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Circuit City is finally throwing in the towel.
Confronted with weak sales, impatient shareholders and a pummeled consumer, the electronics chain has capitulated and retained Goldman Sachs to help negotiate a deal.
Circuit City also headed off a potentially nasty proxy fight with activist investor Mark Wattles by agreeing to nominate three of the investor's candidates to its board.
The moves, made earlier this month, almost certainly presage a sale of Circuit City Stores (CC, news, msgs), likely to Blockbuster (BBI, news, msgs), where Carl Icahn has stepped up and agreed to finance a Circuit City acquisition.
Icahn, Blockbuster's largest shareholder -- has bought into a "game-changing" scheme announced last month in which the troubled electronics retailer would be combined with the troubled movie retailer to create a new national chain selling consumer hardware and software.
Wall Street is dubious, and no other buyers have emerged wanting Circuit City.
"(There's) a lack of potential bidders beyond Blockbuster," says Matthew Fassler, an electronics retail analyst at Goldman Sachs (GS, news, msgs).
There are numerous reasons buyers beyond Icahn are not lining up. Circuit City is in an extremely competitive business with heavy pressure from Wal-Mart Stores (WMT, news, msgs).
At the same time, Circuit City comes saddled with 682 locations, many of which are in poor and underperforming areas, a fact that CEO Philip Schoonover often refers to when discussing his company's poor performance.
"While the Circuit City board has confidence in the company's ability to successfully implement its turnaround plan and generate shareholder value, we believe that we can best serve the interests of our shareholders by exploring all possible alternatives to enhance shareholder value," Schoonover said May 9.
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Circuit City's moribund prospects are likely to turn even gloomier, with U.S. consumer spending in the doldrums and unlikely to recover in the near term. In March, the Commerce Department reported that spending grew just 0.1% and much of that was for necessities such as medical care and haircuts, not the electronics gear found at Circuit City.
Indeed, the competitive pressures are so high that even the leader in the business, Best Buy (BBY, news, msgs), is looking to diversify overseas with a $2.1 billion investment in Europe's largest cell-phone retailer, Carphone Warehouse Group of London. With a market capitalization of $844 million, Circuit City is effectively valued by the market at less than half of Best Buy's investment in Carphone Warehouse.
Circuit City is reeling from five consecutive quarters of declining sales at stores that have been open for a year or more, after increased competition from discount retailer Wal-Mart and warehouse club Costco Wholesale (COST, news, msgs). Last year, several electronics stores were decimated -- CompUSA shuttered all its stores before being bought by a restructuring firm in December, and Tweeter Home Entertainment, Harvey Electronics and Rex Stores filed for bankruptcy.
"This is the kind of mess the electronics business is in -- it's like buying a sinking Titanic," says Howard Davidowitz, chairman of Davidowitz & Associates, a national retail consulting and investment banking firm in New York.
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Shareholder turns up the heatMark Wattles, owner of 6.5% of Circuit City shares and a critic of the company's turnaround efforts, sees benefits in a buyout by Blockbuster or another potential suitor.
That's because Blockbuster has its own litany of troubles. Blockbuster has been forced to reckon with a shift from on-site movie rentals to new venues, with increased competition from video rental models like the one from Netflix (NFLX, news, msgs) and downloads from Apple (AAPL, news, msgs).
"The question is, will the combination of two crippled companies end up crippling both even further," says Burt Flickinger III, managing director of Strategic Resource Group, a retail consultancy in New York.
The one hope, Flickinger says, is Blockbuster CEO Jim Keyes, who came on board in July with Icahn's backing and replaced John Antioco. Keyes, who had engineered a turnaround at 7-Eleven, has started re-investing in Blockbuster's 7,800 brick-and-mortar stores and pulled back from the online DVD rental market that Antioco had invested in heavily. Keyes also has recently shifted to selling DVDs and video games at Blockbuster stores. He bought Movielink.com last year with plans to make movie downloading to televisions available.
Under his leadership, Dallas-based Blockbuster expects to return to profitability this year.
Almost all of Wall Street, and many in the tech community, are puzzled by Keyes' pursuit of Circuit City. Keyes envisions a new digital retail company that leverages complementary products and higher-quality, better-focused store sites.
"Combined, our companies would create a game-changing $18 billion global retail enterprise that is uniquely positioned to capitalize on the growing consumer appetite for content-enabled consumer devices," Keyes said.
In the short term, Keyes said, the companies would trim costs by combining operations and by likely selling the weakest-performing stores. At the same time, he expects that the new, larger company would be able to bolster its buying muscle with vendors and strike better prices.
Keyes also anticipates cross-merchandising opportunities, and the opportunity to sell electronics with access to personalized preloaded movies and digital subscriptions.
"That is what I mean when I say game-changing entertainment retail concept," Keyes said.
This article was reported and written by Pallavi Gogoi for BusinessWeek.
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