31, 2012, this would appear to eliminate any near-term bankruptcy risk. 

    While I was very disappointed with the lowered EBITDA guidance last quarter, I continue to see a very compelling risk/reward proposition in the B shares here.  The liquidity improvements from the sale of their Irish stores, the reduction in their LOC commitments, and recent studio discussions were apparently convincing enough to get lenders back to the table.  Using the $250k implied value per store from the Irish sale suggests an enterprise value near $1.35bb for the remaining 5,400 stores.  Subtracting $850mm in net debt plus preferred, this suggests an equity value of $500mm, or well in excess of $2 per share (this would also equate to a 4x Free Cash Flow multiple).  Still a good pop from the current 70 cent share price.

    In the 8 months since I wrote this up, this company has been buffeted by more body blows than I imagined - from false bankruptcy rumors during a critical debt negotiation to immense competition from Redbox kiosk proliferation and a huge Netflix marketing spend while BBI had no ad dollars to fight back.  Revenues and EBITDA expectations have taken a big hit as a result, but much of that was sacrificed at the altar of an immediate need for improving cashflow.  I think the cashflow/survivability issue can be put to rest now and the company can spend what is necessary to stabilize its market share.

    I continue to believe that this entity will exist in some form well beyond the 5 years predicted by many on this board and that economic value added will accrue very rapidly relative to the current equity capitalization as measured by the B shares.


    SubjectRE: Note offering
    Entry09/14/2009 06:26 PM
    Memberpat110

    Do you know how they plan to apply the proceeds.  Which debt are they going to redeem?  Thanks.

     

     


    SubjectPat
    Entry09/14/2009 09:22 PM
    Memberrasputin998

    According to the 8k, they will pay down the revolver and the Canadian ABL.  They will also allow the Term Loan B holders to swap into the notes or into a new term loan that matures on May 31, 2012.  Any additional proceeds will be used for general corporate purposes. 

    At the end of June, $250mm was drawn on the revolver,  $21.5mm was drawn on the Canadian ABL and $300mm was owed on Term Loan B, $34.6mm of which would amortize over the next 12 months.  They also had $220mm of cash on the balance sheet, all but $25mm of which is now unrestricted thanks to the recent amendment to the Viacom lease LOC requirements.  Finally, we should see about $45mm come in by year-end for the Irish asset sale.  I'm not sure if a successful offering means that they will discontinue the international asset sale process but my sense from my last conversation with management is that they will continue to sell noncore (i.e., ex Canada and Mexico) international assets.


    Subjectthrowing in the towel
    Entry01/25/2010 11:41 AM
    Memberrasputin998

    I recommend taking what's left of your money and running on this one.  I was wrong.  Bad biz, management in denial, and now an insurmountable capital structure seem to make bankruptcy inevitable (though possibly still over 12 months in the future) with likely no recovery for equity. 

    The only positive thing to say here is that the recommended entry price was low enough that losses were manageable (32 cents currently vs. 47 cent entry point), particularly in relation to the undeniable business implosion we've witnessed.  Sorry for the punk idea. 

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