Circuit City Stores Inc. (CC) said Friday it will allow video-rental chain Blockbuster Inc. (BBI), and its largest shareholder Carl Icahn, to conduct due diligence in connection with Blockbuster's bid to buy the consumer electronics retailer.

Circuit City also said it received a letter from Icahn, a Blockbuster board member, saying he's prepared to buy the company if Blockbuster can't get financing on its own or get shareholder approval.

Blockbuster publicly announced a takeover bid of just over $1 billion for Circuit City with plans for creating a huge chain that would sell electronic gadgets and rent movies and games. Circuit City has said it doubts Blockbuster could finance the deal and has resisted opening its books.

Blockbuster said in a statement Friday that it was pleased to reach a due diligence agreement with Circuit City.

"While it is our hope that the due diligence process will reinforce both the strategic and financial rationale behind the deal, we are committed to only doing a transaction that provides substantial benefits for our shareholders," the Dallas-based company said.

Circuit City said the Icahn letter answered some questions related to the potential transaction, and that it would allow Blockbuster and Icahn to conduct additional due diligence.

But Chairman, President and Chief Executive Philip J. Schoonover cautioned about reading too much into the current state of the discussions.

"Let me be clear that our decision to allow Blockbuster and Carl Icahn to conduct due diligence should not be taken as an indication that the board has completed its review of the Blockbuster proposal, that the board has taken a position on the company's value or that it has settled upon a particular strategic course of action," he said in a statement.

Richmond-based Circuit City Stores also said it hired Goldman Sachs & Co. to explore strategic alternatives, which may include a sale of the company, but that its board has not determined to pursue a particular option.

The company also reached a deal to put three of Wattles Capital Management's board nominees up for election at its annual meeting, potentially avoiding a proxy battle with the activist minority shareholder.

Wattles, which owns about 6.5% of Circuit City's outstanding stock, indicated in a regulatory filing with the Securities and Exchange Commission last month that it would ask shareholders to elect five new directors for Circuit City's 12-member board and oust the others.

Mark J. Wattles, owner of the 32-store Ultimate Electronics chain, has criticized Circuit City's turnaround efforts, placing blame on Schoonover and asking for him to be replaced.

In the filing, Wattles questioned the existing board's willingness to hold senior management accountable for poor performance at Circuit City -- which lost $319.9 million in its last fiscal year, compared with a loss of $8.3 million during the prior year.

One of Wattles board nominees will also become a member of the board's executive committee. At least two of Circuit City's current board members will step down or not run for re-election at the meeting in order to accommodate some of the Wattles board nominees.

Shares of Circuit City gained 66 cents, or 13.7%, to $5.45 in premarket trading. The stock closed at $4.79 on Thursday. Blockbuster's stock fell 16 cents, or 6%, to $2.52 in premarket trading. The shares closed at $2.68 on Thursday.