The Viacom International Inc.-Paramount Communications Inc. merger is just the beginning of Blockbuster Entertainment Corp. shareholders' troubles.
In a separate deal, Blockbuster and Viacom are supposed to merge in April in an $8.4 billion deal. The announcement of the merger last month strengthened Viacom's ultimately successful bid for Paramount over QVC Network Inc. because Blockbuster has a strong positive cash flow and very low debt, which would help Viacom reduce the $8 billion in debt incurred through the Paramount merger.
"None of the Blockbuster shareholders like this (Viacom-Paramount-Blockbuster) deal and we, and many other shareholders, have told Blockbuster management what we think," said Mark Goldstein, a partner at Neuberger & Berman, New York, and manager of the Manhattan Fund mutual fund.
"Blockbuster was a great investment for us. We tripled our money and loved the company when it was a nice, simple video chain that generated a lot of excess cash flow, had no debt and expanded well with that cash flow into records, studio investments and some movie work."
But Mr. Goldstein has been paring his position in the last four or five months, reducing his holding from about 2.5% of his portfolio, to a bit above 1%. He would not say how many shares that represents.
"I bought Blockbuster when it was between 11 and 13 per shareSee Merger on and sold about a third of my position when it was between 32 and 35 per share. It has been an outstanding investment, but is much less so with the Viacom deal hanging over it," said Mr. Goldstein.
But because Viacom stock has been dropping precipitously in value, many Blockbuster shareholders are more than disgruntled. "What you see here is a strong company like Blockbuster, with excess cash flow and modest valuations to growth, being locked into a company like Viacom, which is going to suck up all that cash flow to pay down debts," said Mr. Goldstein.
"With Viacom, Blockbuster really went off the deep end," he said. "There is going to be a lot of dead money, big debt, for the next two to three years if this deal goes through .*.*. The main goal of Viacom in the Blockbuster deal is to pay down its overleveraged debt in buying Paramount, a second-rate company in a very glamorous industry. Paramount doesn't make Viacom a better company. Neither of those two companies makes Blockbuster a better company. Our only solace is that Blockbuster management is pretty smart, and we may need to give them the benefit of the doubt and hope they do OK."
Judy Haverty, director of equity research at Harbor Capital Management Co., Boston said: "Blockbuster stock isn't being priced based on its fundamentals anymore. Apparently the market doesn't like the deal .*.*. This (Blockbuster) stock on its merits should be selling in the low 30s, but it's in the mid-20s."
Greg Melvin, portfolio manager of the Federated Growth Trust and the Federated Capital Growth Fund, offered by Federated Investors, Pittsburgh, said his company will vote against the Blockbuster-Viacom stock merger. So will Tim Miller, portfolio manager of the INVESCO Dynamics Fund and the INVESCO Leisure Portfolio, both from INVESCO Funds Group, Denver, and Mr. Goldstein of Neuberger & Berman.
Mr. Melvin said it is "extremely rare" for Federated to go against the wishes of company management, but in the case of Blockbuster, it made an exception.
The Federated Growth Trust and Capital Growth Fund hold about 525,000 Blockbuster shares between them.
For some money managers, the spectacle of the Viacom-Paramount deal was enough to convince them to sell off Blockbuster shares before the proposed merger.
Calamos Asset Management Inc., Oak Brook, Ill., sold off its entire position in Blockbuster, about $2 million worth, at $31 per share in late November.
Nick Calamos, director of research, said the firm bought Blockbuster several years ago at $10 per share, "as a franchise when no one else liked it. It's been a great buy for us and will continue to do well, despite critics of video chains. ...
"We don't like being on the buying side of a feeding frenzy. We get extremely nervous and tend to run," he said.
"Let me put it this way. We were on the losing side, and are glad to be sitting here safe on the sidelines," said Tom Weary, a portfolio manager and vice president of Sovereign Asset Management Corp., Berwyn, Pa. Sovereign holds stock in several members of the losing QVC consortium, including QVC, Bell Atlantic Corp. and Tele-Communications Inc. "The bidding for Paramount got really out of hand. We got really nervous with so many bids flying around. Viacom paid an exorbitant amount for Paramount and we're just glad our companies didn't," Mr. Weary said.
"There are universally negative feelings out there about Viacom," said Mr. Miller of INVESCO."Viacom has been flogging this story for four months and it's very clear, no one is buying it. It is self-evident about how the market feels about Viacom. It's show-me time now for Viacom."
Mr. Miller is "grateful" he sold what Paramount shares he did hold to arbitragers around $79 per share. Mr. Miller currently holds a fairly large Blockbuster position, 3 million to 4 million shares, which he intends to hold, pending the results of the next couple months. Blockbuster shares closed at $24.50 per share Feb. 16, down three-quarters. Paramount shares ended Feb. 16 trading at 767/8, per share, down one-eighth.
The negative feelings, however, are not universal.
Dick Hurckes, portfolio manager of the TNE Capital Growth fund from TNE Fund Group, a part of The New England Cos., Boston, holds Blockbuster stock, but does not hold Paramount or Viacom.
"Paramount was one of the last real stand-alone pieces of gem quality," he said. "It was an obvious takeout for someone interested in being a player in the information highway. Viacom had the delivery system, but it didn't have the content. The merger with Blockbuster we feel is going to be done, but the problem with the investor is what they're going to pay."
He added: "Either the price goes up or they're going to have to sweeten the pot."
"Once they get all the people out of the way and you start to stabilize Viacom's price, we think the Blockbuster shareholders will be protected," said Mr. Hurckes.
However the Viacom-Paramount-Blockbuster deal shakes out, many investors remain optimistic about the entertainment sector, particularly in light of the many telecommunications vendors lining up to provide an information superhighway to global consumers. The information highways will need content - movies, music television and television programming - that will have to be provided by entertainment companies.
The Viacom-Paramount-Blockbuster deal is one of the first huge alliances between companies in various media sectors.
Bill Garrison, research analyst on media and entertainment stocks, Stein Roe & Farnham Inc., Chicago, said business executives see potential value in the impact the Viacom-Paramount deal will have on the "industry and its prospects."
Mr. Garrison thinks active money managers will overweight the entertainment sector in their portfolios.
Mercedes M. Cardona and Steve Hemmerick contributed to this story.
