Ergen’s Blockbuster Victory

Dish Network emerged last week as the
winning bidder for Blockbuster, besting offers from activist
investor Carl Icahn and a group of bondholders by
agreeing to pay $320
million for the troubled
video chain.

But now with the
struggling retailer
in hand — the deal
was approved last
Thursday by the U.S.
Bankruptcy Court
for the Southern
District of New York,
and is expected to
close in the second
quarter — analysts
are split on whether
to call this one a stud
or a dud.

Investors also appeared
to be on the
fence. Shares in Dish
Network gained
a penny each last
Wednesday (April 6),
closing at $24.32, up
0.04%. The stock was
down 37 cents each
(1.5%) to $23.95 last

On one hand, the
Blockbuster buy
looks like another in
a growing line of bargain pickups for Dish — it acquired
hybrid satellite and terrestrial communications company
DBSD North America in March for $1.5 billion. On the
other, it appears like Dish paid a low price for a declining
asset that will only drag it down.

Just how low-priced was this deal? Viacom paid $8.4 billion
for Blockbuster in 1994, using its substantial cash flow at the
time to finance the acquisition of studio Paramount Pictures
that same year. Viacom shed its interest in Blockbuster in 2004.

Moreover, Charlie Ergen is known as a scrappy, savvy
executive who has been left for dead on more than one occasion
only to come back stronger than ever. His survival
skills are legendary.


The Blockbuster purchase comes at a critical time for
Dish. Coming off a year where it lost subscribers for the
last three quarters — it managed to barely end 2010 in
the black, adding 33,000 net new customers — Dish has
struggled to compete as the low-cost video alternative in a
down economy. In a conference call with analysts in February
to discuss fourth-quarter results, chairman Charlie
Ergen sounded like he regretted getting into the satellite
business in the first place, stating that someone who wanted
to break into the TV distribution business today was
perhaps better off starting a service like Netflix rather than
spending billions of dollars on satellites, as he did.

In a way, Blockbuster partially fulfills that wish — it has
a mail-order DVD business with about 1 million customers
and a fledgling online-delivery business called Total
Access that streams movies and TV shows to customers’
computers, mobile devices, TVs, Blu-ray players and game
consoles. But it still has a long way to go: Netflix has more
than 20 million members and is growing.

The addition of Blockbuster’s 125,000 movie and television
show titles also could substantially bolster Dish’s
video-on-demand offering, which has lagged behind its
peers. And the terms of the deal appear to be very favorable
— about $228 million of the purchase price is in cash,
after adjustments. Dish has about $640.7 million in cash
and cash equivalents on its balance sheet, which increases
to $2.9 billion when marketable securities are included,
so absorbing this deal should not be difficult.

But Blockbuster also includes about 1,700 retail locations,
which Dish seemed to say it would continue to operate.
That caused some analysts to send up signal flares.

In a statement, Dish executive vice president of sales,
marketing and programming Tom Cullen specifically
mentioned the stores, adding that combined with the
Blockbuster brand and its multiple distribution methods,
“Blockbuster will complement our existing video offerings
while presenting cross-marketing and service-extension
opportunities for Dish Network.”

In a research note, Sanford Bernstein cable and satellite
analyst Craig Moffett wrote that running the stores could
be a mistake.

“We find it difficult to imagine Blockbuster’s rapidlyshrinking
store base becoming a source of significant incremental
gross additions for the core Dish Network pay
TV service, both for logistical reasons (employee training,
support infrastructure) and the incongruence of the sale
process (‘Would you like a satellite dish with your rental?’),”
Moffett wrote.

Moffett agreed that given the relatively small size of the
deal, it is in no way transformative for Dish. But he feared
that Blockbuster’s rapidly declining business — he called
it “a melting ice cube” — could be a substantial drain on
Dish’s cash flow.

Wunderlich Securities analyst Matt Harrigan took it a step
further, slapping a “sell” rating on Dish (down from hold)
and noting that Blockbuster’s track record is not particularly

“Blockbuster has also already shown itself to be a lessthan-
facile competitor to Netflix,” Harrigan wrote in a research

Indeed, Blockbuster has been in a steep decline — it
filed for Chapter 11 bankruptcy protection in September
and revenue dropped 28% for the 12 months ended Jan. 2.
While some of that is due to store closures, Moffett noted
that same-store sales have been falling steadily — down
8.6% in the third quarter, on top of a 14.4% decline in the
prior year.

“Dish has indicated that they view Blockbuster as a going
concern, but our concern is where it’s going,” Moffett


Not everyone took Dish at its word when it comes to real
estate, however. Several other analysts assume that the
stores would eventually be shuttered. In the meantime,
they could serve as a vehicle to promote satellite TV subscriptions.

Pivotal Research Group principal and media and communications
analyst Jeff Wlodarczak predicted Dish
would rebrand its VOD service under the Blockbuster
name, temporarily use the retail spots to market Dish
products and eventually shut down the stores. He added
they could use Blockbuster’s streaming infrastructure
and its mail order
business to create
a “Netflix-like”
offering for both
Dish and non-
Dish customers.

Collins Stewart
media analyst Tom
Eagan also saw potential
in a Netflix-
like offering,
adding in a report
that Dish could
also use Blockbuster’s
DVDs and
movie rights to
make the satellite
service more competitive
by offering
free DVD rental
and streaming with
a Dish Network subscription. But he pointed out limitations
to that strategy.

Moffett noted that most of Dish’s customer base subscribes
to digital-subscriber-line Internet service, which
has slower download speeds than cable and telco broadband
offerings, making it ill-suited for streaming video.

“The risk is that the synergies here turn out to be more of
a sound bite than a strategy,” Moffett wrote.