If Viacom (NYSE:VIAB) is all set to spin off Blockbuster (NYSE:BBI) because of poor growth and profit prospects, should investors even be interested?
Blockbuster has warned that video rental income will be weak in 2004. As was the case with Hollywood Entertainment (NASDAQ:HLYW), overall revenue is up, but it is movie and game sales and not rentals that are driving growth. DVD rentals, representing 45% of Blockbuster's fourth-quarter sales, face stiff competition.
Netflix (NASDAQ:NFLX), for one, is growing like a weed in the mail-order rental business. At the same time, studios such as Disney (NYSE:DIS) are lowering DVD retail prices, encouraging consumers to buy instead of rent.
Retailers such as Best Buy (NYSE:BBY), meanwhile, are heavily discounting major DVD releases to drive consumers to their stores. Finally, there is everybody's favorite giant Wal-Mart (NYSE:WMT), offering snail-mail rentals and cutthroat prices.
All this is reflected in Blockbuster's fourth-quarter results announced today. Same-store sales fell 6.8% and rental income fell 1% -- even with 348 more stores in business. The good news for shareholders is that cost-cutting and pricing changes boosted gross profit margins in all product categories and allowed the company -- which generated $402.7 million in free cash flow -- to reduce debt by $321 million in 2003.
Still, the challenges facing -- and the mixed signals coming out of -- Blockbuster have not gone unnoticed. The stock sells at a below-market multiple of 12 times earnings. Granted, Hollywood Entertainment sells for nine times earnings. But with $371.2 million in debt and paltry free cash flow, it pales in comparison to Blockbuster, which rings more than four times the sales.
But, just as in Charles Dickens's Oliver, a villainous Fagin is on the heels of our soon-to-be-orphaned company. According to CEO John Antioco, "The Blockbuster board would consider issuing a special dividend, subject to financing, to all shareholders including Viacom."
Clearly, Viacom, with its $10 billion in debt, is looking to cash out. Blockbuster may be looking to borrow on its future as it heads out into the world. It is the debt that could result, and the unknown magnitude of it, that makes it impossible to know whether Blockbuster will be hobbled going forward.
Such are the uncertainties keeping a lid on the stock today. Even at 30% below its 52-week high, it should be of little interest to investors until details of the special dividend are known.
W.D Crotty owns stock in Disney. You can email him or discuss the future of Blockbuster and Viacom with other investors by visiting the Motley Fool discussion boards. For a 30-day free trial to the discussion boards, click here.
