Icahn Agrees to Back Blockbuster’s Bid for Circuit City

The video-rental chain has been seeking access to Circuit City’s books since contacting CEO Phil Schoonover in February. Circuit City resisted Blockbuster’s requests until assured the suitor had financial backing by major shareholder Carl Icahn, who led an effort to replace Blockbuster CEO John Antioco. Circuit City also struck a deal with dissident shareholder Wattles Capital Management to include three of the firm’s board nominees with its own slate at a June 24 annual meeting.

In an April 24 letter to Blockbuster CEO James Keyes, Icahn said he is “ready to acquire Circuit City” if after due diligence Blockbuster can’t get financing or shareholder approval, according to an SEC filing. Circuit City also hired Goldman Sachs to review “strategic alternatives.” Circuit City retained Goldman Sachs in the fall to consider options for The Source by Circuit City stores in Canada.

“While these events are a positive, we think there is a long way to go before any deal is consummated,” Lehman Brothers analyst Michael Lasser wrote in a research note. “We are still skeptical that Circuit City will be sold since we view the company’s challenges to be structural in nature and will be difficult to surmount.”

Circuit City’s woes probably will deepen if Blockbuster acquires it, Lasser said. Blockbuster is struggling to recast itself in the era of Internet-based video downloads, industry officials said. It acquired Movielink last year and now is testing new store formats, including one stressing CE gear. Blockbuster expanded videogames sales chainwide (CED April 30 p4). Blockbuster has tried to sell CE products, through such means as a short-lived venture with RadioShack featuring a store-within-a-store format. After tests at 137 stores, it was scrapped. The past year has seen Circuit City go through a major restructuring, cutting the jobs of 3,400 of higher-paid sales associates, outsourcing IT operations to IBM and launching the 20,000-square-foot “The City” format. “You always hear the comment, ‘One plus one equals three,'” said William Mayer, president of Wells Fargo Retail Finance. “Well, I think one plus one equals less than two in that particular equation.”

Blockbuster responded by talking up cost savings and the ability to cross-sell services with Circuit City, better positioning the retailers to sell content and products. Circuit City, which has tested CD download-to-burn services, could add a kiosk-based video business, Blockbuster has said. Blockbuster, said to be developing a set-top box for streaming films, reportedly is in talks to buy a stake in a new premium cable TV channel being launched by Viacom with Lionsgate Entertainment and MGM.

Circuit City’s board “has confidence” that the chain can “successfully implement its turnaround plan and generate shareholder value,” but also thinks “we can best serve the interests of our shareholders by exploring all possible alternatives to enhance shareholder value,” Schoonover said in a written statement. He warned that allowing Blockbuster to conduct due diligence isn’t an “indication that the board has completed its review of the Blockbuster proposal, taken a position on the company’s value or settled upon a particular strategic course of action,” he said.

Combining Blockbuster and Circuit City isn’t likely to “stem the tide” of Circuit City market share losses to Best Buy, Deutsche Bank North analyst Mike Baker said. Best Buy last week agreed to buy half of The Carphone Warehouse for $2.1 billion to expand its European presence (CED May 9 p3).

As it was letting Blockbuster conduct due diligence, it also was agreeing to include three of Wattles Capital’s four nominees with its slate of proposed board members. The settlement deal heads off a proxy fight that threatened high drama at Circuit City’s annual meeting next month in Richmond, Va. The three Wattles Capital nominees will be chosen soon, said a Circuit City spokesman, declining to comment on the criteria to be used in selecting them. Wattles Capital, which has a 6.5 percent stake in Circuit, filed a preliminary proxy statement in April that sought shareholder support for its four nominees and the ouster of Schoonover and the chain’s board (CED April 29 p1).

Under terms of the settlement pact, Circuit’s board agreed to select James Marcum as one of three Wattles nominees, the Circuit City said in an 8-K filed late Friday at the SEC. In exchange, Wattles agreed not to raise its Circuit City stake Circuit above 15 percent until after the 2009 annual meeting, the chain said. Wattles also is barred from nominating additional directors for election at the 2009 annual meeting, the company said. The Circuit City board won’t grow to more than 15 members until at least after the 2009 annual meeting, the agreement says. At or before that meeting, Circuit City will reduce board membership by two, it says. The board isn’t barred from adding up to three more members “in connection with any material third-party investment” in the company, the filing said. Circuit City also will reimburse Wattles up to $700,000 for costs incurred in the proxy challenge, the 8-K said. - Mark Seavy