Is Circuit City Headed for a Blowout?

Blockbuster's decision not to buy the retailer sent the stock tumbling. A Chapter 11 bankruptcy filing may be in the offing

by Pallavi Gogoi

Will Circuit City (CC) join the long list of electronics retailers, like Tweeter Home Entertainment and Harvey Electronics, that have filed for Chapter 11 bankruptcy protection in the past year? Given that shares of the Richmond (Va.) company are trading at just over 2, Wall Street is betting that could be a possibility. "Circuit City is in very serious trouble, and any scenario is possible today," says Nick McCoy, senior consultant at TNS Retail Forward, a research firm.

Circuit City's market capitalization currently is a mere $368 million—pocket change for a large private equity firm. But buyers are not lining up and have clearly concluded that the chain's problems won't be easy to resolve. On July 1, beleaguered movie-rental company Blockbuster (BBI) effectively delivered a slap in the face to the nation's second-largest electronics retailer by withdrawing its proposal to acquire Circuit City. "Based on market conditions and the completion of our initial due diligence process, we have determined that it is not in the best interest of Blockbuster's shareholders to proceed with an acquisition of Circuit City," said Blockbuster Chairman and CEO Jim Keyes.

Plenty of Cash

Blockbuster's move sent Circuit City’s stock tumbling a further 15%, to $2.14 a share, on July 2.

Now, even if a private equity player decides to buy Circuit City, there's speculation that the buyout might take place under a Chapter 11 reorganization plan. Such a filing could certainly take care of a key problem that CEO Philip Schoonover has often pointed to, which is that many of the company's 682 stores are in poor and underperforming locations, and would be expensive to close because they have long-term leases.

A potential buyer can take advantage of a special provision of the U.S. bankruptcy code, called Section 363, allowing it to sell assets and get out of leases and contractual obligations under the protection of the court. "A 363 sale short-circuits the whole process, and the debtor can sell assets free and clear of any liens, and thus get a cleaner title," says Rich Hynes, a professor of bankruptcy law at the University of Virginia School of Law.

Circuit City spokesman Bill Cimino wouldn't comment on the specifics of the strategic alternative process that the company is pursuing with investment bank Goldman Sachs (GS), but noted that a Chapter 11 filing was not something the company was considering. "We have adequate liquidity," says Cimino.

Wal-Mart Effect

The company says it is making progress toward returning to profitability in the second half of the year, through better sales of accessories and warranties and customer service improvements such as training sales reps to greet customers, ask the right questions, and make recommendations.

Some analysts and investors are doubtful, however. "Sure, the company has cash, but the question is can they return to profitability in this environment? The market is saying no," says Andy Hargreaves, an analyst at investment bank Pacific Crest Securities in Portland, Ore.