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Circuit City (CC)
Should Circuit City Take Down the For-Sale Sign?
It looks like Circuit City is getting ready to call it quits and throw in the towel. The electronic retailer announced that it is hiring Goldman Sachs to advise it on strategic alternatives (which, as we all know, is just another way of 'we are looking to sell the place'). Blockbuster (BBI: Charts, News, Offers), the video rental chain store, made an unsolicited bid for CC in February but only disclosed it publicly last month after being stonewalled by CC management. Obviously, the offer has been languishing on the table for a while now, but today, CC is taking a fresh look at it after Blockbuster answered one of the big question marks associated with the deal, namely, how is a company with a market cap of only $500 million going to come up with the dough to buy CC for $1 billion especially in a credit market where cheap cash is hard to come by. Well, apparently, the answer to that little question is Carl Icahn. The billionaire activist investor who owns about 10% of Blockbuster has backstopped the CC bid, i.e. he is saying that if Blockbuster can't come up with the money to buy CC and/or if the deal does not get shareholder approval, he will buy CC. This no doubt ratchets up the pressure on the CC board to do a deal as shareholders have been extremely receptive to the idea of selling all along. But should CC take the cash and run?
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From a business operational standpoint, this deal makes very little sense for Circuit City. CC's decline over the last couple of years has been well-documented. The stock hit a high of $30 in June 2006 but since then has been sliding precipitously and currently trades at $5.20. Before the Blockbuster bid was made public, it was trading in the $3-$4 range; the stock has lost about 70% in the last 12 months alone. CC is getting out-strategized and out-executed by Best Buy (BBY: Charts, News, Offers) in the mid-to-high end of the electronics market and by Wal-Mart (WMT: Charts, News, Offers) on the low-end. The brand doesn't stand for anything and fails to resonate in consumer's minds. Management initiatives (e.g. launch of 'The City' store concept) aimed at a turnaround haven't gained any traction. The red ink is getting messy too. CC lost about $320 million on its income statement last fiscal year.
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But Blockbuster is no great business either. Although the Dallas, TX, based company has waged an admirable war with Netflix (NFLX: Charts, News, Offers) after being late in recognizing the challenge posed by the online DVD rental service, there is no denying that Blockbuster's core business of rental stores is heading towards irrelevance as online rentals and streaming of videos becomes more popular and widespread. That is why it is hard to see how a Circuit City-Blockbuster deal makes operational sense. Wall Street analysts have likewise panned the deal since it was announced. And to further their point, if Blockbuster is to be a viable business 10-15 years from now, it will have to be so thanks to a strong online and digital presence, not due to a physical one, which is why buying more stores and real estate in the form of CC doesn't make sense. Yes, there will be operational savings for CC and Blockbuster if the deal goes through in the form of reduced marketing and real estate expenses etc. but those synergies take years to bear fruition (e.g. Citigroup (CC: Charts, News, Offers) is still looking for them 10 years after buying almost every financial business under the sun).
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Having said all this, the chances of a Circuit City to Blockbuster deal happening are very high. Never mind the operational case against it, CC shareholders want to see some cash and the Blockbuster bid which is expected to be in the $6-$8 range will show them a bit of green. If the CC board doesn't talk to Blockbuster, major shareholders in CC will start a proxy fight. The fact that CC shareholders are so eager to sell a stock that was trading in the 20's a year ago for just $8 shows how little confidence they have in management and the board. But shareholders do have other alternatives and if/when some of them start exploring some of these, then some substantial value could be unlocked. One such alternative would be to implore the Board to seek alternative buyers. Selling CC to Blockbuster for $6 is not quite selling the company for free but it's close to it. If the deal was an all-stock offer instead, with CC shareholders getting stock in the combined company, that wouldn't be a great deal either because the chances of the combined company succeeding are low. However, if CC could get a bona-fide strategic buyer such as Best Buy interested and the deal was an all-stock transaction, CC shareholders would be better off in the long-run because Best Buy's stock is likely to appreciate significantly in the long-run (especially since a major competitor will be disappearing). There might be regulatory roadblocks in that scenario though.
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But the point is that are likely other strategic buyers out there who could do a better job of extracting value out of Circuit City in the long run than Blockbuster could. The CC board should be looking for them. Another option for CC shareholders, instead of selling on the cheap to Blockbuster, is to oust the current management which has been inept and bring in new blood with experience in restructuring and turnarounds. Intelligent business moves combined with an improved retail environment 2-3 years down the road could see the CC business and stock in good shape again.
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