Bankruptcy Is Blockbuster's Only Hope

(Blockbuster bankruptcy article updated with S&P rating and commentary from the company.)

NEW YORK ( TheStreet) -- Blockbuster's ( BBI) warning that bankruptcy might be looming is a scare for investors who fear for the value of their stock -- but could ultimately be a smart move for the company.

Blockbuster

The video rental store declared in a Securities and Exchange Commission filing on Tuesday that it might be forced to file Chapter 11 if cash flows don't improve and it is unable to restructure its debt. Blockbuster's reportedly has about $1 billion in debt. "These factors raise substantial doubt about our ability to continue as a going concern," Blockbuster said in the filing.

As a result, Blockbuster's shares plunged 30% to close at 28 cents on Wednesday. While the move could ultimately be beneficial for the company, investors fear a bankruptcy filing would leave common shares practically worthless. Shares rallied a bit Thursday in after-hours trading following positive comments from CEO James Keyes, gaining 3.3% to 29 cents.

Still, a voluntary bankruptcy, while painful, may be its only way out, Needham analyst Charles Wolf says.

The news prompted Fitch ratings to cut Blockbuster's rating to C from CCC and downgraded its $675 million in senior secured notes to CC/RR3 from B/RR2. Fitch also affirmed $300 million in senior subordinated notes at C/RR6, which it said reflects poor recovery prospects in a distressed case.

The ratings agency said Blockbuster needs to restructure a large portion of its debt and expects its credit situation to continue to weaken in 2010. Similarly, Standard & Poors also downgraded Blockbuster's corporate credit rating to a "most speculative" grade of CC from CCC. "The CC rating indicates that, in our opinion, Blockbuster is highly vulnerable to default," said S&P in a statement.

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