AOL Buys Stake in Blockbuster.com

As part of the deal, the companies will work to develop broadband technology, which could allow AOL to sell or rent movies over the Internet.
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Call it, "You've Got Movies."

America Online

(AOL)

, among the world's best-known Internet companies, is expanding its presence in the real world. The company announced Wednesday that it will pay $30 million for an estimated potential stake of 3% in

Blockbuster.com

, a newly created subsidiary of

Blockbuster

(BBI) - Get Report

, the video rental arm of

Viacom

(VIA.B)

.

The move, intended to buy exposure in Blockbuster's aproximately 6,900 retail stores, is in part another step in AOL's campaign to creep into the world outside the Internet and lure the Web-wary to join its 19 million members. It follows similar deals like the "You've Got Pictures" joint promotion in

Eastman Kodak

(EK)

stores. But the companies also said they will work to develop broadband technology, which could allow AOL to sell or rent movies over the Internet.

"It's pretty crafty, actually," said Paul Noglows, who covers AOL for

Hambrecht & Quist

and rates the stock a buy. The firm doesn't do underwriting for AOL, partly because Hambrecht chairman Dan Case is the brother of Steve Case, AOL chairman and CEO.

"It's no secret that Blockbuster needs to start looking beyond its stores," Noglows said. "What better partner for them than AOL?"

The companies will add AOL's name to Blockbuster's Web site and make it available from AOL's site. America Online has an on-line mall that charges other companies -- including many on-line retailers firmly in the red -- to sell products through the site.

For Blockbuster, the deal marks the beginning of an ambitious campaign to prepare for whichever direction technology takes home entertainment in the next few years.

The company is soliciting $100 million in equities investments in the new Blockbuster.com, over which it plans to retain a 90% stake.

"It's not the dollars," said Shellye Archambeau, senior vice president for e-commerce at Blockbuster. "We're interested in partners that share our vision. We're going to be the market share leader for whatever channel consumers select."

After the announcement, AOL shares gained 5 1/8, or 4%, to 138 1/4 in afternoon trading. And Blockbuster soared more than 11%, rising 1 7/16 to 13 15/16. Meanwhile, the actively traded class B shares of the video chain's parent company, Viacom, fell 1 point to 42 13/16.

AOL closed up 5 13/16 to 138 15/16, Blockbuster ended up 1 3/8 to 13 7/8 while Viacom closed down 13/16 to 43 15/16.

Given technology's path, the Blockbuster deal could signify more than just real-world advertising for AOL. And of the two, Blockbuster is on shakier footing in the arrangement, analysts said.

The partnership extends to developing broadband content and delivery, or the ability to simply sell or rent movies to members directly over the Internet. Blockbuster brings a catalog of movies and arrangements with movie houses to the table. But AOL has the on-line brand name.

"Once broadband is available plentifully, then you don't have to go to Blockbuster anymore," said Ulrich Weil, who covers AOL for

Friedman, Billings, Ramsey

. He rates the stock a buy, and his firm doesn't do AOL's underwriting. "Blockbuster's willing to be more reasonable on the terms because the water is creeping up to their nostrils.

"AOL can't just stomp them out right away," he added, noting that the contract lasts three years.

Archambeau of Blockbuster said the deal places her company in a better position than new Internet retailers.

"They're trying to establish a brand and paying outrageous costs to do that," she said. "We have a brand that's almost 100% recognition in the U.S. I don't have to go build this foundation, I've got it."

Noglows of Hambrecht & Quist noted that to AOL, $30 million is a relatively small investment.