When Viacom hired Bear Stearns to shop its Blockbuster Video franchise at the end of last year, many of the top names in private equity were rumored to be interested in the property. Carlyle, KKR, Providence Equity, Texas Pacific Group and others were named potential bidders for the video rental chain, but after a protracted ?get-to-know-you period,? the slow-growth Blockbuster was left without any suitors, forcing Viacom to eventually decide on a split-off of the business.
Leonard Green & Partners, meanwhile?a name that was noticeably absent from the Blockbuster discussions ?turned its attention to the relative upstart in the space, Hollywood Entertainment, which itself was dealing with the alienation of the public markets. And earlier this month, the West Coast firm agreed to acquire the Portland, Ore.-based business in a going-private transaction valued at $1.2 billion.?We circled around Blockbuster, and gave it a look, but we didn?t really get up close,? Leonard Green Partner John Baumer told Buyouts. ?Hollywood has higher margins and higher comparable-store increases, and we really like the management team? We feel the company has much more room to grow. It?s under-penetrated in many markets, particularly on the East Coast and in the Midwest, and historically the company has produced high cash flows, with a high return on investment.?
Leonard Green agreed to pay $14 a share for the business, representing a premium of 30% over its stock price a session prior to the deal?s announcement. Based on an 8K filed with the Securities and Exchange Commission, UBS AG will finance the transaction with a $400 million term loan, $400 million in unsecured senior notes, and $200 million in unsecured senior subordinated notes, while Leonard Green and Hollywood Founder Mark Wattles will provide a minimum of $219 million of equity. Leonard Green, which will split ownership of Hollywood down the middle with Wattles, will use its $1.85 billion Green Equity Investors IV, L.P. fund for the transaction.The deal is expected to close in the third quarter, and Leonard Green negotiated a $26.5 million termination fee as part of the agreement.
An Unkind Industry Rewind?
Amid a push by digital cable and alternative offerings from mail-order outfits such as Netflix, retail video-rental chains have felt a chill from the public market, as investors question the growth prospects of the industry. And, due in part to the rise of other video alternatives, Hollywood Video?s stock has been languishing since the last quarter of 2003, settling at a two-year low as recently as March.
Leonard Green, though, feels the pullback has been exaggerated, which opened the door for this investment. ?There?s been a lot of turmoil in the industry, and that created an opportunity for us,? Baumer said. ?We feel the market has misread and overreacted to some of the trends. The stock is priced right now like there won?t be any place for the video-rental industry in the future? Obviously there are threats, but in our judgment they are much less of a threat than the market believes.?
However, while Leonard Green was able to capitalize on the weakness of the stock to buy the company at an attractive price, most analysts believe there will likely be some resistance from current Hollywood shareholders to sell at the given valuation.Bear Stearns International, in a note to clients said, ?To the extent that shareholders are unhappy with the timing and valuation of the proposed transaction, we could likely see some lawsuits emerge over the near-term,? which, the firm added, would make ?likely that the Leonard Green & Partners offer could be sweetened.?
To grow the business, Leonard Green will rely primarily on organic growth, stemming from the addition of new stores in areas where the company is under-penetrated. ?We won?t be looking to do anything radically different. We?re teaming with the existing management so we expect that it will be business as usual? The company has always shown an outstanding return on investment for new stores, and it?s likely that we will continue to find other products and services to sell in the existing stores,? Baumer said. Hollywood Video, for 2003, reported full-year adjusted net income of $90 million on sales of $1.7 billion, representing jumps of 17% and 13%, respectively, over the year ago period.
Hollywood Entertainment owns and operates of the more than 1,900 Hollywood Video stores and roughly 600 video-game specialty Game Crazy outlets. ?K.M.