Carl Icahn wants Blockbuster and Hollywood Video to merge.
To that end, the billionaire corporate raider on Tuesday acquired about 9.9 million shares of Blockbuster, inserting himself squarely in the midst of one of Hollywood’s liveliest auctions, the sale of Hollywood Video.
Icahn said the purchase — of 5.8% of Class A shares and 5.07% of the Class B — makes him the video giant’s single largest shareholder.
The hostile takeover artist made headlines late last month when he revealed he’d accumulated an 8.4% stake in Hollywood Video. Now he’s upped his stake to 9.5%, making him the single largest shareholder in Blockbuster’s smaller rival as well.
The Icahn news somewhat overshadowed Blockbuster’s announcement earlier in the day of plans to eliminate most late fees, marking a seismic shift for the vid rental biz.
Caving to the competitive realities of a dramatically shifting video landscape, Blockbuster said that beginning with the new year, consumers will get a week’s grace period after the due date on movies and games. After that, they’ll automatically own the rental –and be charged for it.
The radical switch takes direct aim at popular online movie rental service Netflix and cable video-on-demand.
Icahn, in an SEC filing, called Blockbuster shares undervalued given the possibility of a merger.
“We appreciate Mr. Icahn’s vote of confidence in Blockbuster,” said Edward Stead, the company’s general counsel.
Surprising many who considered video rental an all but moribund business, the bidding for Hollywood Video has been intense. No. 3 vidtailer Movie Gallery has made an offer — and so has Hollywood Video chairman-CEO Mark Wattles, backed by Leonard Green Partners. Icahn’s presence is sure to ratchet up the pressure and the media attention.
Icahn, a Queens native with an estimated net worth well over $5 billion, made his name in the ’80s, pushing TWA and Texaco into bankruptcy. He made $800 million selling RJR Nabisco in 2000. Most recently, he’s amassed a stake in Mylan Laboratories and is seeking to buy that group to block its proposed purchase of another pharmaceutical company.
As for Blockbuster’s business, the scrapping of the late fee knocks out the last pillar of the vidtailer’s original economic model, which for two decades involved charging customers an upfront fee with each rental and imposing late fees if the movie isn’t returned on time.
The company projected that late fees would have contributed at least $250 million-$300 million to the bottom line in 2005 — about the same as this year.
Although Blockbuster did not disclose total revenue derived from late fees, analysts estimated Tuesday that the $250 million-$300 million in operating income probably means the company is actually taking in a total of $300 million-$350 million in late fees.
Making up loss
Blockbuster chair-CEO John Antioco said he expects to offset that loss through an increase in overall rentals and other new initiatives.
“I don’t want to get into the gory details, but through a combination of revenue increases that will go toward offsetting the loss of late fees, plus other changes in our business model, we hope it will be revenue neutral in 2005,” Antioco said.
There will be an initial hit, however, of $50 million in initial costs associated with implementing the change. Most of that money will be spent on advertising.
Hedging its bets, company also disclosed it will reduce capital in 2005 by about $100 million compared to 2004 spending, mostly by scaling back new store openings and store remodels.
The elimination of late fees will introduce another layer of complexity in managing the chain’s rental inventory, which will now be almost completely unmoored from firm return dates.
As recently as six months ago, Antioco told analysts that he would love to eliminate late fees but couldn’t see a way to guarantee that movies would be returned without them. Now, however, he says he sees little choice but to take the risk.
“Consumers have a lot of options for getting movies today that do not involve incurring late fees, from retail to Netflix to video-on-demand, and there will probably be more in the future. So in that sense I think this reflects a realistic view of the marketplace. It recognizes the competitors we have today and the competitors we’re likely to have in the future.”
Blockbuster wants to reposition itself with customers by removing a significant negative associated with its brand, Antioco said.
“It’s no secret that late fees have been an issue with consumers and that the issue has gotten more and more acute over the last several years,” he said. “We want the Blockbuster brand to be perceived in the most positive way possible, and we have a number of revenue streams that could be enhanced if the brand were perceived more positively.”
Cable operators dismissed the suggestion that the reinvented Blockbuster would take traffic away from their VOD offerings. Cablers said VOD isn’t just about avoiding late fees but about being able to order a movie without ever having to leave the home.
“The technology of VOD is so far superior in terms of giving the consumer control and convenience over when they want to watch and what they want to watch, it’s hard to compare it with the video rental model,” a Time Warner Cable spokesman said.
Comcast, which offers the most VOD programming, also pointed out that nearly two-thirds of that programming is free, which familiarizes viewers with the growing service and provides an incentive to pay for a VOD movie now and then.
“I’m personally happy I won’t be spending $50 a year on late fees,” one cable exec said.
Wall Street analysts were mixed in their reaction to Blockbuster’s announcement. Some analysis said it would be bad for cable VOD, while other said they didn’t understand how Blockbuster could make up for the revenue generated by late fees.
“I don’t get it … I don’t think anybody gets it,” said independent analyst Dennis McAlpine. “I don’t see how you replace $300 million (in revenue) by getting people to feel more warm and fuzzy about Blockbuster.”
Given Blockbuster’s huge rental market share, the move is bound to set off ripples throughout the industry.
Under the new scheme, if a rental movie or game isn’t returned by one week beyond the due date, the customer’s account will be charged a purchase price equal to the price the product was selling for on the date rented.
Those who rented new releases will be charged the new release purchase price; those renting older titles will be charged the previously viewed disc price. Even then, the customer will have 30 days in which to return the product for a full credit minus a $1.25 restocking fee.
Blockbuster’s stock jumped 4.55% Tuesday to close at $9.20, rising another 3.8% in after-hours trading.
Hollywood Video rose 0.69% to $13.07 and was up another penny in late trading.
(Pamela McClintock contributed to this report.)