Tuesday, April 15, 2008

A Blockbuster of a Short Circuit

Circuit City 1-Year Chart (credit Bigcharts.com)
Blockbuster 1-year Chart (credit Bigcharts.com)

Blockbuster reported yesterday that it had made a preliminary offer to acquire Circuit City for at least $6/share in cash. Today, Circuit City acknowledged receipt of the offer and also disclosed that Blockbuster had previously made another private offer for Circuit City. From the two charts above, it's pretty clear that both of these companies have been floundering. Circuit City has been constantly rejiggering to try and compete with Best Buy, and Blockbuster has had its lunch eaten by Netflix. What to do? Of course! The failing Blockbuster should buy the failing Circuit City!

According to the Blockbuster press release:
The transaction would allow both companies to benefit from the revenue growth generated by their complementary products, while the resulting synergies would substantially improve consolidated financial performance, thereby increasing shareholder value.

Blockbuster Chairman and Chief Executive Officer Jim Keyes said, "Our proposal offers Circuit City a significant premium to its existing stock price and creates a game-changing retail concept with a sustainable competitive advantage. We believe the combination will result in a compelling consumer proposition that will drive significant revenue and margin enhancements as well as cost synergies."
What? Benefit from the revenue growth generated by their complementary products? I guess all the people who aren't going to Blockbuster will be able to buy all the products that the people who aren't going to Circuit City aren't buying. And vice versa.

Maybe I'm not being open-minded enough. Let's see. The CEO is telling me this will create a game-changing retail concept. Renting videos and selling technology/electronics products at the same location. Of course! I don't want to go to Blockbuster, and I don't want to go to Circuit City, but put them together and.....................wait a sec, I still don't want to go there.

As for Circuit City's response, the following is from today's press release:
Circuit City, Blockbuster and their respective financial advisors have been in a process of exchanging information regarding the proposal, but to date Blockbuster has been unable to satisfy Circuit City and its advisors that Blockbuster's proposal could be financed. In particular, Blockbuster's proposal appears to contemplate a rights offering of unprecedented size relative to the issuing company's market capitalization and at a price that is at a significant premium to Blockbuster's current market price. Circuit City's advisors have noted that most rights offerings, of which there have been very few in the United States, occur at discounts to market.
So, Circuit City is justifiably concerned about how Blockbuster would finance the purchase. Given how far below the offer price Circuit City stock is trading, the market is also skeptical of the deal.

As for how to play this, I see no reason to get involved, especially on the long side. Both companies have so far failed to accurately anticipate or respond to competitive market forces. It's difficult to envision 1 + 1 summing to much more than zero in this case. The only winners, as is often the case, are likely to be the investment banks, consultants, and lawyers.