Monday May 12, 01:27 PM
Circuit City Gives Up the Fight
By
Pallavi Gogoi
Circuit City is finally throwing in the towel. Confronted with weak sales, impatient shareholders, and a U.S. consumer pummeled by recession, the electronics chain capitulated on May 9 and retained Goldman Sachs (NYSE: GS
- news) to help negotiate a deal. The same day, Circuit City Stores (CC) agreed to allow three board nominees from activist shareholder Mark Wattles to stand for elections [BusinessWeek.com, 4/8/08].
The moves almost certainly presage a sale of the chain, likely to Blockbuster (BBI (LSE: BBI.L - news) ), where Carl Icahn has stepped up and agreed to finance [BusinessWeek.com, 5/9/08] a Circuit City acquisition. The billionaire -- Blockbuster's largest shareholder -- has bought into a "game-changing" scheme announced last month in which the troubled electronics retailer would be combined with the troubled movie retailer to create a new national chain selling consumer hardware and software.
Wall Street is dubious, and no other buyers have emerged wanting Circuit City. "[There's] a lack of potential bidders beyond Blockbuster," says Matthew Fassler, an electronics retail analyst at Goldman Sachs (GS). There are numerous reasons buyers beyond Icahn are not lining up. Circuit City is in an extremely competitive business with heavy pressure from Wal-Mart Stores (WMT). At the same time, Circuit City comes saddled with 682 locations, many of which are in poor and underperforming areas, a fact that CEO Philip Schoonover often refers to when discussing his company's poor performance.
Outlook as Gloomy as Consumers'
"While the Circuit City board has confidence in the company's ability to successfully implement its turnaround plan and generate shareholder value, we believe that we can best serve the interests of our shareholders by exploring all possible alternatives to enhance shareholder value," Schoonover said in a May 9 statement. Wattles Capital Management has also supported the idea of Circuit City being sold.
A far bigger problem for Circuit City? Its moribund prospects are likely to turn even gloomier, with U.S. consumer spending in the doldrums and unlikely to recover in the near term. In March, the Commerce Dept. reported that spending grew just 0.1% and much of that was for necessities such as medical care and haircuts, not the electronics gear found at Circuit City and rivals.
Indeed, the competitive pressures are currently so high that even the leader in the business, Best Buy (BBY), is looking to diversify overseas with a $2.1 billion investment in Europe's largest cell-phone retailer, Carphone Warehouse Group (CPW.L) of London. With a market capitalization of $855 million, Circuit City is effectively valued by the market [BusinessWeek.com, 4/8/08] at less than half of Best Buy's investment in Carphone Warehouse (LSE: CPW.L - news) .
Skepticism About the Combo
Richmond [Va.]-based Circuit City is reeling from five consecutive quarters of declining sales at stores that have been open for a year or more, after increased competition from discount retailer Wal-Mart and warehouse club Costco Wholesale (NASDAQ: COST - news) (COST). Last year, several electronics stores were decimated [BusinessWeek.com, 4/23/07], CompUSA shuttered all its stores before being bought by a restructuring firm in December, and Tweeter Home Entertainment, Harvey Electronics (HRVE - news) , and Rex Stores all filed for bankruptcy. "This is the kind of mess the electronics business is in -- it's like buying a sinking Titanic," says Howard Davidowitz, chairman of Davidowitz & Associates, a national retail consulting and investment banking firm in New York.
But investors don't necessarily view the Blockbuster-Circuit City combination as a winning one either. That's because Blockbuster has its own litany of troubles. Blockbuster has been forced to reckon with a shift from on-site movie rentals to new venues, with increased competition from video rental models like the one from Netflix (NFLX) and downloads from Apple (AAPL). "The question is will the combination of two crippled companies end up crippling both even further," says Burt Flickinger III, managing director of Strategic Resource Group, a retail consultancy in New York.
The one hope, Flickinger says, is Blockbuster CEO Jim Keyes, who came on board in July with Icahn's backing and replaced John Antioco. Keyes, who had engineered a turnaround at 7-Eleven, has started re-investing in Blockbuster's 7,800 brick-and-mortar stores and pulled back from the online DVD rental market that Antioco had invested in heavily. Keyes also has recently shifted to selling DVDs and video games at Blockbuster stores. He bought Movielink.com last year with plans to make movie downloading to televisions available. Under his leadership, Dallas-based Blockbuster posted a narrower-than-expected loss of $85 million for the year ended Jan. 6, 2007, and expects to return to profitability in 2008.
The Keyes to Success
Almost all of Wall Street, and many in the tech community, are puzzled by Keyes' pursuit of Circuit City. Keyes envisions a new digital retail company that leverages complementary products and higher-quality, better-focused store sites.
"Combined, our companies would create a game-changing $18 billion global retail enterprise that is uniquely positioned to capitalize on the growing consumer appetite for content-enabled consumer devices," Keyes said in an Apr. 14 conference call with analysts. He said that in the short term the companies would trim costs by combining operations and by likely selling the weakest-performing stores. At the same time, Keyes expects that the new, larger company would be able to bolster its buying muscle with vendors and strike better prices.
He also anticipates cross-merchandising opportunities, and the opportunity to sell electronics with access to personalized preloaded movies and digital subscriptions. "That is what I mean when I say game-changing entertainment retail concept," Keyes said. Yet Wall Street smells the potential for a very expensive flop. Blockbuster's shares finished the week at 2.66, 14% above their 52-week lows. Since Blockbuster first made its takeover bid public Apr. 14, its shares have fallen 5.3%.
Circuit City's stock, meanwhile, surged more than 10% on May 9 on the news of Icahn's interest, finishing 5.9% higher. Clearly, some investors see a brighter future for Circuit City as an acquisition target than merely a struggling solo player. Still, not everyone is convinced -- the stock price remains lower than the $6 a share Blockbuster is offering. One reason that even seemingly good news for Circuit City shareholders comes with a caveat these days.
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