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Blockbuster Down, But Not Out, After Filing Chapter 11

September 24, 2010

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Just short of 25 years after the late-October 1985 opening of its first store in Dallas - 25 years filled with vociferous doubt by detractors on Wall Street as to its future - Blockbuster, Inc. filed for protection under Chapter 11 of the US Bankruptcy Code on September 23. As dire as it may seem, the company finds itself post-filing in a much better position than the previous day - thanks to the forbearance of its key creditors, including major studios for whom the US rental business, though still in decline, is again (for the first time since the 1980s) becoming a growing proportion of their own shrinking Hollywood aftermarket revenue.

The company used the long run-up to its formal filing to line up creditor support in the hopes of emerging from court supervision quickly, and not suffer the liquidation fate that befell rival Movie Gallery in the second quarter of 2010 as a result of its second bankruptcy in three years. On the same day Blockbuster filed, its partner NCR issued a press release stating that its licensing deal for NCR's Blockbuster Express-branded kiosks - which number nearly 7,000 - will not be impacted by the bankruptcy as NCR fully owns those kiosks and just licenses the Blockbuster name.

Blockbuster said that its company-owned domestic stores, apart from those being closed as a part of restructuring, and its mail-order rental business will remain open. The bankruptcy excludes domestic stores owned by third-party franchisees and its international operations, including stores in Canada, Denmark, Italy, Mexico and the UK, though it said it would no longer fund the losses of its Argentinean outlet. The company has been selling foreign operations to raise capital.

According to Blockbuster, holders of 80% of its 11.75% senior secured notes have already agreed to its bankruptcy reorganization plan, which points to a rapid proceeding of just a few months. This group is thought to include former lead stockholder Carl Icahn, who bought up company debt in recent months after dumping most of his stock in the company at substantial loss by April. Reports suggest that he will name three members of Blockbuster's board of directors when it exits bankruptcy.

Blockbuster's senior debt holders agreed to provide $125m in capital to fund the company during bankruptcy. This is called debtor-in-possession financing because, as new capital supplied by third-parties, the $125m is not subject to creditor claims in the bankruptcy proceeding. The company's common and preferred stock and $300m in unsecured face-value subordinated notes will be wiped out under the pre-packaged plan . As a result, the company's debt will shrink to around $100m, from nearly $1bn, as its secured creditors become its new stockholders via a swap of their secured debt for equity. Current Blockbuster senior management is expected to stay in place.

Separately, video and online film rights suppliers - and various other trade business creditors - will settle past Blockbuster accounts in the bankruptcy proceeding.

The Netflix by-mail rental service, rental kiosks by Redbox and others, movies via video-on-demand and mushrooming electronic entertainment options have all cut into Blockbuster's core traditional movie rental business in recent years. Consumer spending on traditional rental peaked in 2001 at $8.5bn and had fallen more than 60% to just over $3.3bn by 2009 - and Screen Digest is currently projecting a decline of more than 32% to just $2.2bn in 2010.

With minimal success to date in its efforts at 'multi-channel' movie distribution via by-mail rentals, VOD and other channels, the company has been left with an ever-shrinking slice of the declining physical movie business as its main sustenance. That eventually made it impossible for it to service the debt load with which it had been burdened in paying a dividend to shareholders prior to its spin-off from 80%-owner Viacom.

But, after it exits the bankruptcy process, Blockbuster should be a smaller but stronger bricks-and-mortar renter, given its debt will have been cut dramatically and its unprofitable stores shuttered. It has legitimate hopes for survival because its main bricks-and-mortar rival - Movie Gallery, which owns Hollywood Video stores - is completing a liquidation started in May during what was its second bankruptcy filing in three years. Further, studios want Blockbuster, which accounted for more than half-a-billion of their revenue during 2009, to continue in order to provide competition to by-mail services and rental kiosks.

Various estimates suggest store closures will amount to 20%-25% of the company's 3,000 stores. This is a fluid number because lessors - faced with major store vacancies in an already bad retail space market - might offer to reduce rents or provide other incentives, prompting Blockbuster keep open some stores that it had initially earmarked for shutdown. One benefit of bankruptcy that could affect store closures is that companies have the option to cut multi-year leases to just one year.

A non-contested, pre-packaged bankruptcy typically lasts about three months. However, any Blockbuster creditors who are not satisfied with the company's plan - such as preferred stock and subordinated note-holders that would be wiped out - are free to object to the court, which might drag out proceedings. Their ability to alter the plan is dependent upon how the court interprets the rights of the secured creditors, which currently back the plan, to Blockbuster's remaining assets.

Find Out More > iSuppli | Screen Digest US Video Intelligence Service

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