Block to the future

Tech threat won't mar giant vid chain's IPO

NEW YORK — As Viacom prepares to spin off its Blockbuster video rental chain, it’s pushing the IPO of a strong company with a big brand, a robust balance sheet and booming market share. And investors are reaching for their wallets.

To Viacom’s undoubted relief, many have opted to ignore the big storm cloud called video on demand (VOD) — a nascent business that threatens the neighborhood video store by making it a snap for people to order movies at home.

If shares of Blockbuster are hot sellers, there’s a message from Wall Street. Investors don’t give a hoot about potentially crippling competition if it’s still years away. But just in case, Viacom priced the offering so modestly that many on the Street were surprised.

Nice price

“I think the deal will be priced very attractively versus the quality of its management and its growth potential,” said fund manager Larry Haverty. “The technology threat is probably farther off than may appear at first light and is less powerful given the enormous cash flow” from Blockbuster into Hollywood, he added.

“Blockbuster is a category-killer business that has penetrated into communities. The platform has a lot of value, and it’s going to be a terrific deal,” says Marc Gabelli, another believer, who oversees Gabelli & Co.’s media and entertainment portfolio.

Others are less sanguine.

Tom Wolzein of Sanford C. Bernstein & Co. sees stiff competition from VOD hitting in four to seven years. “No investor should plan on a long-term association with Blockbuster stock until the speed and extent of cable digital success are understood,” he cautions.

Earnings climb

At the same time, however, he predicts Blockbuster’s earnings will soar to $146 million in 2002 from an estimated $31 million this year as revenues increase 37% to $6.3 billion.

Viacom’s sale of about 18% of Blockbuster, or 28.4 million shares, will be priced early this week and the new stock will begin trading soon after. The estimated price of $16-$18 per share means proceeds of up to $450 million and values the whole company at $4.4 billion-$4.8 billion. Wolzein predicts that the stock could rise into the low 20s over the next 12 months.

Viacom chairman Sumner Redstone paid about $5.6 billion for Blockbuster in 1994. After Blockbuster performed poorly, Redstone was pummeled in the press and on Wall Street. He restructured and hired John Antioco away from Taco Bell in 1997 to be CEO. His coup, however, was the revenue-sharing deals with major Hollywood studios that rescued Blockbuster and made an IPO thinkable.

Blockbuster has three- to five-year agreements with all the major studios, and at least one studio has discussed a 10-year deal.

Studios profit

No wonder. With revenue-sharing, the major studios realize an estimated $4 billion in cash flow from the homevideo market, or 30% more than they make from U.S. theatrical releases, according to PaineWebber analyst Chris Dixon.

“Unless VOD can demonstrate that the new platform can generate comparable cash flows” for the studios, they have little incentive to jump ship, he said.

Warner Bros. represents a possible wrinkle, Wolzein noted. That studio’s parent, Time Warner, owns a vast cable operation with 12 million subscribers. An alignment of the studio and cable business could favor a faster rollout of VOD on Time Warner systems.

As revenue sharing inflates its sales and profits, Blockbuster execs have been playing up the company’s considerable opportunities for expansion within a highly fragmented industry that includes mom-and-pop stores that go bust every day.

Market share rising

“It’s really a consolidation story,” said one investor who attended a management presentation last week at the tail end of the company’s road show. Blockbuster’s goal, he and others were told, is to move quickly to gain a whopping 50% market share in the next three years — with every 1% increase adding $60 million to the bottom line.

Consolidation will let Blockbuster grow even if its industry doesn’t. That Blockbuster management will eventually wind up owning about 7% of the company after it goes public seems to bolster investor faith in aggressive expansion. In addition, DVD, which is offered in only about 900 of Blockbuster’s 6,600 stores, could provide a major revenue stream once it rolls out more widely.

With all its pluses, Redstone and Viacom execs are unloading Blockbuster because it’s basically a retail company and they don’t think it’s properly valued inside a big entertainment conglomerate. Viacom clearly hopes a successful IPO and happy investors will make it easy to sell the rest of Blockbuster sometime next year.

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