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Split Down the Middle as Tension Mounts on Hollywood Entertainment

The battle of the bond analysts.

Scripts don't get any better than this. At least not on Wall Street.

On one side we have

Fox Entertainment Group

(FOX) - Get Fox Corporation Class B Report

and

Rentrak

(RENT)

, a distributor of video tapes, which have sued video rental company

Hollywood Entertainment

(HLYW)

, alleging various accounting improprieties.

On the other we have Hollywood, which has denied all wrongdoing.

On one side we have one of my very best and smartest sources, who is very long Hollywood. He has gone so far as to hire a law firm to comb through every detail of two lawsuits. A brief compiled by

his

law firm suggests the suits are a joke.

On the other we have another one of my very best sources, who is very short Hollywood. He, too, has also combed through every detail of the two suits, and actually hired law firms to sit through hearings related to the suits. His interpretation: The suits could bring Hollywood down.

And, finally, on the Hollywood side we have Jerry Hirschberg, a debt analyst for

Standard & Poor's

, who recently placed Hollywood on CreditWatch with positive implications -- a good thing.

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On the raising-a-warning-flag-on-Hollywood side we have

Moody's

analyst Marie Menendez, who recently downgraded Moody's rating on the company's bank debt and changed her ratings outlook to negative.

Of all the differences, Hirschberg's and Menendez's may be the most striking. Bond analysts, by nature, tend to be more critical than stock analysts because they report for investors who have first claim on a company's assets. If they're doing their job right, especially with a deeply in-hock company like Hollywood, they should be an early warning sign of trouble.

In this case, the differences in their interpretations couldn't be more acute.

Hirschberg likes the industry growth trends, isn't concerned about whether the company has the cash to cover its interest obligations and believes the company will benefit along with rival

Blockbuster

from the recent trend toward revenue-sharing with movie studios. (Such revenue-sharing agreements allow both Blockbuster and Hollywood stores to stock dozens of copies of the latest and greatest movies by sharing the revenue with the movie studios.)

Menendez's less-than-enthusiastic analysis, on the other hand, cites uncertain business conditions, questions the company's ability to pay interest on debt and critiques that very same trend toward revenue-sharing.

Hirschberg believes revenue-sharing should help Hollywood and Blockbuster take additional share from smaller competitors. Menendez, on the other hand, thinks it's only a matter of time before revenue-sharing spreads to these smaller competitors.

And Menendez believes revenue-sharing has caused Hollywood to lose its edge over Blockbuster because Hollywood has

always

spent heavily on its own to have enough of the hot movies in stock. "That helped them in the early growth years," she says. "When revenue-sharing came in that went away."

As a bond analyst, Menendez measures the probability of default and the severity of the possible loss. She notes that Hollywood has a $300 million line of bank credit, and banks are at the top of the claim-to-assets food chain. Tapes are its most liquid asset, which means they're the easiest to sell.

If for some reason Hollywood were to run into a serious cash squeeze, and was forced to sell its tape inventory to pay back debtholders, she believes "the certainty of the value

of the tapes has severely deteriorated because of the sheer number of tapes pouring into the market."

A Hollywood spokesman, however, says the company is selling more tapes at a higher price than ever before.

This is getting better than a B-rental.

Herb Greenberg writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, though he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at

herb@thestreet.com. Greenberg also writes a monthly column for Fortune.