Disney Reignites DVD Window Release Debate

Includes: DIS, LGF.A, NFLX, SNE, TWX
by: TMT Analyst

In the traditional release window model movies are first released in the movie theatres and about four months later on DVD, and about 45 days later on VOD, and then about 18 months later on pay TV. In about two to three years after the movie’s release they are shown on free and ad-supported TV. And might I dare to add a last option of ad-supported Internet sites like Hulu a few years after appearing on ad-supported TV.

DVD drives the majority of a studio’s sales and a majority of its profits; however, DVD sales are declining, cutting into movie studio profits. As such, the studios have been seeking to shorten the length of time between the movie’s release in the movie theatre and the release on DVD to drive more DVD sales. Naturally, the movie theatres are pushing back on the studios as the compression of the window threatens their profits. If a movie is available on DVD on the same date as in the movie theatre or even a few weeks afterwards, it is likely that some consumers would forgo going to the movies in favor of buying the DVD, leading to lost ticket sales for the movie theatre.

Disney (NYSE:DIS) reignited the debate by making the following comments on their recent earnings call (see transcript here):

And so we really feel that we need to be cautious in terms of the movie business overall, because of the pressure on that very, very important window. And that's why, by the way, we've been in discussions about windowing with the exhibitors, because we feel that it's really important for us to maintain a very healthy business on the exhibition side, and 3D is definitely contributing to that, and a very healthy business on the home video side, which we think is actually in the best interest of the theater owners. A healthy movie business is good for them. They want us investing in innovation, investing in higher quality content. And so mindful of what's going on in the home video side, we feel that it's time, on a case by case basis, movie by movie, to really take a look at how we're windowing the home video product into the marketplace.

Disney, we believe, raised several window release issues with those comments, the first of which is whether the studios will collapse the theatrical to DVD window. We believe that this is highly unlikely for several reasons.

For one, movie theatres are a great way to gauge the level of interest in movies and how the movie will ultimately perform on DVD. That should help studios determine demand and more accurately forecast DVD production levels. For instance, if a movie flops at the theatre then the studio knows that they should not produce many DVDs to avoid massive returns by retailers. Conversely, the immense popularity of Avatar alerts NewsCorp (NASDAQ:NWS) that they should produce a high number of DVDs so that they do not miss out on sales.

Second, the success of a movie at the theatre helps determine how much a studio charges for the movie on pay and free television because the contracts are tied to the level of box office receipts. The higher the box office receipts the higher the studio charges the cable and broadcast network for the movie.

Lastly, DVDs will be eventually replaced by various forms of electronic sell-thru, permanently cutting into the DVD profit stream for the studios and providing further incentive to keep the theatrical window intact.

A second issue we believe Disney raised is whether an exclusive DVD sell-thru or sales only window should be created, meaning that DVDs will not be available for rental. This came about because the studios believe that Redbox’s $1 per night rental is eroding the economics of the DVD sell-thru business. Warner Brothers (NYSE:TWX) has addressed the issue forcing Netflix (NASDAQ:NFLX) to agree to a 28-day delay for new releases after they hit the movie shelves. In return Netflix agreed to get more WB movies for its streaming feature and copies of WB movies at reduced cost. WB and Redbox failed to agree to this deal and are embroiled in litigation although there are reports that the two will agree to a deal similar to the one struck with Netflix– Redbox is also in litigation with Universal and Fox. We note that Redbox does have a deal with Disney, through Paramount, and with Sony (NYSE:SNE) and Lionsgate (LGF) whereby Redbox obtains their movies on the same day they hit the shelves, in return for significant payment commitments from Redbox.

This new window could likely stem the decline in DVD sales in the near-term but longer-term it will be meaningless as the world moves to digital.

How about the 45 day DVD to VOD window? Time Warner has tested collapsing the DVD/VOD window and stated that DVD sales were not hurt. Other studios have disagreed. DVD profits are much more significant in both absolute dollars and in margins for DVD vs. VOD and thus studios have a vested interest is preserving that window.

In all, we believe that the theatrical window likely collapses by one day per year but never all at once. Some measure of a collapse can be sustained by all parties because over 90% of a movie’s ticket sales are generated in the first four weeks in the theatres. Hence, the theatres can agree to a partial collapse over time provided that the studios continue to deliver blockbuster hits and new technologies like 3D continue to drive increased profits for the theatres. Indeed, that is what has been happening over the past few years.

See previous write-ups on media stocks here.

As for the DVDs, their sales likely approach zero, asymptotically, over time as digital distribution models take hold and remove DVDs from the windowing argument entirely.

Disclosure: None