Seeking Alpha
Profile| Send Message| ()  

The corporate graveyard is littered with companies that were either unable to adapt to structural changes within an industry, or were - in the saddest of situations - unaware that these changes were even happening.

Blockbuster Inc. (BBI) currently suffers from a combination of those two factors, a predicament exacerbated by the emergence of aggressive competition to its core video rental business. This competition has intensified to the point that Blockbuster could be forced into either bankruptcy or irrelevancy within the next 12 to 18 months.

Most of us have stepped inside one of Blockbuster's brick and mortar video rental locations; at one time, getting in the car and heading to Blockbuster was actually an exciting event. Then Netflix (NFLX) came along, offering customers video rentals by mail, immediately siphoning sales from Blockbuster.

Presently, subscription based video-by-mail services account for 36% of all videos rented by consumers, compared with a 45% share for rentals purchased at physical store locations. Blockbuster has also attempted to offer a Netflix-like service, however, it has clearly been unable to compete in this arena. The company's total revenue was nearly $700MM less in 2008 than in 2003; a sign that it has been woefully incapable of replacing lost brick and mortar sales with online and mail alternatives.

As a comparison, Netflix logged 2008 revenue that was over $1B more than it recorded in 2003.

Recently, video rental kiosks have made an enormous splash by offering cheap $1/day rentals, in prime locations (Wal-Mart (WMT), grocery stores). DVDs rented at these kiosk locations now account for 19% of all video rental activity.

More importantly however, is the marketing research firm NPD Group's prediction that, in the year 2010, 30% of all video rental transactions will take place at kiosks! A market share shift of that magnitude, in such a short period of time, will likely destroy Blockbusters brick and mortar sales. The company appears to understand the dying nature of a DVD rental physical storefront, and has plans to charge headfirst into the kiosk rental business. Blockbuster only has 500 such machines right now, but expects to roll out 7000 in the year 2010 alone.

Alas, this effort may be a textbook example of "too little, too late"; the leading player in the kiosk game - Redbox - already has machines in over 15,000 locations. The traditional real-estate cliche - location, location, location - has distinct parallels in kiosk site selection; a kiosk must be located in a venue that is convenient for the consumer. With a 14,500 machine disadvantage, it's likely that Blockbuster will struggle to compete with Redbox in the battle to place kiosks in the most convenient spots.

Over the next year, the largest threat to the kiosk distribution model will be licensing disputes with change-averse Hollywood studios. As far as Blockbuster is concerned however, the question of whether or not studios will succeed in stymieing kiosk sales is effectively the difference between a bad or worse outcome for the company; they will either continue to make a push into the market - from an extremely disadvantaged position - or their only chance of survival will be squashed by the studios.

This rapid shift in the video rental business is occurring at a horrible time for Blockbuster. The company's revenues are on pace to decline $1B, or almost 20%, in 2009 compared to 2008.

Assuming that NPD Group's projections regarding kiosk market share are correct, Blockbuster's second half numbers will deteriorate even further from already depressed current levels. I wouldn't be surprised if the company logs less than $4B in revenue for 2009, a greater than 33% decline in annual revenue since 2004's $6B year. Unfortunately for Blockbuster, that isn't even the bad news; the company has $415MM worth of debt obligations due between now and the end of 2010.

So how does a company with less than $100MM in cash, rapidly declining sales, and gruesomely negative cash flow meet such an obligation? Well, Blockbuster's strategy is to do the only thing they can: slash G&A as rapidly and as deeply as possible, and sell assets like there's no tomorrow (because there might not be). This was a borderline-achievable goal prior to the rapid ascent of kiosk rentals; under present conditions however, it may be impossible.

Simply put, sales may be declining faster than Blockbuster's ability to preserve cash via cost cuts and asset sales.

Many people still visit Blockbuster's physical locations, and may be disheartened in the event the company is unable to meet it's looming debt obligations. My movie viewing habits will not be disrupted though; I've been streaming Netflix video content, on-demand, through my XBox for several months now.

Disclosure: no positions

Source: Blockbuster Could Collapse in 2010