Invest Intelligence When It Realy Matters

Blockbuster Then and Now: Lessons for Traders and Investors

It’s extraordinarily rare to find a book that provides specific securities analysis, enabling investors to profit based upon the recommendations. One of the reasons this is such a rare event is because there are so many variables that can change between the time the analysis has been made and when the book reaches readers. As a result, authors do not even attempt such an analysis. Of course another reason is due to the fact that most authors of investment books lack the practical experience needed to translate theory into reality.

Those who happened to read my 2006 book America’s Financial Apocalypse know well that I predicted virtually everything we see today, including a depression, a New Deal, the collapse of Fannie Mae and Freddie Mac, followed by a taxpayer bailout, the collapse of the commodities market, a major correction in the Chinese market and much more. It remains as the authoritative book on America’s economic collapse and is certain to remain valuable for many years to come.
Furthermore, since that time I have made every single major market call up and down, most having been published in the public domain. You can review just a few of these predictions here.
In addition, those who read Cashing in on the Real Estate Bubble (2006) will recall I specifically advised readers to consider shorting Fannie Mae, Freddie Mac, Accredited Lenders, Fremont General, Novistar Financial, the banks and homebuilders. I even provided a short selling tutorial and showed on each price chart when a short position should be considered. As you can imagine, those who followed these recommendations made up to 100%.
Now, I want to illustrate another example how you could have made a good deal of money from just one of the many case studies in my most recent book, The Wall Street Investment Bible. The following is a reprint from a section in this book, released in January 2009. 
“Blockbuster Inc. is a global provider of in-home rental, retail movie and game entertainment content. At its peak it had over 9000 stores in the United States and 27 countries. The first Blockbuster store opened in 1985 and seized the growing popularity of high cost “blockbuster” films that began during that period. Due to its strategy of piggybacking onto grocery chains’ customer base combined with very limited competition, Blockbuster grew rapidly to become a successful and well-known brand.
In 1994, Blockbuster was bought by Viacom. Perhaps Viacom had ideas of eventually using the Blockbuster’s brand recognition for delivering on-demand digital media. By February 2004, Viacom Inc. announced it would divest its 81.5 percent equity interest in the Blockbuster. This announcement occurred at a critical time for Blockbuster due to the intense competition from venders offering online subscription services (Netflix).
Blockbuster certainly experienced a combination of success and luck in seizing the market for movie and game rentals. Management was wise to invest in excellent real estate locations. Just when Blockbuster was starting to take off the DVD was launched (around 1994). This new technology helped boost the movie rental market to new heights due to the cinema-like quality now available at your local video store. While several other companies explored the idea of adding movie rentals (grocery chains), they were unable to execute and unwilling to commit to this venture.
Rather than becoming a retail distributor of DVD rentals, Blockbuster should have formed exclusive licensing agreements with movie studios, whether through direct ownership investment in these companies or in individual movie projects.Viacom could have assisted Blockbuster with an undertaking of this magnitude. Without such agreements, everyone was free to open movie rental business. Accordingly, Netflix and Wal-Mart realized the huge market opportunity and lack of competitive barriers and used the power of the Internet to gain market share. 
Blockbuster responded with its own subscription-based services, both online and in-house. In the short-term it would struggle to deliver strong to the shareholders while transitioning into this new revenue model. In addition to intense competition from Netflix, Blockbuster has struggled to replace revenues from late fees. Because of its subscription-based services, it’s losing up to $300 million per year from the absence of late fees. Shifting revenue models and forcing a price war is never a solution. As I wrote in my 2004 newsletter, ‘management must look beyond the current issue and structure a digital delivery business to customers.’  
In early October 2004 after the stock crashed, I felt management would hear the wake up call and restructure itself as an online provider of on-demand movies for viewing and purchase, games, music, and maybe much more. It would need to gradually phase out a large number of stores over the next decade, as its Internet and digital delivery strategies gained acceptance. This would cut costs and allow them to pay the $2 billion debt they had amassed. 
In order to execute this long-term strategy, Blockbuster would need to form alliances with Internet providers and cable companies. In this process, I advised a shutdown of several stores to be phased in gradually. I released a report in late 2004 which summarized proposed changes (figure 11-1).
If management took this route, I felt the company could come back stronger than ever, and eventually force Wal-Mart and Netflix out of the business. By January 2005, I realized the management was lost. This was unfortunate since execution of a digital strategy could be fueled by their strong brick-and-mortar presence. And this familiarity would be an easy transition for the customer, as well as the added convenience of store visits.
                                                                    Figure 11-1. Proposed Future Strategic Direction for Blockbuster

Those who seized the buying opportunity highlighted in my newsletter ($7 on October 19, 2004) did quite nicely over the 3-month holding period, recording returns in excess of 35 percent.
At the time of the new position, I placed a 6-month price target of $11 and a 1-year target of $14, based upon relative valuation and the assumption of a restructuring as described. The critical step that made me realize the management was lost occurred when management engaged in a bidding war with Movie Gallery for Hollywood Video, their closest brick-and-mortar competitor.
With bids as high as nearly $1.5 billion combined with intentions of shutting down much of those stores, it became apparent to me management was confused and nervous; often the two go together. One cannot engage in a price war with one competitor and attempt to acquire another competitor for a price that matched their own market cap, especially when they had a large debt-to-equity ratio.
It was clear to me that Blockbuster’s strategy was to force competition out of the market and regain price control. However, they were trying to do the impossible; resist the commoditization of their services. Blockbuster has since closed over 1200 stores as this book was about to be released and I expect many more closings over the next few years.
While the company went into the red in 2004, the CEO and Chairman, Joe Antioco received a 5-fold increase in salary. Meanwhile, he proved again and again he was unfit to lead the company into the next phase of progression. It should be easy to understand how a CEO can get a 500 percent increase in compensation after a terrible year if he is also the Chairman of the Board.
Figure 11-2. Price Chart for Blockbuster

Once I determined management was not going to move in the appropriate direction in a timely manner, I dumped the stock and have been bearish ever since. Fortunately, I made a nice trade and got out when Blockbuster demonstrated its strategic confusion. I did not feel Blockbuster could continue over the longer term if Antioco remained as CEO.
Since that period, Antioco has been replaced by a new CEO, but it may have been too late. Blockbuster is learning the hard way after suffering from a long period of terrible management and strategic confusion.
Antioco was more focused on increasing his compensation during a period of massive losses. In what could be their last stand, Blockbuster is now looking for a real business to merge with because they waited too long to respond to industry change.
It’s easy to see Blockbuster’s loss has been Netflix’s gain. With much better management, Netflix has been able to steal away market share with no debt. And they’ve been ahead of the curve when it comes to what will be a transition to on-demand videos. This is a classic case of a long-short investment position.
This analysis was written in August 2008. So now, let’s have a look at what’s happened since then. 
As you can see from the chart above, the long-short strategy has paid off big, as my strategic analysis and managerial assessment for Blockbuster and Netflix have remained firmly in tact. 
Yesterday, Blockbuster announced it will close nearly 1000 additional locations. The only thing that surprises me about this is WHY MANAGEMENT WAITED SO LONG. 
Blockbuster had a chance to leverage its once strong brand name, but management remained in “strategic limbo” while clinging onto struggling stores. The time for a digital strategy has come and passed for Blockbuster.
As its last chance to stay afloat, management is trying to cut costs by closing stores. You can bet there will be more store closings before it’s all over. Short of a miracle, Blockbuster is unlikely to recover, as the window of opportunity has passed. Much of the company’s fate will depend upon management’s ability to renegotiate debt covenants and secure favorable refinancing arrangements with creditors.
If a miracle isn’t in the cards, Blockbuster might still be able to secure favorable terms with creditors. However, shareholders should not expect this to bode well for them, as the deal is likely to be shuttled to a private equity firm. If this happens, shareholders will be lucky to break even on the take out price. The buyer could even could cause substantial dilution by a variety of methods. Alternatively, common stock dilution could also occur through the issuance of warrants or convertible bonds as a condition of favorable financing terms. 
There are many possible fates for Blockbuster, but I do not see positive outcomes for common stock shareholders. If in fact something does happen that sends the stock soaring, I would advise shareholders to use that as an opportunity to exit. 
One of the learning points to take from this analysis is that investors need to understand everything that determines a company’s market position, weighing it with competitors. 
Another learning point is that you can profit from fundamentally unsound companies in the short-term, as long as you understand relative valuation, qualitative analysis and technical analysis, as every stock is a potential buy at the right price.
Most important, you need to know when to get in and when to get out. But if you are not able to reach a relatively high certainty for your entry and exit positions, your best move as a trader is to stay away from fundamentally unsound companies. At minimum, in order to have the slightest chance with this approach, you must follow the company very closely so you can gauge investor sentiment relative to material changes. 
This is just one example of the investment insight and analysis contained in The Wall Street Investment Bible. 
But understand this. It is a book meant only for the most serious of investors who wish to learn unique insights as they add to their investment management and stock selection methodology.  
You can read the Introduction and view the expanded Table of Contents here.

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