Movie Gallery Says It’s Amenable to Merger with Blockbuster

While there’s no indication talks have taken place between the chains, combining the 2 rental giants “makes a lot of sense,” Johnson said. A Blockbuster spokesman declined comment. Blockbuster has struggled financially and was sharply criticized last year by billionaire investor Carl Icahn for a “fumbling” attempt to buy Hollywood (CED May 13 p3). Icahn was later elected to Blockbuster’s board along with his nominees Strauss Zelnick and Edward Bleier.

Movie Gallery emerged as major rival to Blockbuster following its $1.2 billion acquisition of Hollywood Video last year that created a chain with 4,773 stores as of April 2. While Blockbuster has focused on internal growth, Movie Gallery has been aggressive in buying up rival chains, including 300 stores from Video Update out of bankruptcy protection in 2001. While a Movie Gallery-Blockbuster merger might have raised antitrust issues in the past, increased competition from discount and CE chains along with the availability of video online has expanded the field, Movie Gallery officials said. Of a merger with Blockbuster, Johnson, responding to a question from an investor, said Movie Gallery “would be very receptive to something of that magnitude. “We're going to do what makes the most sense for shareholders to create value.”

The possibility of a merger was raised as Movie Gallery continues to digest its purchase of Hollywood and seeks to pare back investments in non-core businesses, company officials said. It opened 70 stores during the first quarter and closed 46. Movie Gallery has said it’s weighing an IPO as one of several options for disposing of its Game Crazy videogames format, which occupied sections of 648 Hollywood stores as of Jan. 1 (CED March 28 p7). Hollywood has said a Game Crazy IPO isn’t likely to occur before 2007 (CED March 24 p6). Movie Gallery also is considering spinning off or finding partners for a vending machine kiosk business that has 30 locations and will add 50 more this year, Johnson said. Also being shopped is a video-on-demand business (CED Aug 5/04 p4) that Movie Gallery began developing through acquisitions in 2003-2004, but never launched. Movie Gallery forecast the purchase of Hollywood would generate $50 million in savings by year-end. About $20 million in savings was recorded in 2005, with the remainder being registered this year, Johnson said.

As it seeks to dispose of non-core businesses, the chain is continuing with plans to sublease 1,200-2,600-sq.-ft. of 2,200 Movie Gallery and Hollywood stores. It hired Excess Space Retail Services (CED March 17 p6) to help in subleasing and so far has signed 22 agreements and secured letters-of- intent for 399 stores from 294 individuals, company officials said. About 250 national retail chains have sent letters-of- interest for multiple locations, company officials said. Hilco Real Estate also has begun trying to renegotiate leases for more than 1,100 locations not involved in the sublease program (CED April 20 p7), Johnson said. The renegotiations, which could involve reducing the length of the lease or monthly payments, aren’t expect to start having an impact on earnings until 2007, Johnson said.

Movie Gallery also is coming under pressure from shareholders to boost its stock value. George Schultze and his Schultze Master Fund, which own 2.7 million shares (8.6%) and Movie Gallery’s 11% senior notes due 2012, said in a filing in late April that the chain will be asked to take “shareholder value-enhancing steps.” Movie Gallery is “always very receptive to any suggestions our bondholders would have,” Johnson said. Movie Gallery made a $17 million bond payment on May 1, company officials said.

Meanwhile, Movie Gallery reported first-quarter net income improved to $40.3 million, from $18.3 million a year ago, as revenue soared to $694.3 million from $233.7 million with the addition of Hollywood stores. Same-store sales declined 6.7% amid a “soft home video release schedule,” Movie Gallery CEO Joseph Malugen said. Movie Gallery and Hollywood same-store sales declined 3.7% and 7.7%, respectively. Same-store rental revenue fell 7.7% overall at Movie Gallery (5.6%) and Hollywood (8.8%). Same-store sales products jumped 18.2% at Movie Gallery, but were down 3.9% at Hollywood. The sharp increase in product sales at Movie Gallery was due to the chain carrying a broader assortment of CE gear, company officials said. Rental margins increased to 69.6% from 69.4%, while those from product sales dipped to 24.3% from 28.5%. Rental accounted for 82.2% of Movie Gallery’s first-quarter revenue, down from 92.7% a year earlier, while those from products increased to 17.8% from 7.3%.