It’s Christmas for Netflix (NFLX). Why? Because Reed Hastings & Co. get to wake up to news that the already vanquished Blockbuster (BBI) is making a ludicrous bid for equally troubled electronics retailer Circuit City (CC).
The conceit of the deal is that Circuit City Blockbuster will become THE destination for digital media tools and content. If not for the existence of Netflix, VOD, iTunes (AAPL), Best Buy (BBI), Amazon (AMZN), and many other companies, this might–might–make sense conceptually. In the real world, however, it’s a horrible idea. Why?
- Tie two bricks together and they still don’t float
- Blockbuster can’t afford Circuit City, which means it has to do a dreaded “rights offering” (equity) and raise even more debt.
- We’re headed into a recession, which means the operating performance for both companies will deteriorate, amplifying the weight of the debt load
- In the years it will take to integrate these companies, more nimble and focused competitors like Best Buy and Netflix will race that much farther ahead.
- Blockbuster will now be so distracted that the transition to electronic delivery, already challenging, will now be its last concern.
So why should Netflix be cheering? Because this deal confirms that Blockbuster is desperate (not news) and confirms that Blockbuster will be even more distracted as a competitor over the next year or two.
Analyst Doug Anmuth of Lehman largely agrees:
# The proposed acquisition is seemingly intended to further Blockbuster’s efforts to become a convenient source for media entertainment, but we believe the implications for Netflix are mixed.
# Successful combination of Blockbuster and Circuit City would immediately provide Blockbuster with a larger retail footprint throughout the U.S. and a broader customer base to which it could market its rental/download options in-store. As a result, the combination could potentially delay the number of net physical store closings by Blockbuster over time.
# However, the extensive use of both financial and management resources by Blockbuster throughout this process could be positive for Netflix as Netflix continues to focus on growing its subscriber base, building its Watch Instantly content, and driving digital distribution to the TV with hardware OEMs.
# The acquisition of a major retail chain also highlights the growing divergence between the strategies of Blockbuster and Netflix. While both are aiming to be preferred destinations for media content, Netflix remains largely a by-mail DVD delivery service that is making the slow but ultimately critical transition toward digital delivery. The potential BBI-Circuit City deal emphasises Blockbuster’s focus on traditional retail and could move Blockbuster further away from the DVD-by-mail business.
# Blockbuster noted that it expects 1Q08 EBITDA of approximately $110 million, considerably higher than the consensus estimate of $89 million. While it is already clear that Netflix had a strong 1Q based on its mid-quarter guidance increase, we believe Blockbuster’s better than expected bottom line provides further confirmation that Blockbuster is focused on profitability more than DVD-by-mail growth at any cost.
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