Sunday, November 19, 2006

BBI Bye Bye

Blockbuster Inc (BBI) $4.75

We are not usually fans of short ideas at StockReply but a clever friend of ours has brought this one to our notice.

BBI is the spin off from Viacom (VIA , VIAB) that, as the world knows, rents out and sells media from its 9,000 stores, principally in the States. It is having its lunch eaten every which way as alternative (and easier and cheaper) ways of viewing entertainment at home proliferate (cable, satellite, internet, telephone). If that weren't enough Netflix has way outclassed and outrun it in the fast growing home postal market.

Much recent comment has focussed on the Netflix rivalry but this really misses the point, which is this: there will be no physical home video rental market in ten years time in all of Blockbuster's principal markets. These are 100% digital media; in other words, this is bit shifting and this will all done via tubes or wirelessly more cheaply and faster and without getting off your couch. No need for Blockbuster (and bad news for Netflix fans too, we think).

But listen to the next bit carefully. The above is not enough to clinch the short thesis. A declining business can make a shrewd investment. What sinks Blockbuster is all the above plus its capital structure. BBI has $700m or so in net debt and capital leases and, deep breath, minus $130m in tangible net worth. Moreover, it has lost money in each of the last three calendar years, 2003-2005. Admittedly, it has produced positive free cash flow this year and has reduced its debt but this has been at the cost of cutting advertising expenditure.

This is a race to the bottom between fleeing customers and shareholders and time will eventually be called by the bankers.

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