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Bankruptcy Is Blockbuster's only hope

Wednesday, March 17, 2010 - 11:50am

Blockbuster's (BBI) warning that bankruptcy might be looming is a scare for investors who are worried about the value of their stock — but restructuring could ultimately be a smart move for the company.

The video rental store declared in a Securities and Exchange Commission filing on Tuesday that it might be forced to file Chapter 11 if cash flows don't improve and it is unable to restructure its debt. Blockbuster reportedly has about $1 billion in debt.

"These factors raise substantial doubt about our ability to continue as a going concern," Blockbuster said in the filing.

As a result, shares of Blockbuster are tanking 26.1% to about 29 cents in morning trading, with investors fearing that a Chapter 11 filing would render common shares worthless.

Still, a voluntary bankruptcy, while painful, may be its only way out, Needham analyst Charles Wolf says.

Blockbuster has provided little confidence that it will be able to recover on its own. Last month the video rental company reported a fourth-quarter loss of $434.9 million, or $2.24 a share, as same-store sales fell almost 16%.

But no one can say Blockbuster isn't trying. Over the past several years, the company has shuttered underperforming stores, cut costs and rolled out kiosks in an effort to compete with Netflix (NFLX) and Coinstar's (CSTR) Redbox.

"There's a role for physical stores to play in video distribution," Wolf says. "And Blockbuster's plan to close underperforming stores is spot on."

Earlier this week Blockbuster also said it is in talks to divest its European unit.

The company has also said that it will reduce its costs by $200 million this year.

Still, no matter what the company does, there is always the looming shadow of debt and interest burden, which was caused by the special dividend Blockbuster was forced to pay when it was spun out of Viacom (VIA) in 2004.

"A voluntary Chapter 11 would enable Blockbuster to reduce its debt burden and interest payments to manageable levels and [allow it] to implement its strategy for closing underperforming stores and building a digital distribution business," Wolf says. "I can see why management is contemplating it."