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The Video Store Shakeup Could Hurt Strip Center Owners

Less than two weeks after video rental leader Blockbuster Inc. launched a hostile takeover bid for Hollywood Entertainment Corp., Hollywood surprisingly accepted a $1.2 billion buyout offer from third-ranked Movie Gallery. Hollywood teamed with the smaller buyer rather than tempt the Securities and Exchange Commission's ire by creating a behemoth that could raise antitrust questions.

Blockbuster could come back with another bid. Movie Gallery's offer only values Hollywood at $13.25 per share. And the breakup fee in the deal is a relatively low $27 million. Industry analysts think that Blockbuster may be more than willing to cough up that fee and raise the offer price to $14 or $15 per share.

All of this drama is occurring during a tumultuous time for video stores. The explosion of the DVD-rental-by-mail programs run by Netflix and Wal-Mart has forced big changes. In recent months both Blockbuster and Hollywood launched store rental programs with Netflix-like terms: flat monthly rates with unlimited rentals.

Blockbuster, in turn, also runs an online service to compete with Netflix and Wal-Mart. The three have engaged a pricing war, with each firm lowering rental costs in the past six months. Blockbuster is the low-cost king at $14.99 per month.

Blockbuster -- with much fanfare -- also ended its unpopular late fees this month. (In reading the fine print, however, you learn that by keeping a movie for more than a week, the renter is charged the purchase price of the movie. If the movie is returned within 30 days, though, the renter can get a refund, minus a "restocking" fee.) By dropping late fees, Blockbuster is forfeiting $250 million to $300 million in operating profits, banking that the loss of fees will be offset by greater rentals.

Also a blow to video chains, the use of video-on-demand services is increasing. The threat they pose, however, is muted because of the large gap between the time movies are released on DVD vs. on demand

"Although we acknowledge the benefits of video-on-demand, we do not recognize the service as a real threat until the window between the video rental release date and the VOD release date closes meaningfully," wrote Arvind Bhatia, a video rental analyst for Southwest Securities. The average lag is between 40 and 50 days, according to Bhatia's report.

Rental spending in 2004 totaled $8.1 billion, down about 0.4 percent from 2003.

How will the changes impact brick-and-mortar locations? A merger between Blockbuster and Hollywood would create redundancies in many markets and likely lead to a large number of store closings. But if Movie Gallery's bid stands, there is less cause for concern.

Movie Gallery, though not as well known as Blockbuster or Hollywood, has grown swiftly in10 years. It operates 2,475 stores nationwide and purchased 200 companies (predominantly local chains). Hollywood operates 1,920 video stores and 600 video game stores. Blockbuster has 9,000 stores.

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