Shares of Blockbuster Inc. lost nearly a third of their value Wednesday after the video rental chain warned that it may have to file for Chapter 11 bankruptcy protection in the United States.

A shopper walks out of a Blockbuster video store in Richmond, Va., in 2008. The company has seen its margins eaten away by Internet-based video rental alternatives. (Steven Helber/Associated Press)

In recent years, margins in the normally recession-proof movie rental industry have eroded away due to lower cost alternatives, and the Internet.

Competition from DVD-by-mail company Netflix Inc. and DVD vending machines operated by Coinstar Inc. have eroded the Dallas company's revenue at the same time as it staggers under a crippling debt load.

Blockbuster's traditional storefront retail model of sales has much higher costs and results in the company's comparatively large debt burden.

In February, Blockbuster announced plans to shutter 500 stores and restructure. At the time, the company owed just under $1 billion US in leases on locations. It has already closed some 1,300 locations.

Meanwhile, the company predicts further declines in its sales. The chain said it expects a key sales measure to drop in the mid-single digits to high single digits in 2010 — and a "further deterioration" could leave it unable to service its debt, leading to default.

The Dallas company's key sales measure sank 16 per cent in the fourth quarter — a dismal holiday season performance despite higher advertising.

The company said in a regulatory filing late Tuesday that it was suffering "significant liquidity constraints," and could have to file for bankruptcy protection if it was unable to persuade creditors to restructure a big chunk of its debt or if its business continued to deteriorate.

Three-month stock chart for Blockbuster Inc. on the NYSE. (CBC)

"The increasingly competitive industry conditions under which we operate has negatively impacted our results of operations and cash flows and may continue to in the future. These factors raise substantial doubt about our ability to continue as a going concern," Blockbuster said in a regulatory filing late Tuesday.

Blockbuster is pursuing several measures to help shore up cash. It wants to sell some of its international business and it is pursuing a debt-for-equity swap to help alleviate its debt burden. It wants to swap all or part of its senior subordinated notes for common stock.

It said it owed $975 million under senior secured notes and senior subordinated notes as of Jan. 3.

If approved, the swap would significantly dilute current shareholders, which partly explains why the stock sagged on Wednesday.

Shares fell 13 cents, or 31.5 per cent, to 27 cents in midday trading Wednesday. Earlier shares traded at an all-time low of 25 cents. They have traded as high as $1.56 in the past 12 months.

With files from The Associated Press