Novice Investing - Blockbuster Goes Bust?

Date: Thursday 20th 2008f November 2008 04:00:30 PM

Blockbuster Goes Bust? - 09/20/2005

By: Hari Wibowo

Most of you probably are familiar with Blockbuster's blue and yellow sign. It has 9100 stores nationwide and engages in DVD and video games rental. Revenue for 2004 totaled $ 6.05 Billion. Its market cap? On Friday 09/16/05, Blockbuster (BBI) was valued at $ 840 Million. Meanwhile, Netflix Inc. (NFLX) has risen to be a viable competitor to Blockbuster. It is currently valued at $1.2 Billion with 2004 revenue of $ 506 Million.

What seems to be the problem here? 3 months ago, Blockbuster share was traded at $ 10. Recently, you can buy BBI at less than $ 5 a share. Has Netflix become such a formidable nemesis? At the end of 2004, Netflix has amassed 2.6 Million online subscribers. Meanwhile, Blockbuster online, which was launched in the summer of 2004 trails with 1 Million online subscribers.

One glance at their income statement tells a lot. Blockbuster spent half of its revenue on selling general administrative (SG & A) expense. SG&A includes everything from store employees, maintenance crews to your stationary supply. Meanwhile, Netflix with its smaller operation, spent less than 40% of revenue for SG&A expense. It might be due to the fact that Netflix has no brick and mortar presence. Still, does that warrant the sell off in Blockbuster's share price? I believe so.

Looking at the balance sheet of each, Blockbuster has $ 139 M in cash and $ 1.20 Billion in long term debt. The real cost of acquiring Blockbuster is ($840 M - $ 139 M + $ 1200 M)= $ 1.901 Billion to a potential acquirer. Meanwhile, Netflix has $ 171 M of cash with no long term debt. The real cost of acquiring Netflix is ($ 1200 M - $ 171 M + $ 0 )= $ 1.02 Billion.

For fiscal year 2005, Blockbuster (price tag $ 1.90 Billion) is expected to lose $ 60.7 M, while Netflix (price tag $ 1.02 Billion ) is expected to earn $ 16.7 M. Armed with this information, it is no surprise the market has punished Blockbuster's share price to around $ 5 per share. When a highly leveraged company struggled to produce profit, the market will punish it hard due to the higher risk of default.

Another troublesome fact from Blockbuster is its $ 1.14 Billion in goodwill. Goodwill is the value assigned to a business above the value of its physical asset. In general, the higher the return generated from an asset, the higher its goodwill value is. In Blockbuster's case, it is expected to return a loss and therefore the value of goodwill might be worth less than is reported.

Blockbuster (BBI) at $ 5 per share seems compelling. But, high debt level, uncertain profitability and Netflix's superior business model, makes Blockbuster (BBI) such a highly risky investment. Blockbuster online rental has a potential of turning things around. It reaches the 1 million mark relatively quickly. Therefore, investors interested in BBI need to watch on this before deciding to invest into BBI. I really think Blockbuster online is the one thing that can turn things around. Opening more brick and mortar stores won't.

END

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding Blockbuster Inc. (BBI) or other securities.

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