Dollar-rental debate: deals or lawsuits?

Studios split over doing business with firms like Redbox

A split among Hollywood studios on how to deal with dollar-rental DVD companies suggests two distinct camps: those who emphasize disc rentals and those who focus on sales.

"About 80% of Sony's stuff does really well in rental," an exec at a rival studio notes. "So that's why they did their direct deal with Redbox. Warner Bros., Fox and Universal do mostly sell-through, so they don't want people renting."

It's a blunt explanation for the differing postures struck to date by a handful of studios. Sony is more sensitive to the rental market because of its outsized revenue from direct-to-video titles, which skew heavily toward rentals.

Whatever the motivation, Sony and Lionsgate recently decided to provide DVDs directly to Coinstar-owned Redbox and other dollar-rental chains for the first time. In exchange, the studios secured pledges from the kiosk companies to limit used-disc resales to wholesalers, which had been supplying rental outfits with Sony and Lionsgate releases indirectly.

By contrast, Warners, Fox and Universal continue to refuse direct relationships with the kiosk crowd and have ordered the studios' wholesalers not to provide DVDs to dollar-rental companies for the first 28, 30 and 45 days of their release, respectively.

The pissing match comes as all of Hollywood is being impacted by a dramatic dip in DVD sales as well as by the recession. This month, the Digital Entertainment Group released midyear U.S. sales figures showing spending for first-half 2009 on DVD, Blu-ray Disc and digital distribution was $9.73 billion, off 3.9% compared with the same period last year.

Universal was the first to break bad with the kioskers in a policy announced last year. That prompted an exchange of litigation between the studio and the Illinois-based Redbox. A judge recently tossed two of three Redbox claims against the studio but let a critical antitrust claim to go forward.

Fox and Warners this month announced their similar policies and were subsequently slapped with their own Redbox lawsuits. The studios might have been rousted from their watch-and-wait postures when Sony struck its direct deal with Redbox last month, or they simply might have become impatient in waiting for a definitive court decision.

In any event, there still has been no word from Disney or Paramount, which continue to allow wholesalers to provide product.

Paramount sources said the studio is having discussions about how to proceed, but a Disney insider said it's unlikely that the Burbank studio will do anything one way or the other until there is a ruling out of U.S. District Court in Wilmington, Del.

A big question for Disney and Paramount executives to chew on: What do they hate worse -- dollar pricing or used DVDs? Many execs believe dollar rentals undermine consumers' enthusiasm for buying DVDs, while easy access to titles on the used market stokes interest in new releases.

Meanwhile, all the talk about dollar rentals and the effect on disc revenue seems to have rattled Wall Street, heightening investor concerns about the DVD ecosystem. After Warners made its legal move, Coinstar was down 10% -- but shares of every entertainment conglomerate tumbled as well.

"It doesn't appear to us that Redbox is going away any time soon," Wedbush analyst Michael Pachter wrote in an Aug. 14 note circulated on his downgrade of Blockbuster stock to a "neutral" rating. "Redbox will continue to gain share at Blockbuster's expense."

Pali analyst Richard Greenfield estimates Warners, Fox and Universal combined are keeping Redbox from 55% of major studio DVD product -- and he advises other studios to also restrict Redbox.

"We have a hard time understanding how a studio would not feel threatened by Redbox's current business model," he wrote in a recent research note.

But analyst John Kraft at D.A. Davidson says studios can't shut Redbox out for long, even if the courts rule in their favor. That's because Redbox can simply buy copies from Wal-Mart or other retailers, stick them in a new jewel case and slap a new bar code on them.

In fact, that's what Redbox has been doing with Universal titles.

"While we believe Redbox and the studios would benefit from working together, and would expect some margin compression in the coming quarters, Redbox certainly doesn't seem particularly hamstrung by their work-around procedures," Kraft said in a note to investors.

Tony Wible of Janney Montgomery Scott says studios need to rethink distribution windows in light of some dramatic trends that are afoot. To wit: Adams Media Research calculates that first-half DVD sales fell 13%, while subscription rentals rose 16% and digital offerings climbed 40%.

"If this trend persists, we believe studios will be forced to make more changes in their distribution windows, which will increase studio risk but may be the only solution to keeping studio operations afloat," Wible wrote.