Blockbuster's making headway

Run-up might be coming at Netflix, Movie Gallery's expense

Blockbuster appears to be hitting its stride, possibly at the expense of its video-rental competitors. At least that is what Wall Street has been saying.

Case in point: Shares of Blockbuster kept hitting 52-week highs last week, while Netflix Inc. and Movie Gallery were the worst performers Thursday on The Hollywood Reporter's Showbiz 50 stock index, and were in the bottom 10 the following day. Movie Gallery, however, turned in a strong performance Monday — No. 1 on the index — though it remains 62% off its 52-week high. Blockbuster was just short of its 52-week high.

The reason for Blockbuster's sudden fortune, analysts said, is a thrust into the space Netflix invented more than seven years ago: subscription DVDs by mail.

Netflix still leads, with 5.7 million subscribers, but Blockbuster, which jumped in less than three years ago, said last week that it signed up its 2 millionth paying customer during the just-ended fourth quarter.

Movie Gallery, second to Blockbuster in the number of physical rental stores it controls, has no online service to compete with those from Netflix and Blockbuster.

Analysts tie Blockbuster's online success to Total Access, the initiative it launched Nov. 1 that lets online users exchange movies in stores as well as through the mail. In the nine weeks since Total Access was unveiled, Blockbuster has risen 50%, while Netflix has dropped 19%.

Pali Research analyst Stacey Widlitz said Blockbuster "is the only service that can offer an integrated in-store and online approach."

Widlitz, who has a "buy" rating on Blockbuster, also said that, fortunately for Blockbuster, cannibalization of its in-store customers is not a factor.

"We believe new online customers are coming from Netflix, or Blockbuster is keeping existing customers from leaving for Netflix," she said.

Widlitz is bullish on Blockbuster for more reasons than just Total Access. She also likes Blockbuster's plans to sell stores in foreign markets. Spain already is gone, the company just closed its last store in Peru, and it recently received regulatory approval to sell its Taiwan operations.

Blockbuster also will benefit from "the continued demise of Movie Gallery," Widlitz said, as well as from the further closing of Blockbuster's underperforming stores. Last week, the company agreed to sell its 72-store Rhino Video Games chain to GameStop.

The market for the DVD-by-mail concept, where Blockbuster plays second fiddle to Netflix, will grow from $1.7 billion in the U.S. last year to $2.5 billion in 2010, according to Adams Media Research.

Next up is the digital-download market, which Adams expects will rocket from $32 million last year in the U.S. to $2.8 billion in 2010.

While Adams predicts that Blockbuster and Netflix will have a stake in that business, observers expect Netflix to be a bit bolder a bit sooner.

Netflix has said that it will talk about its specific plans for the digital delivery of movies on-demand when it next reports quarterly financial results on Jan. 24.

Netflix once spoke of a partnership with DVR pioneer TiVo Inc. for delivering movies on-demand, though both companies have been mum on details and many expect that the relationship has soured.

Apple Computer, meanwhile, has been offering movies and TV shows through iTunes, and the company has promised that its box, code-named iTV, which many expect to be showcased at this week's Macworld conference, will easily bring the iTunes movie experience to TV screens.

Piper Jaffray analyst Gene Munster said there is nearly a 100% chance that iTV will be revealed during Macworld and predicts that it will be in Apple stores in the March quarter.

"The iTV lets users access iTunes content stored on a computer and view it on a television," Munster said. "Whereas the iPod gives portable access to the same content, the iTV brings the content into the digital living room. Therefore, the iTV provides further integration between the Mac and iPod sales segments by adding a third significant growth driver to the mix."
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