Nightmare On Main Street

A year after swallowing Hollywood Video, Movie Gallery is fighting for its life

When the team at video rental chain Movie Gallery Inc. boldly bought rival Hollywood Video for $1.2 billion last April, it looked like a potential blockbuster deal. Literally. By merging, the duo staved off a hostile bid for Hollywood Video from archrival Blockbuster Inc. (BBI ). With 4,800 stores, Movie Gallery vaulted into the No. 2 video rental spot. The Dothan (Ala.) company, which built its franchise by serving tiny towns like Clarksville, Ark. (population: 7,000), suddenly became a major player in big cities such as Atlanta and Los Angeles.

Just a year later, Movie Gallery's tale has gone from love story to horror show. The Hollywood Video deal left it deeply in debt. Worse, the rise of online video rental services sucked even more revenue from the retail chain. Then, a weak slate of new movies on video last year, such as Starsky & Hutch, kept bored movie fans home. Same-store sales at both Movie Gallery and Hollywood Video plummeted 15% last June. "Quite frankly, it was the perfect storm," says Thomas D. Johnson Jr., senior vice-president for corporate finance and business development at Movie Gallery.

Johnson might want to work on a more felicitous metaphor. All the main characters die at the end of The Perfect Storm. And Movie Gallery is battling some heavy weather. The company posted a 57% increase in profits from 2001 to 2004 -- a performance that helped it land the No. 61 spot on BusinessWeek's 2005 list of fastest-growing small companies. But later that same year, Movie Gallery recorded a $553 million loss. Absent one-time charges, it earned $31 million -- a 38% drop from its previous year's profit. Overall, sales slid almost 5%, to $2 billion. To try and stanch the bleeding, Chief Executive Joseph Malugen is shuttering unprofitable outlets and seeking new ways to prop up the bottom line.

It's a scary plot twist for Movie Gallery. Founded by Malugen in 1985, the chain carved out a down-home niche by delivering big movie titles at cheaper prices to customers in towns with fewer than 20,000 people. Movie Gallery then rapidly climbed up the ranks of video rental players by acquiring dozens of small video chains.


Like Blockbuster, Movie Gallery is struggling to compete with online subscription services such as Netflix. Overall in-store sales for video rental outlets shrank 13% last year, to $7.1 billion, according to Adams Media Research Inc. But online sales more than doubled, to $1.4 billion. Movie Gallery's Johnson says that because the company is weighed down by its $1.2 billion in debt, it can't afford to launch an online service. "There is growth ahead, but it is going to be at the expense of video stores," boasts Steven M. Swasey, spokesman for Netflix.

With just $135 million in cash at the end of 2005, Movie Gallery faces a bruising fight just to stave off bankruptcy. Vulture investors are already circling. Movie Gallery's stock, worth about $3 on Apr. 24, has lost more than 90% of its value in the past year. Investors have short positions, or a bet that the stock price will decline further, on 18.6 million of the company's 32 million shares. Movie Gallery says hedge funds are snatching up its bank debt, too, which could indicate that they're jockeying for a seat on a creditors' committee should the company file for bankruptcy. "It's a bear run on the company," Johnson says.

To fight back, Movie Gallery executives have twice renegotiated lending agreements with bankers to ease payment terms. The company plans to close 100 stores and lay off 300 of its 1,800 workers by the end of the year. Hoping to slash at least 20% from its $500 million in annual rental costs, it is negotiating subleases in almost half its stores. But Movie Gallery won't see much benefit from these moves until 2007.

As Movie Gallery's saga shows, strategic missteps can bring any company's hot streak to a cold halt. That was more than evident at the cavernous Hollywood Video in Decatur, Ga., one recent evening. Just a handful of customers perused the DVDs. Nearly a third of the store was dedicated to old-format VHS movies. And used DVDs were being hawked at a deep discount, some at a price of four for $20. One title summed up Movie Gallery's current dilemma. It's called Scary Movie.

By Brian Grow

    Before it's here, it's on the Bloomberg Terminal.