Video: Blockbuster bout

By John W. Schoen Senior producer
updated 5/11/2005 6:14:26 PM ET 2005-05-11T22:14:26

Corporate raider Carl Icahn claimed victory Wednesday in the shootout for control of the nation's biggest home video retailer, calling the shareholder vote a great day for stockholders everywhere who want to hold corporate managements more accountable.

“We won a very strong victory,” Icahn told CNBC. “Most importantly, we want accountability and I think that is going to be done.

The vote electing Icahn and two other dissident candidates to the company’s board of directors was a referendum on Blockbuster Chairman John Antioco and his management team. Antioco had vowed to resign his $50 million-a-year job if he lost the vote.

"I would be lying if I told you this is a happy day, because it is not," Antioco said. "But we'll roll with the punches."

Antioco declined to answer questions from reporters, including whether he would accept Icahn's offer to stay with the company. That invitation was influenced by the generous terms of Antioco’s severance package, said Icahn.

“We certainly don't want to be in a position, the board to be in a position, to have to pay a $50 million golden parachute,” he said. “And so the board was able to cure the default, so to speak.”

Icahn, who made a fortune in the 1980s with raids on TWA, USX, and Texaco, holds a roughly 10 percent stake in Blockbuster. He has been harshly critical of the current management’s strategy of spending heavily to fight back competition from rivals like mail-order distributor Netflix. And he wants Blockbuster to pay shareholders like him a bigger dividend.

“I think shareholders are fed up with a lot of management,” he said Wednesday. “Some managements are good. But it is ridiculous and almost reprehensible if a company is not doing well that the CEO gets a $50 million bonus, and 20 to 30 percent of the workers are laid off.”

As proxy fights go, this one was nasty, with both sides turning up the heat as the vote approached. In an April 7 letter, Icahn claimed that Blockbuster management botched a potential takeover of rival Hollywood Entertainment and needs to curb “egregious bonuses” to executives. Blockbuster CEO Antioco fired back with a letter accusing Icahn of making misleading statements and creating “turmoil and uncertainty” that is hurting the company. And on a conference call last week to discuss the company’s latest financial results, Antioco and Icahn squared off again — until Icahn was cut off in mid-sentence by the operator.

Shareholders Wednesday basically had three choices: endorse the status quo, vote for Icahn’s slate, or split the difference — keeping Antioco, but electing two of the candidates hand-picked by Icahn, who owns nearly 10 percent of Blockbusters stock.

Blockbuster vs. Netflix
Their decision could have a major impact on the $24 billion home video market.

Until recently, Blockbuster was the company to beat in home video rentals. With some 9,000 stores worldwide, the company has enjoyed a dominant position as the leading provider of home video and games in the U.S. and 24 other countries, taking in $6 billion in revenues last year.

But from virtual obscurity six years ago, online rival Netflix has delivered a serious blow to Blockbuster’s business. Netflix has more than three million subscribers who pay a monthly fee to go to the company's Web site and pick from some 40,000 movie titles. Subscribers' DVD choices are delivered by mail, and they can keep up to three of them for as long as they like. The company says it can deliver movies to nearly 90 percent of its subscribers within one business day.

Without the heavy cost of building, maintaining and staffing stores, Netflix has been able to quickly grab a big piece of the home video rental market. Netflix Founder and  CEO Reed Hastings has estimated that the average Netflix customer will generate more than $100 of profit over the life of their subscription at a cost of about $40 in marketing costs, a formula he called “a great bargain for us.”

So far the plan is working. For the past four years, Netflix's revenues have roughly doubled each year; the company made $21.6 million last year on revenues of about $500 million. And about half of those revenues came at Blockbuster’s expense, according to Michael Pachter, an analyst at Wedbush Morgan Securities

But Netflix no longer has mail-order video market to itself. Last year, Blockbuster spent more than $200 million to launch its own mail-order online service and now claims nearly 1 million subscribers. Wal-Mart has also entered the fray with an online rental service, but has not disclosed how many subscribers have signed up.

All this competition is good news for DVD renters. Netflix charges $18 a month for up to three DVDs at a time. Blockbuster has fired back with a $15 a month plan and added two free in-store movies or video games. Not to be outdone, Wal-Mart is pitching a $13 a month plan with unlimited DVD rentals.

The DVD rental wars have also eliminated one of video renters' major pet peeves — the "late fees" charged if they didn't watch their selection and return it on time. Dropping those late fees cost Blockbuster some $145 million last year and contributed to the company’s $1.2 billion loss for 2004. The “no late fee” program also cost the company some $630,000 to settle claims by 47 states on behalf of consumers who didn’t read the fine print — and were charged the purchase price of the DVD if they kept it more than a week. (The policy remains in place.)

Blockbuster’s management says the heavy investment in its new strategy is paying off. The company expects to double its subscription base to 2 million by early next year. But the plan remains costly: analysts expect Blockbuster to spend another $170 million this year and lose another $500 million in late fees. The company also plans to continue opening new stores.

That aggressive — and costly — expansion plan is at the center of the battle for control of the company. Simply put, Icahn and his supporters want the company to spend less and let more of its revenues flow to the bottom line -- and to shareholders.

“If you’re spending $350,000 per new store — if you stop building those new stores, you’re going to generate a lot of cash out of the existing stores,” said media analyst Dennis McAlpine.

Blockbuster's management has said it needs to continue investing in new stores and online subscribers and that its strategy is working.

Another eToys?
Meanwhile, Netflix CEO Hastings has said his company is continuing to open up its lead, and that Blockbuster’s strategy isn’t working.

“When you look at Blockbuster’s spending, they'll have spent close to $400 million to be able to get to break-even 2 million subscribers,”  Hashings told CNBC last month . “It’s actually a very large investment to get in this market and be successful. And despite their very heavy spending, we're continuing to grow very rapidly.”

But it’s much too early to count Blockbuster out, say analysts. Some believe that the company’s multiple channels of distribution (both online and instore), along with multiple offerings that include video games and DVDs for sale, gives the home entertainment giant the staying power to outlast its smaller rival.

“I’m convinced that Netflix is doomed. They’re toast,” said Pachter. “This is really like eToys... It doesn’t matter if the product is better, if your competition is that formidable.”

Waiting in the wings for both competitors is the threat of an entirely new way of watching movies -– video on demand. Delivering movies via cable television systems holds the promise of an even faster, cheaper form of distribution.  But that day may be years away, for several reasons.

For starters, the technology is not in place yet for cable companies to duplicate the huge backlist of some 40,000 titles that the rental companies can provide. McAlpine estimates that some 70 percent of Netflix business comes from people renting older movies.

Bu technology aside, the economics of renting and selling DVDs is extremely profitable for Hollywood studios, say analysts. Pachter estimates that that the movie industry makes roughly two-thirds of its profits from DVDs.

“If you could get everything on video-on-demand, you wouldn’t necessarily buy a DVD player,” he said. “And if you don’t have a DVD player, you’re not buying any DVDs -– which is where the studios profits are coming from. So video on demand hurts them.”

DVD sales are growing much more quickly than rentals, generating some $15 billion in sales last year, up from just $2.8 billion in 2000, according to J.P. Morgan. During that period, rental revenues grew to $5.8 billion from $640 million.

And the coming switch to high definition television gives Hollywood another compelling reason to keep DVDs alive, says Pachter.

“As we migrate to HD, they’re counting on you throwing away your entire library of DVDs and buying all new (HD) DVDs,” he said. “And they can’t wait to sell them to you.”

The Associated Press,  Reuters and CNBC's Jerry Cobb contributed to this report.


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