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Best Buy (NYSE:BBY) is the largest specialty retailer of consumer electronics in the US and competes with retailers like Wal-Mart (NYSE:WMT) and RadioShack (NYSE:RSH). Best Buy sells a variety of electronic devices such as TVs, home theater systems, cameras, appliances, computers, mobile phones, video games, software, and offers repair/installation services to consumers across the country under different store brands.

Best Buy recently introduced CinemaNow, which offers on-demand video content including movies and TV shows, on blu-ray disc players and home-theater systems from LG Electronics (OTC:LGERF). The service will be offered via software developed by Sonic Solutions (SNIC), and will be embedded in the hardware sold by Best Buy.

Best Buy Wants a Piece of the Growing Digital Media Market

The digital video-on-demand market has grown at a tremendous pace in the past few years, fueled by increasing broadband penetration, higher broadband speeds and the emergence of new online business models from companies like Netflix (NASDAQ:NFLX) and Apple (NASDAQ:AAPL). As reported by Blockbuster (BBI) in its SEC filings, the digital video-on-demand market grew at a rate of 37% between 2006 and 2008.

Best Buy is the market leader in consumer electronics in the US, with more than 22% market share. The retailer will leverage its large US customer base to promote its in-home digital video service efficiently by embedding it within the media devices that it sells.

Mitigate Threat from Established Players like Apple and Neflix

Best Buy’s foray into the digital media market is an attempt by the company to mitigate the threat of declining DVD sales. Retail sales of DVDs have been on a downward trend in recent years as a result of demand for online and on-demand movie rentals. This worries retailers like Best Buy and Wal-Mart who make a significant amount of money from the sale of DVDs.

Below is our forecast for Best Buy’s revenue per square foot for its US stores which includes the revenues that the company generates from DVDs. You can modify the forecast below to see how sensitive Best Buy’s stock is to fluctuations in this key operating metric.

Apple, in particular, is a growing threat to retailers as it can control movies and software that can be funneled through its popular devices like the iPad and the iPhone. Apple’s advantage will be challenged by initiatives like Best Buy’s offering of CinemaNow service.

Long Way to Go for Best Buy in Digital Media

Best Buy has a long way to go before offerings like CinemaNow can pose significant competition to video-on-demand offerings by Apple, Netflix and cable service providers (Comcast (NASDAQ:CMCSA), Time Warner (NYSE:TWX)). Over the long term, Best Buy will look to install CinemaNow and potentially other on-demand services in virtually every media device that it sells.

You can see our complete model for Best Buy’s stock here.

Disclosure: No positions

Source: Best Buy Prepares for Declining DVD Sales With CinemaNow Offering