Blockbuster/Circuit City: OK, I don't get it either

Sun Microsystems CEO Scott McNealy had a colorful assessment of the planned merger between Hewlett-Packard and Compaq: it's like two garbage trucks, he said, backing into each other in slow motion. (Beep, beep, beep...thunk.)

That brings me to Monday's rather stunning news that Blockbuster, the giant video chain that's seen better days, is trying to buy Circuit City, the giant consumer electronics retail chain that's also seen better days. The offer, which was made in February and is just now becoming public, is worth $6 to $8 per share--between $1 billion and $1.3 billion total. It's about a 54 percent premium above Circuit City's value before the news broke.

Now you can argue McNealy was way off base on the HP-Compaq merger, but he'd be spot on if he applied the double-garbage-truck metaphor to Blockbuster and Circuit City. As Peter Kafka at Silicon Alley Insider wrote earlier, it seems like they'd "rather be in a low-margin business than none at all."

In fairness, there is some logic to what they're trying to do. By combining a company that sells the entertainment with a company that sells the equipment that entertainment plays on, you have the mass-market equivalent of Apple's retail stores. If Blockbuster really is developing a set-top box that could allow movie downloads from another Blockbuster acquisition, Movielink, the Blockbuster/Circuit City hookup moves from the realm of the insane to the "nice idea if it were operating in a vacuum" category. At least that's the theory.

But here's the reality: Apple has around 200 retail stores and can meticulously control what is sold in them and how they are run. Apple retail employees go to a veritable boot camp before they're allowed to sell in Apple stores. By comparison, the combined Blockbuster and Circuit City would have 9,300 retail stores, with 5,500 in the United States (though I have to think more than a few of them would be shut down). Quality control? They're going to have to bring in a logistics expert from the military for that one.

Wall Street already hates this. Blockbuster was in the middle of a modest turnaround, after several years of suffering at the hands of Netflix's lightweight mail distribution business and various forms of digital distribution such as on-demand television from Comcast. The company's net income for the first quarter, which ended March 31, is expected to be $30 million, compared to a net loss of $49 million a year ago. Not great, but it's a start.

Pundits already worry a Circuit City takeover could distract Blockbuster executives (they're right) and divert money that could be used elsewhere (they're right about that, too). In afternoon trading Monday, Blockbuster shares were down 14 percent to $2.69 per share.

Circuit City shares, of course, jumped more than 30 percent to $5.12 in afternoon trading. Talk about a company suffering from a changing market...and Best Buy. For the full fiscal year, which ended February 29, Circuit City lost $321 million on $11.7 billion on revenue. The fourth fiscal quarter, thanks to $65 million in reduced costs, did show signs of improvement, with a modest $4.5 million profit on $3.65 billion (sales were down 7.7 percent from same quarter a year ago). But this is not exactly a company with a long line of suitors.

So bring this troubled pair together and what do you get? Well, I'm not sure, to be honest. I suspect Circuit City's ownership also has no idea, since the Blockbuster offer has been on the table since February 17.

Here's what I do know: You'd get a really big company with about $18 billion in combined sales. It would be saddled with a lot of real estate, and it could achieve some cost savings by shutting down some of those stores. But this isn't some roll-up strategy (like Larry Ellison is doing at Oracle) where costs can be quickly squeezed out and a bigger outfit can just roll in the cash. With this, you have two companies struggling to keep up with both more nimble (Netflix, Amazon.com) and much larger competitors (Best Buy, Wal-Mart, Comcast). It's a lousy place to be.

This proposed deal may have one thing going for it: Billionaire corporate raider Carl Icahn is reportedly backing the move and is willing to finance it. He owns about 16 percent of Blockbuster's Class A shares, so I have to think he sees real value in acquiring struggling Circuit City. But as my CNET News.com colleague Dawn Kawamoto wrote a few months back, Icahn's interest doesn't always translate to a Midas touch.

Like most other people who learned about this deal Monday morning, I'm baffled. And I smell desperation.