By Mike Caggeso
Editor's Note: This is the 19th Installment of an Ongoing Series Highlighting the Global Investing Outlook for 2008.
While 2008 has not been the banner year for mergers and acquisitions (M&A) that 2007 was, several blue-chip operations including Microsoft Corp. (MSFT), Time Warner Inc. (TWX) and JPMorgan Chase & Co. (JPM) have picked up where private-equity firms left off last fall.
Now, Blockbuster Inc. (BBI) is the latest high-profile company to join the deal-making ranks with a takeover proposal of its own.
After a private bid went unanswered, Blockbuster made an unsolicited $1 billion acquisition bid for wounded electronics retailer Circuit City Stores Inc. (CC) for at least $6 a share – a move that sent Circuit City's shares up 60% in pre-market trading Monday.
Blockbuster said it first approached Circuit City Chairman and Chief Executive Officerwith the offer on Feb. 17, but when the movie-rental giant didn't get a response, Blockbuster decided to take its proposal public "because it believes the shareholders of Circuit City should have the opportunity to participate in determining the destiny of the company."
However, Blockbuster already has an outline with regard to what that "destiny" would be: The merged companies would create a $18 billion retail enterprise that would benefit from their complementary products, marketing, distribution and financial synergies.
"Our vision for the 'new' Blockbuster is to be the most convenient source for media entertainment," Blockbuster Chairman and Chief Executive Officerwrote in a letter to Schoonover.
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A Blockbuster Deal for a Browbeaten Market
Circuit City is the second-largest electronics chain in the United States, but the company has struggled recently. Over the past year the company has slashed retail management positions, eliminated jobs at its corporate offices and laid off 3,400 retail workers.
Blockbuster hasn't faired much better. Once an innovative icon in family entertainment and a cornerstone in the realm of media distribution, Blockbuster has more recently been the victim of increased competition and such technological changes as "video-on-demand" that have threatened its business. So it's cut marketing costs and shed unprofitable customers in a desperate bid to fend off the Internet-based Netflix Inc. (NFLX).
The company's troubles have led some – including Circuit City – to question whether or not Blockbuster even has the capital to follow through on its $1 billion all-cash offer.
"To date Blockbuster has been unable to satisfy Circuit City and its advisers that Blockbuster's proposal could be financed,".
The statement also questioned whether the proposed acquisition would require debt financing (and, if so, what the terms and structure would be) and how large a rights offering would be required to fund the transaction.
In a conference call, Blockbuster's Keyes said the company has the support of billionaire board member.
Presuming Blockbuster does indeed secure the proper financing, Louis Basenese, an mergers and acquisitions (M&A) expert and the editor of The Takeover Trader newsletter, said the deal bodes well for both companies, but mainly because independently, they are headed for the trash heap.
"This is clearly a merger to fight off extinction," Basenese said. "Combining forces might only delay the inevitable."
Technology business blog, the Digital Home, called Blockbuster's proposal "laughable."
"Blockbuster is nothing more than an irrelevant shadow of its former self. For years, the company stood atop the rental business and destroyed any and all competitors in its path," Digital Home author Don Reisinger wrote. "But once Netflix saw it fit to change the way the rental business works, Blockbuster couldn't adapt and its once booming business turned into an overpriced cesspool of old business models."
A 2008 M&A Revival
A recent report from Thomson Financial indicated that the global volume of M&A plunged 31% to $661 billion in the first quarter of 2008. But that drop-off comes after a banner year for M&A activity. Total global deal volume checked in at $4.5 trillion in 2007, up 24% from the previous high-water mark set in 2006.
Since then, credit conditions have tightened significantly as many banks were badly burned by credit defaults. But while an era of "easy money" has come to an end, there is still ample opportunity for takeovers and tie-ups.
Basenese attributes most of the drop-off in M&A to a shift in the balance of power. Over the past several years, private equity firms had established themselves as the main drivers behind M&A activity by outbidding companies for assets.
However, it was those same buyout firms that led to the collapse in first quarter deals, with a 77% drop in acquisitions. And that has opened the door for companies flush with cash to get back down to business.
"Corporations are sitting with almost near record amounts of cash on their balance sheets," Basenese said. And with that, they can "take advantage of the depressed stock prices of competitors without the fear of being outbid by overly aggressive private equity shops."
Deals on the Docket
Microsoft made its move with an unsolicited $44.6 billion bid for Internet portal operator Yahoo! Inc. (YHOO). So far, Yahoo has done its best to thwart Microsoft's advances, but most analysts believe Microsoft will get its way if it ups its $31 a share offer.
If that buyout goes through, it will be the largest-ever acquisition in the high-tech sector, exceeding even Kohlberg Kravis Roberts & Co.'s $26 billion buyout of First Data Corp.
However, Yahoo's explicit opposition to the takeover makes it impossible to rule out a narrow escape.
"While we continue to see no other competing bidders, we believe Yahoo is aggressively pursuing strategic alternatives. One possibility is a tie-up with Time Warner, whereby Time Warner would contribute its online content assets to Yahoo in exchange for a stake. We believe this could serve as a forcing function to a higher Microsoft bid," Citigroup Inc. (C) analyst Mark Mahaney wrote in a note to clients.
Time Warner's AOL recently made a move of its own, with its $850 million acquisition of Bebo Inc., a popular online social network. The San Francisco-based Bebo has 40 million members around the world and an especially strong presence in Britain. While social networking sites such as Facebook Inc. and MySpace.com have the American market locked up, 60% of Bebo's traffic comes from Europe and 16% from Asia.
According to a recent report in BusinessWeek, eBay Inc. (EBAY) may be the next tech company to make a move in the M&A market. Lorraine McDonough, eBay's mergers chief, told the magazine that her company is in a "good position to make acquisitions."
The company kicked off 2008 with a hasty purchase of payment-security firm Fraud Sciences for $169 million. And eBay isn't stopping there. The company expects to make eight or nine more acquisitions this year.
Despite stagnating economic growth and an abysmal credit market, high-tech mergers and acquisitions have surged 132% this year through March 25. And other sectors are likely to follow suit.
More Still to Come
Basenese believes that several converging factors will provide the "deal grease" needed to jumpstart the M&A market:
- An absence of private equity – exacerbated by the credit crunch – opens the door for corporate buyouts in the first half of the year
- A full-force return of private equity kingpins later in the year
- The devalued dollar makes U.S. companies more attractive to foreign buyers
- Stock market woes have devalued companies, making more of them takeover targets
"Many takeover targets just trade at too good a price to pass up. Adding to the urgency is the fact private equity buyers won't be sitting on the sidelines much longer. More and more of the leveraged loans in the pipeline are being cleared," Basenese said in an interview.
"Once those loans clear, rest assured private equity will return, making acquisitions more expensive for strategic buyers."
News and Related Story Links:
The Digital Home:
Blockbuster's pending acquisition of Circuit City is laughable