updated 1/10/2005 9:29:42 AM ET 2005-01-10T14:29:42

Video rental giant Hollywood Entertainment Corp. has agreed to a buyout offer of about $850 million from smaller rival Movie Gallery Inc. in a deal that would create a stronger challenger to the industry leader Blockbuster Inc.

The planned combination announced Monday of the No. 2 and No. 3 video rental chains would create a company with annual revenue of approximately $2.5 billion and approximately 4,500 stores.

That would still be a distant second to Blockbuster which has 9,000 outlets worldwide, however.

Hollywood Entertainment, based in Wilsonville, Ore., near Portland, has been looking for a buyer for several months and had attracted bids from both Movie Gallery and Blockbuster as well as from a management group.

Under the deal announced Monday, Movie Gallery would offer $13.25 a share, or about $850 million, in cash for Hollywood Entertainment's shares. It would also assume about $350 million in Hollywood's debt in the deal.

The offer represents a slim 1.5 percent premium over Hollywood Entertainment's closing price of $13.05 on Friday on the NASDAQ Stock Market.

Joe Malugen, Movie Gallery's chairman, president and CEO, said in a statement the deal would create a stronger competitor with "a broader geographic presence and greatly improved distribution capabilities and scale."

In August, Hollywood Entertainment had agreed to let its chairman and chief executive and Los Angeles buyout firm Leonard Green & Partners to take the company private for $10.25 a share. The deal, however, allowed Hollywood to solicit other bids, and the CEO said he welcomed Blockbuster's offer.

In November, Dallas-based Blockbuster offered $11.50 a share for Hollywood and said early in December that it may sweeten its offer for its rival which is based in Wilsonville, Ore.

On Nov. 19, Movie Gallery of Dothan, Ala., said it had offered an undisclosed amount for Hollywood.

Blockbuster already has 9,000 outlets worldwide. Hollywood Video has 2,000 Hollywood Video stores and more than 700 Game Crazy specialty stores. Movie Gallery has more than 2,000 outlets.

Copyright 2004 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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