Circuit Proxy Fight Enters Home Stretch

LAS VEGAS — Dissident shareholder Mark Wattles has formally taken his beef with Circuit City's management and board directly to the company's shareholders.

Wattles, through his investment vehicle Wattles Capital Management, submitted a proxy solicitation last month urging stockholders to elect his four hand-picked nominees to the company's board and to remove its current directors and management.

He also repeated his call for Circuit City to give full consideration to Blockbuster's unsolicited buyout offer, and to open its books fully under due diligence.

Wattles received additional support on that point from HBK Investments, a Dallas-based hedge fund that controls 9 percent of Circuit City stock and has an even larger stake in Blockbuster.

In a separate filing last month with the Securities and Exchange Commission (SEC), HBK echoed Wattles' arguments for the sale and also cited a potential $300 million in cost savings by combining the two chains.

The filing also included a letter to Circuit City chairman Phil Schoonover, which stated in part: "While we can understand the board's desire to become comfortable with how Blockbuster would specifically finance this transaction, this offer should be taken seriously and Circuit City should immediately provide access to due diligence information and commence good-faith negotiations."

Circuit's board and financial advisors, Goldman Sachs, have expressed doubts that Blockbuster could swing the $1 billion-plus purchase price, given the video rental chain's much smaller market capitalization.

But HBK, Wattles and Blockbuster have all indicated that the deal could be financed through Circuit's own capital resources and possibly those of billionaire financier Carl Icahn, who sits on Blockbuster's board. They also argue that in a classic Catch-22, Circuit City's refusal to share its inner workings prevents the parties from structuring a deal.

Wattles, in his proxy solicitation, reiterated his rationale for replacing Circuit's board and management team, citing the company's poor stock and marketplace performance compared to its competitors. He also reduced his director slate from five to four nominees in accordance with Circuit City bylaws.

Results of the proxy fight are expected to be announced at the retailer's annual meeting on June 24.

Excerpts from Wattles' filing follow:

"We do not believe that the existing board has served the best interests of the company's shareholders. Without change to the existing board, we fear that the company's intrinsic value will continue to erode further.

"The company's turnaround efforts led by Mr. Schoonover and his senior management team have resulted in a substantial decline in the company's operating performance and significant loss of shareholder value. Approximately two years ago, after what turned out to be a temporary industry-wide oversupply of flat-panel TVs, Circuit City's senior management initiated a 'turnaround' to address what it perceived as a permanent reset to a lower level of gross margins in the industry.

"Since then, the competition's gross margins have essentially recovered, but Circuit City's have further deteriorated, resulting in a 'turnaround' that has unfortunately gone in the wrong direction.

"We believe the failure of the 'turnaround' to date has also been due, in part, to senior management searching for a 'silver bullet' rather than focusing on basic retail execution, such as having the right products for sale, priced strategically, displayed well, and sold by the right people. As a result, Circuit City's performance is now significantly worse than when the turnaround first began.

"Many of the same operational issues currently plaguing Circuit City were also adversely affecting Ultimate Electronics when WCM [Wattles Capital Management] first became involved … To improve Ultimate Electronics, WCM assembled a new management team and worked with them to formulate and implement a company-wide plan to build sales while increasing gross margin, and in the process restore the health of the business.

"As a result, Ultimate Electronics stores today have positive same-store sales, increasing gross margins and increasing EBITDA [earnings before interest, taxes, depreciation and amortization]. We believe that our nominees can help accomplish the same turnaround success with Circuit City."