Blockbuster to Circuit City: Why Can't We Be Friends?

Circuit City boss Phil Schoonover has long served as the lumbering prey of activist investor Mark Wattles. But in the wee hours this morning, Schoonover had a nice note tacked to his door by a different predator. It seems Blockbuster's Jim Keyes didn't like the fact that earlier conversations with Schoonover did not produce a deal.

With rumors swirling that Circuit City had hired Goldman to shop the company, Keyes decided to move, and his letter certainly benefits from translation.

Keyes: Dear Phil:

Translation: We already know each other personally. And yes, I know Schoonover rhymes with "Soon-over," but I'm not going to mention that.

Keyes: Since early December, we have had a number of conversations regarding the potential combination of our businesses.

Translation: Because those conversations have not produced the outcome I wanted, I'm now making those conversations public.

Keyes: As a follow-up to those discussions, I would like to formally reiterate our interest in pursuing an acquisition of Circuit City.

Translation: We want this deal bad enough to go hostile.

Keyes: The purpose of this letter is to ensure that there is no ambiguity and to outline our proposal.

Translation: The purpose of this letter is to inform your shareholders that they have deal. We understand they're not a happy bunch.

Keyes: Our vision for the "new" Blockbuster is to be the most convenient source for media entertainment.

Translation: We're not just exploiting a mismanaged asset in a down economy. We actually have a business concept. In fact, it's a full-fledged "vision."

Keyes: We have undertaken a series of strategic initiatives including enhancement of our core rental business; a transition from solely rental to a concentration on consumer retail; and development of the fast-growing digital download market.

Translation: Our core business is dying, so we're changing our core business. That's not rocket-science, but it's harder to excecute than it looks.

Keyes: We are pleased that these strategic initiatives have begun to improve our financial results and anticipate further improvement going forward.

Translation: It's working... sorta.

Keyes: The combination of Blockbuster and Circuit City will result in an $18 billion retail enterprise uniquely positioned for the convergence of media content and electronic devices.

Translation: You have been getting killed by the big boxes. This deal will enable you to offer something different from Wal-Mart, Target and, yes, Best Buy... hopefully for at least for 18 months.

Keyes: We would seek to differentiate products in both Blockbuster and Circuit City stores by offering exclusive content and content-enabled devices.

Translation: Our combined size would allow us to do exclusive licensing deals. Otherwise, we're both stuck in businesses that are increasingly commoditized.

Keyes: Both companies would benefit from complementary products, marketing, management strengths, technology and distribution and the resulting synergies would significantly improve consolidated financial performance.

Translation: While you've been gutting the capability out of your organization, we've kept most of ours. It's very complementary. (Thanks for already firing everyone, so we won't have to.)

Keyes: Overall, I strongly believe that a combination of Blockbuster and Circuit City would deliver significant value to our respective shareholders, enhance the overall customer experience, and energize our employees.

Translation:This is probably your last chance to walk out on your own, claiming victory.

Keyes: Based on our review of publicly available information, we are confident that we can provide a substantial premium to your shareholders with an all cash offer in the range of $6.00 to $8.00 per share...

Translation: OK, so your shareholders were actually dreaming about $8 to $10, but we assume they'll settle for doubling the current value of their holdings.

Keyes: ...subject to due diligence.

Translation: Nothing personal, but we've noticed that distressed companies sometimes over-stretch the numbers.

Keyes: We are also willing to pursue alternative structures which would enable Circuit City shareholders to receive stock and participate in what we believe would be an exciting future for the combined enterprise.

Translation: And we'll throw in a dozen free copies of Finding Nemo.

Keyes: Given current debt market conditions, we believe most of the cash necessary would be generated through the issuance of additional Blockbuster equity, most probably in a rights offering to our existing shareholders.

Translation: We're not exactly dealing from a position of strength ourselves. But at least we're playing offense.

Keyes: We believe they, and the market, will recognize the merits of this transaction...

Translation: We believe they, and the market, will take the money and run.

Keyes: ...and we are confident that we can raise the required equity.

Translation: We've talked with bankers, and they didn't laugh.

Keyes: The borrowing capacity of the combined business would provide the remaining cash proceeds.

Translation: Ok, so we'll have to leverage this thing a bit to make it work.

Keyes: Time is of the essence and we are focused on minimizing the risk of business disruption.

Translation: Isn't Wattles still leaning against your front door?

Keyes: We are prepared to commence a very short due diligence process immediately...

Translation: Our due-diligence team checked in to the Residence Inn down the street from your headquarters over the weekend. Fortunately, they found a good bar nearby where they could watch the Masters.

Keyes: ...on the basis of exclusivity, with the intention of entering into a definitive agreement shortly thereafter.

Translation: We know you've got Goldman looking for alternative buyers. Do you really want to risk screwing up this deal?

Keyes: Attached, as an appendix to this letter, you will find a concise list of the most critical due diligence items which we would need to review in order to confirm our final offer.

Translation: Our due-diligence team is enjoying the free continental breakfast at the Residence Inn. They've already been to the gym and read the papers.

Keyes: We have reviewed this potential transaction with our board of directors, and it is with their full support that we make this request to move forward.

Translation: It's great having a supportive board. Isn't Wattles replacing yours?

Keyes: Given the importance of this opportunity to Blockbuster and the strong desire to complete it as soon as possible, we would be grateful for your response no later than 5:00 PM CST on February 21, 2008.

Translation: We made the deadline clear.

Keyes: Again, I thank you for the time you have spent discussing this opportunity with me.

Translation: I am disclosing the fact that you and I had direct conversations so that your shareholders know that you saw enough merit in this deal to engage personally.

Keyes: I am prepared to discuss the details of this proposal at your earliest convenience,,,

Translation: I've got a conference call on Wednesday afternoon, and a couple of performance reviews on Thursday. But for you, I can move them.

Keyes: ...and believe that we will be able to quickly come to a mutually beneficial agreement.

Translation: We don't want this to turn into a goat-rope, like MicroHoo.

Keyes: I look forward to working together on this exciting opportunity.

Translation: Face the cameras, smile, hold the handshake and consider this the most elegant exit imaginable for you.

Keyes: Very truly yours,

Translation: This is the final chance to maintain the appearance of civility.

Keyes: Jim Keyes, Chairman and Chief Executive Officer, Blockbuster Inc.

Translation: Yes, I am as edgy as they say.