Blockbuster's Busted Plan

Kristin Graham
  NOV 16, 2009 8:25 AM

Investors willing to gamble on company's turnaround are taking a huge risk.


I’ve seen my fair share of CEOs lose sight of where their businesses are headed during restructuring periods, but Blockbuster’s (BBI) Jim Keyes is a lost soul.

The 7-11 guru brought in to revive Blockbuster’s retro business model was practically crying out in desperation for shareholders to be patient with his turnaround efforts during the third-quarter conference call last week.

Browsing through the conference call, Keye’s went through what seemed like an endless list of partnerships and new initiatives. Given his expertise on consumer convenience in the retail industry, Keyes has built a vision to become the “come and get it anyway you want it” movie and game rental outlet. While creativity and innovation are the key ingredients to reviving a floundering business model, Keyes and his team aren’t developing the right areas of the business.

Of course, you don’t need me to tell you that. The first line of the income statements says it all. Revenue for the third quarter dropped 21% and comparable sales fell 14%. From there, things get worse. An operating loss of $3.5 million was recorded and mounting interest expenses weighed down the bottom line resulting in a $116.8 million loss, compared to a $20.6 million loss last year.

The results were atrocious. Furthermore, they make it even harder to believe that management successfully raised $675 million from bond investors back in September.

Even in survival mode -- which Keyes admitted to being in during the quarter -- Blockbuster burned through $58.9 million of free cash flow. Thus, it’s difficult to understand how the company plans to invest in its new ideas given that it can’t even fund daily operations with internal cash flow. Throw in the addition interest expense from the newly raised debt -- all together there's a staggering $962 million of debt on the balance sheet -- and that $675 million will be dried up in no time.

What bothered me the most from the quarterly report was Keye’s continued justification of Blockbuster’s physical store base. While it's closing a substantial number of outlets, he still believes that Blockbuster’s key advantage over rivals Netflix (NFLX), Apple (AAPL), Amazon (AMZN) and Redbox (CSTR) are its stores.

I’m shocked that such a reputable and successful CEO doesn’t see just how dead Blockbuster’s store-based business model is. In today’s age, it’s all about digital delivery -- precisely where Blockbuster lacks. Keyes knows Blockbuster needs to adapt, but he’s changing the company in the wrong areas.

Rather than wasting capital on redecorating and recreating store experience (customers have already established Best Buy (BBY) as their go-to spot for newly released games, consoles, and other electronic systems), Blockbuster should be figuring out a way to lap its competitors in a technological manner. If Blockbuster wants to provide a “get it anyway you want it," it’s going to have to be in a digital form.

When consumers began moving toward the mail and digital delivery methods a few years ago, Blockbuster lost its brand identity. The company fell too far behind and is now frantically trying to catch up to date to avoid going under.

Keyes has limited capital to play with in this process and there's no room for error. Even if Blockbuster were on the right track to investing in potentially lucrative ideas, it would be difficult to turn around the brand given the liquidity situation. Unfortunately, I think he’s taking Blockbuster in the wrong direction.

Investors willing to gamble on this very unlikely turnaround are taking a huge risk on this penny stock. Personally, I’d rather put $0.78 towards a Redbox flick.
Position in AAPL.