The DVD Rental Race Analyzed

Thomas Hawk writes "Netflix and Blockbuster have been locked in a price war with regards to the DVD rental space. Wedbush Morgan Equity Analyst Michael Pachter has a $3 dollar price target on Netflix and is in contrast bullish on Blockbuster. Davis Freeberg challenges Pachter's thinking that Netflix will be the loser in the DVD rental battle and Pachter himself responds back on his rationale on why he thinks Blockbuster has the advantage." From the article: "Irrespective of what Pachter thinks about the overall DVD rental business, Pachter's seemingly obvious prediction would appear pretty dire for Netflix. Pacther updated his price target for Netflix On 4/22/05 with the new $3 price. If Pachter is right, then we should expect to see Netflix's stock fall by approximately 75% over the next 12 months."

Comments

I'm no market analyst, just a movie watcher...

[garcia]

If you know someone who is using Netflix right now ask them about the service? Do they like it?

I don't know a single person that uses Netflix so that's rather difficult. I also haven't heard it *anywhere* other than on Slashdot. I wouldn't even know it existed otherwise.

Now go into your local Blockbuster Video store and ask the clerk there how he feels about his employer.

I have a feeling that they will have no comment... We all know what happens when you bite the hand that feeds you.

Netflix's customers are huge evangelists for the service and they view the service as fun, innovative and exciting -- not bad for a growing company with very little debt.

This guy is probably a customer for this young and new company w/o many subscribers (compared to Blockbuster). I really can't speak either way about it though as I have never used them myself.

Blockbuster on the other hand is a bloated company, with tons of debt, who is laying off it's employees, cutting back their hours, fending off a shareholder proxy fight with Carl Icahn, who has had their CEO recently announce that if he was not re-elected he would resign from the company.

Ok, yeah, it's bloated - along with plenty of other companies out there. I am not fan of Blockbuster and their tactics which include blatant lying to their customers and potential customers about their "no late fees" crap.

Cutting back hours? I don't know about that. I know of a couple Blockbusters around here and they are open the same hours they have been for years. At least you know that the movie rental places are open on Thanksgiving and Christmas.

In the long run, all three companies, Netflix, Movie Gallery and Blockbuster will face a tremendous battle to stay alive when Video on Demand becomes widely available, but in the short run, if you agree with Pachter, then you should short Netflix and use the proceeds to buy Blockbuster and Movie Gallery.

I'm not holding my breath for VoD, really, I'm not. Even if/when it does become "viable" I have a feeling it will continue to be expensive and a little bit behind the DVD release dates. I really don't see any advantage to VoD but then again I have ~6 different movie rental places within 5 miles of me. YMMV.

I realize that I am a bit different than most people when it comes to renting DVDs. I'd prefer to buy them. Target has great deals on movies (i.e. Pulp Fiction with extended crap for $10 and many random titles for $7.50). I spend a lot of time looking through the $5 bins at Walmart for movies. I also buy previously rented DVDs which are usually 3 or 4 for $20. I don't frequent Blockbuster as I always feel uncomfortable in their store. I prefer Hollywood Video because of their random titles that are $1 back if you return the movie within 24 hours.

So I really don't care if Blockbuster or Netflix do well or not but I certainly don't believe for a second that the sudden downfall of the rental business will come from VoD. Then again I'm not a market "analyst" blogging away about stock prices... I'm just a movie watcher that doesn't like to pay a whole hell of a lot to watch a movie once.

Re:I'm no market analyst, just a movie watcher...

[jp10558]

I've used netflix quite a bit (in fact every time I have a full time job - currently in college though). Their prices aren't bad - especially given where I live there is no cable anyway.

So, for the price of basic cable I can get DVDs right to my doorstep, usually with no more than a day lag time. I can hold on to those movies, with no penalties. They have a selection that puts the "local" (30 mile one way trip) blockbuster to shame.

I think services like NetFilx will be able to find a niche if they want to - specifically with rural america (which is pretty big IIRC from the last election etc...).

With gas costs rising, do you want to drive 20+ miles to get to blockbuster, and then drive back, and then be locked into driving them back within a week (or 2 now?) or else fees? Gas is somewhere around $2.20 a gallon most places in the US.

I think the average gas mileage is 25MPG or so. So figure on average 3 gallons per trip out to blockbuster for many rural americans. That's 6 gallons once you return the movie. So, it cost you around $13 just for travel, not counting wear and tear on the vehicle or time. That one trip to blockbuster just about paid for a standard NetFlix monthly package, before you rent one video. And this assumes your time is worthless.

Of course, we try to make our blockbuster trip coincide with other shopping and such, but that's not always feasible, though the new extended time (I think, I haven't really looked at whatever the "end of late fees" became) it's a lot easier compared to the 2 day turn around time on new releases previously.

With more TV shows coming out on DVD a year later, and with our situation in the country, when the analog TV goes dark, we'll just up our NetFlix subscription. Better quality, better choice(4 analog tv stations on a good day), and no commercials.

So, I think NetFlix can do very well if they don't mind catering to the rural market.

Re:I'm no market analyst, just a movie watcher...

[badasscat]

They have 1.5 million customers.

They have 3 million subscribers, not 1.5 million (I hate to link to such a dire-sounding headline, but the article does have a lot of hard info). And their subscriber base is growing rapidly.

Every day at my office you can see a bunch of those red envelopes in the office inbox. And a lot of us that subscribe get them at home, so clearly there are more where I work than I even know about.

This is a popular service and one that people really like. One of the first things I learned when picking stocks is that the bottom line is the product has to be something people want. The quick test of any stock is to look around at what people are saying about the company, not from a business perspective but as customers. I have honestly heard the words "I love Netflix" more times in one week than I've probably heard the words "I love Blockbuster" in my entire life.

That doesn't mean the company's on the road to success, but it does mean they have the basic building blocks right. Blockbuster's really got nowhere to go but down at this point.

Re:I'm no market analyst, just a movie watcher...

[Surt]

1.5 million customers + 4 in your office of 25 people => skewed sample.

If one in 6 working age americans used netflix that would be a customer base more like 30 million.

Netflix needs to be acquired

[winkydink]

It's pretty clear that Blockbuster has the size, relationahsips, channel, and most importantly, money to crush Netflix. Each day that passes is, in reality another day that the value of the company decreases. Rather than "talking with Amazon" or thinking they can get a bazillion dollar deal, Netflix should get off their collective butts and start shopping around.

Who would buy them? Well Walmart is an obvious choice. The current offerring sucks. Barnes & Noble? Target? I'm sure there are others, these are the only ones that immediately jump to mind.

Re:Netflix needs to be acquired

[shayne321]

Netflix should get off their collective butts and start shopping around.

I keep reading people saying this, but my question is: Why? Every interview I read with the founder of Netflix says he's having a ball running the company as is, they're moderately successful, profitable (how many startups can you say THAT about?), and have a strong brand.

What would the deep pockets of wal-mart, amazon, or blockbuster give them? It's not like there's a lot of room for innovation in the online rental market. I go to the site and request a disc, they mail it to me, I mail it back. What sort of value added service are they going to provide, offer to mail me popcorn with my disc? Thanks but no thanks.

I think Netflix has a good thing going, and the founder has said repeatedly he is not going to get into a price war with blockbuster, he is going to compete on service.

Granted I'd love to see netflix do away with throttling, but for my $18/month I'm happy.

Re:Netflix needs to be acquired

[Morinaga]

Blockbuster has the size, marketing and money to TRY and crush Netflix. However, they also have overhead, tons and tons of overhead. Retail consumer locations cost money but nothing in comparison to the empolyment costs of having people in those buildings. When you run a company that floats a margin above large amounts of overhead your company's profit margins look like the DOW with very high Highs and very low Lows. Overhead produces the types of losses you see from Airlines and car manufacturers. They have fixed costs in this massive retail chain that don't change without significant closings, firings etc...

Netflix on the other hand has a much more flexible overhead structure. They have fewer customers? Well first, they KNOW how many fewer they have because they have subscribers and a predictable cash flow regardless of customer usage unlike Blockbuster. Second, if they get fewer customers they spend less on postage. Perhaps they reduce purchasing on new titles. At worst perhaps they lay off employees.

Netflix is a remarkably proficient business model. The biggest issue is that since they went Public in '02 they have become part of the beast that is stakeholder appeasement. They are a 'growth' stock. Shareholders want growth so a company has to invest in infrastructure, marketing, promotions and everything under the sun to show revenue growth. It frankly doesn't matter if the growth is done smartly as long as it's not slowly. The board of directors gets pressue for stock growth, which bears pressure on the CEO for that same growth (who is beholden to their own income (ie options) to show growth). The days of developing a solid income stock company are dead. Profits be damned if revenues grow by 19.5%!! Who cares if you lost 100 million in a quarter. Anyway, that's all a tangent rant but suffice to say that because Amazon posted losses during their growth years doesn't mean the business model won't work. It also doesn't mean there's no place in the market for retail when a web service is available.

Re:Netflix needs to be acquired

[fm6]

Why? Every interview I read with the founder of Netflix says he's having a ball running the company as is, they're moderately successful, profitable (how many startups can you say THAT about?), and have a strong brand.

All beside the point. Netflix isn't a mom-and-pop business that can stay open and independent as long as they have money coming in. They're a publically held company whose management holds their jobs at the pleasure of investors. None of those investors have seen any serious returns on their investment, since profits get plowed back into the company, and the stock price is about what it was when the company went public. And some current investors have probably seen loses, assuming they bought in when the stock was about 3 times higher.

Right now investors seem to be buying managements line that they're building long-term growth. But that can't last forever, not with Netflix locked in a price war with Blockbuster. Eventually, stockholder will revolt. That will probably lead either to a hostile takeover or a management change in preparation for a friendly takeover.

Granted I'd love to see netflix do away with throttling...

Don't get your hopes up. Do the math: if you assume mailing costs are 80 cents a disk, and a non-throttled account can rent 5 disks a week, then the account costs them $17.20 in an average month just for mailing. Add in other costs and they're losing a couple dollars a month on that account. Maybe my assumptions are too high, but it's still very clear that such an account would make them a small profit, at best. So they have to throttle -- though they really ought to be more honest about the fact.

Netflix

[mrbaggs]

Speaking as a longtime user of Netflix I think they will be around for a while given their excellent service and selection.

Investment Rule

[stecoop]

7.5% of Netflix is currently owned by Netflix Co-Founder and CEO Reed Hastings. Given that Netflix stock has already fallen by 60% over the last 12 month and that their stock is currently one of the largest short postions on Wall Street, a $3 price target seems a little aggressive .

Second rule in investment is never say a stock can go no lower. The trip to zero is a hard fall at any price.

First rule, you probably are wondering, is: buy low and sell high.

One important thing Michael Pachter is missing

[Emperor Shaddam IV]

Is the fact that Blockbuster's previous practices of changing late fee's that were outlandish, has pissed a ton of people off. Also, Blockbuster used to not carry a lot of movies because they were too of the wall or "racy" or "sexually" oriented.

Blockbuster pissed me off so bad in the 1990's I haven't rented from them in several years, nor would I even consider renting from them if they charged less than half what Netflix did.

Check out the other people they pissed off:
http://www.google.com/search?hl=en&q=blockbuster+s ucks

Re:hmmmmm

[winkydink]

Well, reading TFA, it would seem that video on demand from cable is in this race, and looks to be the odds on winner...

Really? Do you think you'll be able to watch the movie as many times as you want in a given period for a fixed fee? Can you "lend" your copy to a friend? I'm also pretty sure that they will devise some way to "force" you to watch advertising (granted, DVDs do this too, but it appears that may be changing based on recent proposed legislation).

I'm sorry, but I believe that saying Video on Demand will replace DVDs is a lot like saying eBooks will replace paper (and I'm a big eBook proponent).

Financial analysts

[Petronius]

These are the same people that predicted that Enron and Worldcom were the companies of the future, that Lucent was going to grow forever, that QQQ was the ticket to retiring at 30. Who gives a shit about their opinion? Listen to successful investors: W. Buffett, Peter Lynch, they'll tell you that the best thing to do about analysts is to ignore their predictions. So what does this guy know about Netflix? Has he actually even tried their service?

DVD Evangelism

[brontus3927]

I have to agree with Freeberg. Short of changing their corporate direction like NetZero (not that it hasn't worked for NetZero, emphasising the low-cost pay service over the ad-based free service), NetFlix is always going to have high popular opinion. NetFlix customers are very similar to Apple customers in that regard. They see themselves in a good vs evil fight with a giant corporation (Blockbuster for NetFlix, Microsoft for Apple). Netflix customers are fighting the good fight. Despite this, everyone thinks in the Microsoft business model of "there can only be one company in a given market" Two (or more, and more is better) companies can peacefully co-exist in teh same market. I use Netflix. My sister uses Walmart's service. My neighbor stopes at Blockbuster on the way home from work to rent DVD's because their an impulse item for him. To each their own. I don't see any of the services as inherently better or worse than the other.