May 9, 2008: 1:29 PM EDT
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Circuit City opens books to Blockbuster

But the electronics retailer says it's still considering alternatives to a Blockbuster takeover.

By John Simons, writer

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Blockbuster's largest shareholder, Carl Icahn, told Circuit City he's ready to buy the company if Blockbuster cannot complete a deal.

(Fortune) -- After a several weeks of playing coy, Circuit City has agreed to allow potential suitor Blockbuster to review its books, setting in motion the process of putting itself up for sale.

In February, Blockbuster CEO Jim Keyes initiated the offer in a private letter to Circuit City CEO Philip Schoonover. "The combination of Blockbuster (BBI, Fortune 500) and Circuit City (CC, Fortune 500) will result in an $18 billion retail enterprise uniquely positioned for the convergence of media content and electronic devices," Keyes wrote. "We would seek to differentiate products in both Blockbuster and Circuit City stores by offering exclusive content and content-enabled devices. Both companies would benefit from complementary products, marketing, management strengths, technology and distribution and the resulting synergies would significantly improve consolidated financial performance."

Blockbuster, the Dallas-based movie rental and retail company operates over 6,000 stores worldwide. In the U.S., 95 percent of Circuit City's 682 stores are within 5 miles of a Blockbuster outlet. Circuit City has been struggling to compete with Best Buy, Wal-Mart and others in the discount electronics space. The retailer's revenue fell 5.5 percent in 2007 to $11.7 billion.

Blockbuster publicly revealed its $1.03 billion, all-cash offer to purchase Circuit City in mid-April. But Circuit City's initial response was rather reserved. The company's board posed a number of questions to Blockbuster. In an April statement, Circuit City said, "Blockbuster has been unable to satisfy Circuit City and its advisors that Blockbuster's proposal could be financed." Circuit City's board said it was unwilling to allow Blockbuster in to look at its books until it satisfactorily answered the question of financing.

Apparently Carl Icahn, who is Blockbuster's largest shareholder, and a board member of the company, has put some of Circuit City's skepticism to rest. Icahn assured Circuit City that he is prepared to purchase Circuit City in the event that Blockbuster were unable to obtain financing or the appropriate shareholder approval necessary to complete the deal.

"We are pleased to have reached an agreement with Circuit City to conduct due diligence and further explore a possible merger between our two companies," said Blockbuster's management in statement Friday. "We continue to believe this combination would create significant cost and operating synergies therefore unlocking substantial value for our shareholders."

Even so, Circuit City CEO Philip Schoonover made it clear that his company hasn't completely given in to the idea of the purchase. "Let me be clear that our decision to allow Blockbuster and Carl Icahn to conduct due diligence should not be taken as an indication that the board has completed its review of the Blockbuster proposal, that the board has taken a position on the company's value, or that it has settled upon a particular strategic course of action," he said in a statement.

Friday's announcement boosted Circuit City shares 8 percent to $5.18 by noontime. Over the last year, the retailer's shares have fallen nearly 70 percent. Blockbuster shares fell 1.5 percent to $2.65 by midday Friday. Its share price has dropped 46 percent over the last 12 months.

Blockbuster has a rather ambitious plan to become a one-stop shop for entertainment as well as hardware devices that deliver it. "We are on a mission to transform Blockbuster into the brand that conveniently provides entertainment for consumers physically and electronically," said Blockbuster spokesperson, Karen Raskopf. "With or without Circuit City we are all about the convergence of hardware, software - that is content - and service." To that end, Blockbuster is rumored to be in talks with device makers designing a living room box that downloads and plays movies. The company already owns a movie download service called Total Access.

Analysts are not terribly excited by Blockbuster's grand vision. As many observers point out, hardware and services like the ones the company proposes already exist in an increasingly crowding marketplace. Apple (AAPL, Fortune 500), Microsoft (MSFT, Fortune 500), and Vudu all offer set-top movie rentals and devices. And TiVo (TIVO), with its digital video recorders in 2.5 million homes, offers movie downloads through a partnership with Netflix (NFLX). To top of page

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