Blockbuster vs. Netflix: Playing the Online DVD Rental Market

After years of trailing Netflix (NFLX), movie rental giant Blockbuster (BBI) has finally realized that it might have a competitive advantage over its main rival: about 8,500 storefronts worldwide. By integrating in-store and online DVD rentals into its new Total Access movie rental program, Blockbuster is finally making some gains at Netflix's expense.

However, looking at the share prices of both companies, one has to wonder whether Wall Street is too optimistic about Netflix's future and too pessimistic about that of Blockbuster. Despite having annual revenue that trounces NFLX by a factor of four, Blockbuster's market cap ($1.09 billion) trails that of Netflix ($1.75 billion) by nearly 40 percent. Netflix's EBITDA for the first nine months of 2006 came in at $46 million, only 25% of Blockbuster's $188 million.

So, Blockbuster at first blush appears to be a much cheaper stock with 60% of the market cap of Netflix, but with 4 times as much revenue and EBITDA. Even using a P/E ratio, which hurts Blockbuster given they have a fairly high debt load, BBI shares trade at more than a 10% discount to Netflix based on 2007 projections.

Given these numbers, there has to be some explanation for the wide valuation disparity. Growth investors would surely point out that Netflix is focused solely on the high growth online DVD rental market, whereas the bulk of Blockbuster's business comes from the storefront, which is a deteriorating market.

That said, Blockbuster's 8,500 stores are worth something, even if it is far less than five or ten years ago, and Netflix has no stores. Going forward, does NFLX have an advantage over Blockbuster when it comes to securing incremental online DVD rental customers? Making the case that they do is difficult, especially since BBI is now allowing customers to return their online DVD rentals at local stores.

Another way to look at it is to analyze the online DVD rental market itself. I have made the point before on this blog that five or ten years from now it is very possible that nobody will be renting DVD's on a web site and returning them through the mail. The cable companies seem to have a powerful distribution network via the on-demand model, and there is no reason to think that every movie that Blockbuster and Netflix have could be part of a mass digital library, accessible to every customer who has a cable box.

If the online mail order model does indeed go away, it would be hard to argue that Netflix is better positioned than Blockbuster. Both companies could very well die under such a scenario, but Wall Street seems to be unfairly down on Blockbuster's propsects versus those of Netflix. The current valuation disparity seems pretty drastic to me, and I'm not sure it makes any sense.

As always, your comments and opinions are welcome.

BBI and NFLX-One-Year Comparison Chart

Comments

[borisb:]

netflix owns this market with highly effective and mostly stable to this point 84% marketshare. netflix patented service is higher quality, well organized, and profitable. the only phantom advange that BB has over netflix is market cost. but netflix claims as they reach scale in key markets the market ing cost is going to cascade down from 30% of sales towards sub 20%. notably Northern California has 1/2 the national marketing cost and 15%+ household penetration. Netflix blanketed the country with robotic smart hubs in 2002 with well spent IPO money. They have envisioned a market of 20-30 million subscribers and have been investing this way for years, so the war is mostly over.

2007 Jan 09 06:53 PM

[Chad Brand:]

However, in the fourth quarter NFLX's market share of new accounts came in at around 55% versus BBI's 45%. It remains to be seen if BBI can maintain that momentum, or if it was just a one-time pop thanks to more advertising. Maybe BBI will maintain that level of marketing.

2007 Jan 10 11:09 AM

[borisb:]

Yes, Blockbuster is spending heavy to garner articifical super-sized sucess, and plans to keep spending. On the other hand, Netflix is enjoying a effective heavy wieght national tv ad campaign and plans to offerring exciting video on demand that will work on Apple-Tivo-cable boxes. The big picture is that there is 8 million subscribers and another 20 million-ish to go/grow. If they split the market both companies will do well. we shall see. i am partial the netflix in the 23s as being near the low end and might have a good to great bounce 27s-34s

2007 Jan 10 09:22 PM

[amberlicious:]

Hi Borisb,
I'd like to know how you got your 84% market share figure. I'm doing a marketing plan on them and that information source would be very helpful as I cannot source a web blog ;) thanks amberlicious*


On Jan 09 06:53 PM borisb wrote:

> netflix owns this market with highly effective and mostly stable
> to this point 84% marketshare. netflix patented service is
> higher quality, well organized, and profitable. the only phantom
> advange that BB has over netflix is market cost. but netflix
> claims as they reach scale in key markets the market ing cost is
> going to cascade down from 30% of sales towards sub 20%. notably
> Northern California has 1/2 the national marketing cost and 15%+
> household penetration. Netflix blanketed the country with robotic
> smart hubs in 2002 with well spent IPO money. They have envisioned
> a market of 20-30 million subscribers and have been investing
> this way for years, so the war is mostly over.

May 20 07:55 PM