April 13, 2007

Research Associate: Shrabana Mukherjee, MBA Editor: Sanjay Chowdhary, M.Fin.

Sr.Editor: Ian Madsen, CFA: ; 1-800-767-3771; x9417

www.zackspro.com 111 N. Canal Street, Suite 1101 l Chicago, IL 60606

Blockbuster Inc. / (BBI-NYSE) / $6.52

Note: All new or revised material since the last update is highlighted.

Reason for Report: CEO's Departure Prev. Ed: March 12, 2007

Recent Events

On April 13, 2007, BBI announced that it has named company veteran Nick Shepherd, Senior Executive Vice President and Chief Operating Officer. In his new position, Shepherd will be responsible for all aspects of the company's global store and online operations. He will continue reporting to John F. Antioco, Blockbuster’s Chairman and CEO.

On March 20, 2007, CEO John Antioco said that he would leave the company by year-end 2007 and accept a smaller bonus for 2006 than called for in his contract. He will receive a bonus of $3.5 million, below 7.7 million, claimed by him.

Blockbuster Inc. is in advanced talks to acquire Movielink LLC, an online movie-downloading company owned by the major Hollywood studios.

On February 22, 2007, Blockbuster Inc. announced that it has agreed to sell its Australian subsidiary and grant master franchise rights to rental chain Video Ezy as part of a plan to divest its foreign operations.

On February 27, 2007, BBI reported its 4Q06 and FY06 results. Highlights are as follows:

·  Total revenue was $1.51 billion in 4Q06, an increase of 1.4% y/y; and in FY06, total revenue was $5.52 billion, a decrease of 3.5% y/y.

·  Net income in 4Q06 was $12.9 million, compared to $18 million in 4Q05; and adjusted net income in 4Q06 was $20.4 million, compared to adjusted net income of $25 million in 4Q05. In FY06, net income totaled $54.7 million, compared to a net loss of $588.1 million in that year-ago period.

·  Adjusted EPS in 4Q06 was $0.09, compared to $0.12 in 4Q05. In FY06, adjusted EPS was ($0.03), compared to ($0.40) in FY05.

On January 1, 2007, Blockbuster Inc. stated that it has completed the sale of its Taiwan unit to Webs–TV Digital International for an undisclosed amount. The deal included 89 company-owned and 40 franchise stores.

On January 1, 2007, Blockbuster Inc. announced that it has agreed to sell its Rhino Video Games chain to GameStop Corp. for an undisclosed price.

Overview

Headquartered in Dallas, Blockbuster Inc. (BBI) is a leading global provider of in-home movie and game entertainment, with more than 8,000 stores throughout America, Europe, Asia, and Australia. The company offers prerecorded videos as well as video games for in-store rental, sale and trade, and sells other entertainment-related merchandise. The company also operates through Blockbuster Online, an online service-offering rental of movies delivered by mail. More information on the company can be obtained from BBI’s website: http://www.blockbuster.com

According to analysts, investors should make an investment decision based on their assessment of the following issues:

Key Positive Arguments / Key Negative Arguments
·  BBI’s initiatives to drive growth in both active members in stores and subscribers for Blockbuster Online would support revenue and profit growth in an otherwise declining in-store rental industry.
·  BBI’s ability to integrate its online services with in-store offerings provides the company with a distinct competitive advantage.
·  BBI continues to focus on improving its profitability, growing market share and reducing SG&A costs, which analysts believe is the right strategy under current industry conditions.
·  Analysts believe BBI has positioned itself well to gain share from its competitors that have no online service. / ·  BBI faces increased competition from retail mass merchant sales of low-priced DVDs, online rentals, and other sources of in-home entertainment, such as digital video recorders and other devices that are capable of downloading content for in-home viewing.
·  BBI is affected by piracy in certain international markets and from other forms of leisure entertainment.
·  BBI shares could suffer if other companies, like Amazon.com, make a high profile and successful entry into the online DVD subscription business.

Note: The company’s fiscal year ends on December 31.

Revenue

CONSENSUS PROJECTED SALES

FY Ends Dec / 4Q05A / 2005A / 1Q06A / 2Q06A / 3Q06A / 4Q06A / 2006A / 2007E / 2008E
Rental Revenue / $1,040 / $4,206 / $1,064 / $990 / $998 / $996 / $4,039 / $4,051↓ / $4,027↑
Merchandise Sales / $473 / $1,587 / $349 / $314 / $316 / $502 / $1,457 / $1,429↓ / $1,463↓
Other / $18 / $73 / $16 / $14 / $16 / $16 / $61 / $58↑ / $57↑
TOTAL REVENUE / $1,531 / $5,864 / $1,429 / $1,319 / $1,329 / $1,513 / $5,564 / $5,510↓ / $5,508↓
Same-Store sales / -10.1% / -4.9% / -5.2% / -2.5% / -1.4% / -0.7% / -2.1% / 3.0%↔ / 2.8%↓
Store growth / -0.6%
TOTAL REVENUE ( $ in millions) / 4Q05A / 2005A / 1Q06A / 2Q06A / 3Q06A / 4Q06A / 2006A / 2007E / 2008E
Digest Average / $1,531 / $5,864 / $1,429 / $1,319 / $1,329 / $1,513 / $5,564 / $5,510↓ / $5,508↓
Digest High / $1,531 / $5,864 / $1,429 / $1,319 / $1,329 / $1,513 / $5,591 / $5,637↔ / $5,713↓
Digest Low / $1,531 / $5,864 / $1,429 / $1,319 / $1,329 / $1,513 / $5,524 / $5,368↔ / $5,352↔
Digest Average YoY Growth / -3.1% / -7.7% / -5.7% / -4.1% / -1.1% / -5.1% / -1.0%↑ / 0.0%↓
Quarterly growth / 10.4% / -6.6% / -7.8% / 0.8% / 13.8%

The company reported that revenue in 4Q06 increased 1.4% to $1.51 billion, compared with $1.49 billion in the year-ago period, primarily due to an increase in worldwide same-store merchandise sales and favorable foreign exchange rates. Total revenue in the period also included the favorable impact of an approximately $30 million increase in revenue from Blockbuster's online rental service, which added approximately 700,000 online rental subscribers during the fourth quarter, including approximately 500,000 paying subscribers. According to Zacks Digest average total revenue in 4Q06 was $1.51 billion, down 1.1% compared to the year ago period.

Revenue in FY06, according to the company, decreased 3.5% to $5.52 billion from $5.72 billion in FY05, mostly due to the closure of stores resulting from accelerated actions to optimize the company's asset portfolio and a 2.1% decrease in worldwide same-store sales. According to Zacks Digest average total revenue in FY06 was $5.59 billion, down 4.7% compared to the year ago period.

Worldwide same-store sales included the favorable impact of a $105.5 million increase in sales at Blockbuster's online rental service resulting from growth in the subscriber base, which nearly doubled to approximately 2.2 million subscribers, including approximately 2 million paying subscribers, at the end of 2006.

Rental revenue was $996.1 million in 4Q06, a decrease of 4.2% y/y and 0.2% q/q, driven mainly by the smaller store base. The disappointing result is attributable to the weakness in the rental of DVDs, which generated $876.9 million in revenue (down 4.4% y/y), and games, which contributed $98.5 million in revenue (down 19.5% y/y).

Management attributed the softness to: 1) unseasonably warm weather, 2) aggressive discounting by retailers on DVD sales, and 3) a low installed base for new generation game platforms.

Despite the weakness in rentals, BBI appears to be increasing its market share. The company’s domestic rental same-store sales increased 0.3% y/y. This is the fourth consecutive quarter of positive same-store domestic movie rental sales. According to Zacks Digest, average rental revenue in FY06 was $4.04 billion compared to $4.2 billion in the year ago period.

Merchandise revenue was $501.7 million in 4Q06, an increase of 6.2% y/y, driven by game sales that despite the greater-than-expected store closures. Game sales increased 15.5% y/y to $269.5 million, attributable to strong merchandise same-store sales internationally (+21.8%) and offset to some extent by weakness in domestic markets (-14.0%). DVD sales, which came in at $141.8 million, decreased 6.5% compared to year ago period. According to Zacks Digest, average merchandise revenue in FY06 was $1.48 billion compared to $1.58 billion in the year ago period.

One firm (Citigroup) believes that domestic game rentals would pick up due to: 1) strong recent rental data and 2) widespread new platform adoption.

Please refer to the Zacks Research Digest spreadsheet on BBI for more details.

Margins

CONSENSUS PROJECTED MARGINS

Margins / 4Q05A / 2005A / 1Q06A / 2Q06A / 3Q06A / 4Q06A / 2006A / 2007E / 2008E
Gross / 51.8% / 54.9% / 56.1% / 55.9% / 56.4% / 51.8% / 55.0% / 54.5%↑ / 54.2%↓
Operating / 4.6% / -0.1% / 1.6% / -0.3% / 0.5% / 3.1% / 1.4% / 1.9%↓ / 2.7%↓
Pre-Tax / 2.9% / -1.7% / -0.3% / -1.9% / -1.3% / 1.7% / -0.3% / 0.7%↔ / 1.9%↓
Net / 2.2% / -1.3% / 0.7% / -1.6% / -1.1% / 1.2% / 0.1% / 0.0%↓ / 0.8%↓

According to the company, gross profit increased $7.8 million y-o-y primarily due to the increase in merchandise revenue, which was driven primarily by strong games sales internationally. The gross margin in 4Q06 remained essentially flat year over year at 51.8%. FY06 gross margin increased to 55% compared to 54.9% in FY05. Operating income in 4Q06 totaled $45.8 million, compared to operating income of $57.0 million in the year-ago period. Total 4Q06 SG&A expense increased $17.9 million y-o-y largely due to increased promotional activities and costs incurred to launch and support Blockbuster Total Access.

Operating income in FY06 totaled $79.1 million versus an operating loss of $388.0 million in the year-ago period, which included a $341.9 million non-cash charge to impair goodwill and other long-lived assets. According to Zacks Digest, average operating income was $67 million in FY06 compared to operating loss of $4.5 million in the year ago period. Adjusted operating income increased $133.2 million to $115.4 million in FY06 from an adjusted operating loss of $17.8 million in FY05, mostly driven by the ongoing cost containment initiatives that the company began during 3Q05.

In FY07, one firm (BMO Capital) expects an increase in advertising expenditure to offset the much-improved operating margin. It, however, expects a decrease in depreciation and interest expenses to improve earnings year over year. Importantly, it believes the increased advertising expenditure is important for Blockbuster to strengthen its competitive position in a highly-competitive industry.

Please refer to the Zacks Research Digest spreadsheet on BBI for more details.

Earnings per Share

According to the company, in 4Q06, net income was $12.9 million or $0.05 per diluted share, compared with 4Q05 net income of $18.0 million or $0.09 per diluted share. Adjusted net income in 4Q06 totaled $20.4 million or $0.09 per diluted share, compared with adjusted net income of $25.0 million or $0.12 per diluted share in 4Q05.

For FY06, the company reported net income of $54.7 million or $0.23 per diluted share, compared with FY05 net loss of $588.1 million or $3.20 per diluted share. Excluding the favorable resolution of multi-year tax audits, store closure and severance costs as well as certain other items, adjusted net income in the full-year 2006 totaled $6.3 million or $0.03 loss per diluted share, compared with an adjusted net loss of $73.6 million or $0.40 per common share in FY05. Zacks digest average of diluted EPS is ($0.07) in FY06 compared to ($0.40) in FY05.

FY ends Dec / 4Q05A / 2005A / 1Q06A / 2Q06A / 3Q06A / 4Q06A / 2006A / 2007E / 2008E
Digest High / $0.12 / ($0.40) / $0.05 / $0.30 / ($0.07) / $0.09 / $0.21 / $0.20↔ / $0.45↓
Digest Low / $0.12 / ($0.40) / ($0.03) / ($0.16) / ($0.15) / $0.05 / ($0.13) / ($0.11)↓ / ($0.06)↓
Digest Average / $0.12 / ($0.40) / $0.04 / ($0.06) / ($0.09) / $0.08 / ($0.02) / $0.01↓ / $0.26↓
Digest YoY Growth / -152.6% / 114.1% / 75.0% / 30.8% / -30.6% / 96.3% / -166.7%↓ / 2500.0%↑
Quarterly Growth / 192.3% / -69.4% / -250.0% / -63.6% / 192.6%

Highlights from the chart are as follows:

·  2007 forecasts (6 analysts) range from ($0.11) to $0.20; the average is $0.01.

·  2008 forecasts (5 analysts) range from ($0.06) to $0.45; the average is $0.26.

Please refer to the Zacks Research Digest spreadsheet on BBI for more details.

Target Price/Valuation

The average Zacks Digest price target of the analysts providing such a number is $7.70 (↓ from previous report; 18.10% upside from current price). The price target ranges from $6.00 (7.98% downside from current price) to $9.00 (38.03% upside from current price). The analyst (BMO Capital) with the lowest target price of $6.00 has used the DCF method to calculate the target price. Two analysts with the highest target price of $9.00 (Sterne, Agee & Leach, Wedbush) used sum-of-the-parts analysis, and 20X untaxed FY08 estimated EPS of $0.45, respectively, to value the shares.

Rating Distribution
Positive / 50.0%
Neutral / 50.0%
Negative / 0.0%
Avg. Target Price / $7.70 ↓
Digest High / $9.00
Digest Low / $6.00↓

Please refer to the Zacks Research Digest spreadsheet on BBI for more details.

Capital Structure/Solvency/Cash flow/Governance/Other

Cash flow from operations increased $399.9 million to $329.4 million in FY06 from $70.5 million deficit FY05 driven by an improvement in profitability. Free cash flow (net cash flow from operations minus capital expenditure) improved $460.8 million to $250.9 million FY06 from a negative $209.9 million in FY05. Total debt in 4Q06 was $984.2 million, down $10.6 million from $994.8 million in the year-ago period.