Circuit City Gives Up the Fight

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Skepticism About the Combo

Richmond (Va.)-based Circuit City is reeling from five consecutive quarters of declining sales at stores that have been open for a year or more, after increased competition from discount retailer Wal-Mart and warehouse club Costco Wholesale (COST). Last year, several electronics stores were decimated (BusinessWeek.com, 4/23/07), Rex Stores closed down over 78 stores, CompUSA shuttered all its stores before being bought by a restructuring firm in December, and Tweeter Home Entertainment and Harvey Electronics filed for bankruptcy. "This is the kind of mess the electronics business is in—it's like buying a sinking Titanic," says Howard Davidowitz, chairman of Davidowitz & Associates, a national retail consulting and investment banking firm in New York.

But investors don't necessarily view the Blockbuster-Circuit City combination as a winning one either. That's because Blockbuster has its own litany of troubles. Blockbuster has been forced to reckon with a shift from on-site movie rentals to new venues, with increased competition from video rental models like the one from Netflix (NFLX) and downloads from Apple (AAPL). "The question is will the combination of two crippled companies end up crippling both even further," says Burt Flickinger III, managing director of Strategic Resource Group, a retail consultancy in New York.

The one hope, Flickinger says, is Blockbuster CEO Jim Keyes, who came on board in July with Icahn's backing and replaced John Antioco. Keyes, who had engineered a turnaround at 7-Eleven, has started re-investing in Blockbuster's 7,800 brick-and-mortar stores and pulled back from the online DVD rental market that Antioco had invested in heavily. Keyes also has recently shifted to selling DVDs and video games at Blockbuster stores. He bought Movielink.com last year with plans to make movie downloading to televisions available. Under his leadership, Dallas-based Blockbuster posted a narrower-than-expected loss of $85 million for the year ended Jan. 6, 2007, and expects to return to profitability in 2008.

The Keyes to Success

Almost all of Wall Street, and many in the tech community, are puzzled by Keyes' pursuit of Circuit City. Keyes envisions a new digital retail company that leverages complementary products and higher-quality, better-focused store sites.

"Combined, our companies would create a game-changing $18 billion global retail enterprise that is uniquely positioned to capitalize on the growing consumer appetite for content-enabled consumer devices," Keyes said in an Apr. 14 conference call with analysts. He said that in the short term the companies would trim costs by combining operations and by likely selling the weakest-performing stores. At the same time, Keyes expects that the new, larger company would be able to bolster its buying muscle with vendors and strike better prices.

He also anticipates cross-merchandising opportunities, and the opportunity to sell electronics with access to personalized preloaded movies and digital subscriptions. "That is what I mean when I say game-changing entertainment retail concept," Keyes said. Yet Wall Street smells the potential for a very expensive flop. Blockbuster's shares finished the week at 2.66, 14¢ above their 52-week lows. Since Blockbuster first made its takeover bid public Apr. 14, its shares have fallen 5.3%.

Circuit City's stock, meanwhile, surged more than 10% on May 9 on the news of Icahn's interest, finishing 5.9% higher. Clearly, some investors see a brighter future for Circuit City as an acquisition target than merely a struggling solo player. Still, not everyone is convinced—the stock price remains lower than the $6 a share Blockbuster is offering. One reason that even seemingly good news for Circuit City shareholders comes with a caveat these days.

Gogoi is a contributing writer for BusinessWeek.com.