The group decided to view this case as potential investor of Blockbuster Entertainment Corporation
Blockbuster Entertainment Corporation reported posted earnings in 1998 of $15,498,000 on revenues of $136,893,000. This resulted into a net income per common and common share equivalent of $.58 earnings per share. (Exhibit 2) A closer look at figures posted for the periods ending 1997 end 1996 would show a dramatic increase in revenues and its equivalent earnings per share.
As the corporation was holding its annual stockholders meeting on May 9, 1998, Bear, Stearns and Co., an independent accounting firm, issued a report critical of Blockbuster Corporation’s accounting suggesting that the company’s stock was grossly overvalued. According to Lee J. Seidler, if not for the corporation’s unique strategy of using cash combined with disputable accounting practices, the company would have had only $.07 earnings per share in 1998. (Exhibit 6 Table 1)
In response to the report, Blockbuster Corporation’s shares plunged $3.375 a share to $30 1/8 on May 9, falling even further by $3.875 to close at $261/4 on May 10.
“In view of the reported gross overvaluation of shares, is it sensible to buy shares of stock of Blockbuster Corporation or not?”
Description of Framework for Analysis
In examining the facts of the case of Blockbuster Entertainment Corporation as a potential investor, Group 3 is concerned with determining the veracity of the critical analysis of the Bear, Stearn’s and Co in relation the company’s financial statements and financial strategy, in particularly the usage of accounting methods of the company as to goodwill amortization and depreciation amortization of hit tapes and its effect on the company’s reported earnings per share (EPS).
In addition, the company’s cash flows from operating and financing activities are appraised as to ascertain the company’s capacity to generate cash. Group 3 is concerned as to the viability of returns in maintaining investor confidence, likewise with growth and stability of earnings.
Earnings per share (EPS): According to Bear, Stearns and Co., the discrepancy in EPS stems from automatically adopting a 40 year amortization period. The SEC, as asserted, also required that the amortization period be related to the nature of the business and that in a typical hi-tech acquisition, goodwill is to be amortized over a period of 5 to 7 years.
Our analysis surmises that Blockbuster Entertainment Corporation (BV) in effect adopted an amortization in consonance with APB Opinion No. 17, as required in mergers treated as purchase. Group 3 realizes that this was in consonance with standard practice applicable at that time, which the corporation labeled as “intangible assets relating to acquired business.” (Exhibit 1, Consolidated Balance Sheets)
But as admitted, there is no correct amortization for goodwill in mergers. It is only a guess that 5 years amortization would be reasonable for a videotape store. In applying the 5 year amortization to Blockbuster Entertainment Corporation instead of 40, Bear, Stearns and Co. says this would reduce the earnings per share by $.14. However, the argument lies in whether it is appropriate to use 5 years or 40 years. Both BV and Bear, Stearns and Co.’s stand have equal weight, as both to have been compliant with SEC standards.
Another area in focus is the slowing down of amortization of hit tapes from 9 months to 36 months beginning 1988. This resulted to raising the EPS by $.11 in 1988 totaling to $.57. The stretching of amortization quadrupled the life of hit tapes, as claimed by Bear, Stearns and Co and that BV is implying that this was demanded by the SEC which is doubtful. Comprising 20% - 25% of total inventory, this is a major slice of sales and profits for the corporation. BV contends that the economic of life of new feature films,...