Buyout of Video Chain May Collapse

An attempt by Hollywood Entertainment Corp.’s founder to buy back the No. 2 video-rental chain in partnership with Los Angeles buyout firm Leonard Green & Partners was in danger of collapse Friday for lack of financing.

Leonard Green, which teamed with Hollywood Entertainment founder Mark Wattles in making the $888-million cash offer, blamed the financing glitch on “industry and market conditions,” Hollywood Entertainment said in a brief statement issued Friday morning.

Officials at the Wilsonville, Ore., parent of the Hollywood Video chain declined to elaborate except to say that talks were continuing in hopes of salvaging the transaction.

A new deal could include terms that “differ materially” from the original agreement, Hollywood Entertainment said. The original agreement called for a buyout at $14 a share.

Hollywood Entertainment shares tumbled 23% on the news, sliding $2.98 to $9.81 on Nasdaq.

Late Friday, the company said second-quarter earnings rose 5.2%, to $20.2 million, or 32 cents a share.

That profit and other performance measures appeared to be in line with Wall Street’s expectations and with the terms of the company’s agreement with Leonard Green, leaving analysts guessing at the cause of the financing problems.

Leonard Green referred calls to one of its partners, John Baumer, who didn’t return phone calls and e-mail messages.

In announcing the deal in March, officials said they believed that growth in used-video sales and video-game rentals would help overcome problems facing Hollywood Entertainment and its much larger rival, Blockbuster Inc. Systems that deliver films directly to TV sets, computer-based rental services such as Netflix and the competitive market for video sales are cutting into the high-margin business of renting videos from stores.

Stocks of competing companies including Blockbuster have declined by about 15% since the deal was announced, and analysts speculated that Leonard Green might be seeking a lower price because of that and because the last half of this year looks tough for the video-rental business.

During the third quarter of 2003, eight movies that made more than $100 million at the box office were released as rentals, noted Arvindh Bhatia, an analyst with Southwest Securities in Dallas. That contrasts with only one such rental coming out in the third quarter this year: “The Passion of the Christ.”

Sputtering economic signals and the Federal Reserve’s raising of a key interest rate also have slowed what had been a hot market for the high-yield junk bonds that would finance the deal, noted Richard Peterson, a mergers strategist at Thompson Financial. That slowing market and the continued tough times for the industry could make investors demand higher interest rates to fund a Hollywood Entertainment buyout, he added.

Many observers were betting the deal would still go through, if at a lower price.

“One thing we are clearly hearing from analysts is that it doesn’t make much sense for Hollywood Entertainment to remain public,” said Jason Ghassemi of FactSet Mergerstat, a Santa Monica-based provider of information on mergers and acquisitions.