US CREDIT-Blockbuster debt gains after Circuit City dropped

By Karen Brettell

NEW YORK, July 7 (Reuters) - Blockbuster Inc's (BBI.N: Quote, Profile, Research, Stock Buzz)
abandonment of its bid to acquire Circuit City Stores Inc
(CC.N: Quote, Profile, Research, Stock Buzz) removed some event risk hanging over its debt, and if
the movie rental chain records further earnings improvement,
its bonds could go still higher.

The risk of Blockbuster making a renewed bid for Circuit
City, however, could be negative for its debt if it exposes
Blockbuster to long-term store leases in underperforming
locations.

Blockbuster's Chief Executive Jim Keyes cited "market
conditions" last Tuesday as a reason for withdrawing its offer
for Circuit City, valued at up to $1.3 billion, and said the
deal was not in the best interests of its shareholders. For
details, see [ID:nN01311841]

The company's 9 percent bonds due 2012 rose to 84.25 cents
on the dollar on Monday, from 82 cents before the
announcement, according to MarketAxess.

The cost to insure Blockbuster's debt with credit default
swaps dipped to around 1,040 basis points, or $1.04 million
per year for five years to insure $10 million in debt, from
1,094 basis points before the news, according to Markit.

JPMorgan analyst Carla Casella raised her recommendation
on Blockbuster's debt to "overweight" from "neutral," where
she put the debt after the Circuit City bid was announced.

RISKS VS BENEFITS

Bondholders had been concerned that Blockbuster would tap
its credit facility to finance some of the acquisition, and
this debt would rank above its unsecured bonds. Circuit City
was also viewed as unattractive by some analysts as it has
negative cash flow and expensive long-term leases.

"Management still believes there would have been
considerable synergies between the two businesses, and that
buying a retailer would have given it access to much needed
retail point of sale and logistics systems," Casella said in a
report.

However, Blockbuster can build those systems for $300
million over the next three to five years, which is cheaper
than the risks of taking on bad leases and negative cash flow
of Circuit City, she said.

"If Circuit City were to file for bankruptcy, we would
expect Blockbuster to take another look," she added.

Blockbuster's credit profile weakened in 2007 on worsening
operating performance as store closures and investments in its
online business ate into its margins.

Turnaround efforts helped Blockbuster post
better-than-expected profits for the fiscal first quarter in
May, boosted by cost cutting, including store closures,
reduced advertising and overhead expenses and better product
mix. [ID:nN15525467]

JPMorgan's Casella expects improvements in its credit
profile to continue, adding that Blockbuster's Keyes told her
in a recent meeting that the company remains focused on
generating cash flow and reducing debt.

The company is likely to generate earnings before
interest, taxes, depreciation and amortization, or EBITDA, of
$350 million for 2008, more than the $250 million required to
meet covenants on its debt, she added.

Blockbuster's appetite for Circuit City, however, leaves
lingering event risk on its debt, and the company needs to
show further earnings improvement, said Gimme Credit analyst
Kim Noland, who retained an "underperform" recommendation on
its debt.

"Blockbuster's struggling business model is a concern
despite substantial improvement in recent results and event
risk has not disappeared," Noland said in a report.
(Editing by Jan Paschal)