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Blockbuster still eyeing Circuit City (Updated) - May 14, 2008

Shares of Blockbuster were fairly quiet Wednesday, closing unchanged on the day, as investors await Q1 earnings on Thursday. The shares had been climbing earlier in the wake on reports that Blockbuster's management met with several big shareholders to assure them it would only pursue its proposed acquisition of Circuit City if due diligence shows the deal would be accretive. Blockbuster CEO Jim Keyes is sure to be quizzed on the deal by analysts on the company's conference call scheduled for 10:00am EDT.

For the most part, analysts remain skeptical of the deal, seeing it as a distraction for BBI management just as the chain is getting its operations in order and lacking in strategic synergy. Citigroup analyst Tony Wible threw management a lifeline, however, publishing a note on Tuesday spelling out why the deal could be a hit. His thesis: Circuit City stores would be overhauled to improve the in-store experience (nowhere to go but up) and significantly boost entertainment sales. Overlapping stores would be combined into expanded Circuit City outlets and most non-entertainment SKUs would be eliminated. In their place would come "beverage and video game lounges and kid zones."

Wible thinks the deal could generate incremental EBITDA of $433 million in 2008 and $571 million in 2009.

Blockbuster was dealt another wildcard this week, however, with word that its largest shareholder, Carl Icahn, who has hinted he may try to buy Circuit City himself and force a merger with Blockbuster, may now be in pursuit of Yahoo. CNBC reported Tuesday that Icahn has accumulated nearly 50 million shares of Yahoo since Microsoft withdrew its bid for the pioneering web portal and may seek to run a slate of directors for Yahoo's board in order to force a sale to Microsoft. Whether Icahn's interest in Yahoo would push his interest in a Blockbuster/Circuit City deal, only Icahn knows.

Media Wonk can't say whether an acquisition of Circuit City would be accretive for Blockbuster. But we continue to believe a merger of the chains makes more strategic sense than the deal is generally given credit for.

The distinctions between entertainment products, services and the devices you play them on are only going to blur over time, as is how you'll buy and rent them. If you're going to be in the brick and mortar retail business, there are efficiencies to be had by bringing all three pieces under one roof. It would also put more of Blockbuster's destiny in its own hands: Getting into the electronics and entertainment sell-through business is a surer way out of DVD rental cul de sac than is waiting on the studios to sort out the digital rights tangle sufficiently to allow a retailer like Blockbuster (or Netflix, Amazon or iTunes for that matter) to turn digital distribution into a substantial, high-growth revenue stream.

UPDATE: Blockbuster reported strong first-quarter earnings Thursday on the first increase in same-store sales in five years. Earnings press release is here. 
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