DALLAS - Blockbuster may be forced into bankruptcy after a bungled effort to compete in the online video rental market, shareholders say in a federal class-action claim against Blockbuster and Viacom.
Plaintiffs say the company misled them about its debt obligations, which have crippled Blockbuster's restructuring effort as it tries to compete with rival Netflix, Inc., an online-only video rental service. Blockbuster acknowledged in an SEC filing on Tuesday that it "may not have sufficient cash flows from operating activities, cash on hand and available borrowings under (its) credit facilities to service (its) indebtedness." If it is unable to raise additional funds through a private offering, it may have to file for bankruptcy protection. As the defendants tried to redesign themselves to compete in the online market, Viacom divested its sizable stake in Blockbuster, offering Viacom shares in exchange for 144 million common shares of Blockbuster. Blockbuster then took on over $1.1 billion in debt to pay a $5 special dividend, of which Viacom was the primary beneficiary, the suit states. In the related prospectus, the defendants made bold assurances that Blockbuster was to "transform itself ... from a place where you go to rent a movie to a brand where you go to rent, buy or trade a movie or game, new or used, pay-by-the-day, pay-by-the-month, in-store or online." This would rely heavily on the integration of its online subscription service with its 9,100 brick-and-mortar video stores, among other initiatives. Blockbuster stated that debt obligations would not hinder this effort, that cash flow from the core in-store business would sustain the transformation. But it was wrong. Blockbuster missed company estimates for the second quarter, recording a net loss of more than $57.2 million on Aug. 8. Last Tuesday, Blockbuster acknowledged in its latest SEC filing that it "may not have sufficient cash flows from operating activities, cash on hand and available borrowings under (its) credit facilities to service (its) indebtedness." If Blockbuster is unable to raise additional funds through a private offering, it fears it may have to file for bankruptcy protection. What happened? The plaintiffs say the defendants knew they were "wholly unprepared to build the technological infrastructure necessary" for the integration of the in-store and online businesses. Blockbuster stores were powered by aging computer servers that kept charging online customers late fees. This forced the company to do away with all late fees, even those for non-online customers, the suit states. This erased a profitable source of revenue and, worse, introduced the much-maligned "No More Late Fees" policy that has infuriated customers and state attorney generals and led to a slew of class-action lawsuits. The policy forces a customer to purchase a video after a one-week grace period has expired - a return can be made but customers then get hammered with a restocking fee. Meanwhile, Blockbuster has engaged in a pricing war with Netflix that has forced it to slash online subscription rates by more than 50 percent, to as low as $9.99 per month.
All the while, the plaintiffs' shares have been in free fall - shares closed Thursday at $4.07, more than 60 percent below the 52-week high of $10.65. Plaintiffs are represented by Randall Pulliam with Baron & Budd, P.C. in Dallas and Steven Schulman with Milberg Weiss Bershad & Schulman LLP in New York.
