Blockbuster Seems Headed for Bad Ending

Not every stock priced below $10 a share will be a profitable investment. Some of the companies trading at these prices are doing so because their operations are in disarray or their business segments in severe decline.

One great example of this is Blockbuster(BBI Quote), the giant video retailer. Indeed, the entire video-rental market is ailing, mainly due to negative same-store sales results, competition from video-on-demand (VOD), overleveraged balance sheets and plans by movie makers to release their titles through VOD and in cinemas at the same time.

Given all these headwinds, Blockbuster is a stock that is best avoided.

At the end of 2005, Blockbuster operated 7,158 company-owned movie-rental stores and 1,884 franchised stores, and generated revenue from its newest initiative, online movie rentals, where it competes with the likes of Netflix(NFLX Quote) The company also generates approximately one-third of its revenue through selling merchandise in its stores, though this business carries significantly lower gross margins, about 22% vs. almost 70% for video rentals.

From a fundamental standpoint, Blockbuster's financials are dismal, at best. The company has delivered negative same-store sales for the past three years, been forced to amend its credit agreement with JPMorgan three times, and completed a recent $150 million convertible preferred offering that showed signs of financial desperation, as it was done to meet creditor leverage demands.

Blockbuster reported its fourth-quarter and full-year earnings results in early March. For the quarter, revenue declined by 11% from the same quarter a year ago, to $1.53 billion, and the company delivered a profit of 17 cents a share. For the full year, sales declined 3.1% to $5.86 billion, and the company lost $70 million in operating income vs. an operating profit of $170 million in 2004. Despite the decline in revenue, the company's cost of goods sold increased, which compressed gross margins enough to weigh on operating results.