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Over the past five years, many analysts and investors (including Bill Gates) have called an end to the Optical Disk due to the rise of digital downloading. Revenue from digital downloading, however, was up 16% or so in 2010, which is actually much lower than the growth of Blu Ray, which saw a 53% increase yoy.

Netflix (NASDAQ:NFLX) reported good earnings, which mean an EPS of $3. Nevertheless, everyone in love with the stock invested after hours (up 10% to $202), signaling the belief that downloading is the future. VOD grew 20% last year, however, which does not garner the same multiple expansions that apply to the cable companies.

Of course, Netflix is sporting a huge growth rate and some will argue that on a cash flow basis the stock is not too overvalued here. Companies benefitting from Blu Ray are hated – Best Buy (NYSE:BBY) is sitting at multi-month lows, for example. Here are the major players in the space, and this is my take on valuation as well as industry trends.

(NFLX) – Netflix grew earnings by 55% over the last year’s quarter, but sales did not meet analyst estimates on revenues. The company projects a 30% revenue growth rate in 2011 but has warned that global expansion will deliver a $50MM hit to earnings (which is a big chunk of the company’s yearly profit). While I like the management and the growth story at Netflix, I think many on Wall Street are too quick to write off Blu Ray, considering that the studios have much better margins on Blu Ray sales then they receive from NFLX streaming. A new release DVD runs $20 or higher, and this means studios can make bigger budget films such as Avatar and Inception because revenues per film are much higher in the Blu Ray channel -- NFLX bought their Starz catalogue for $30MM, which is not enough to fund half of the next Avatar. Studios will want to keep their gravy train alive and their business model in tact, which is why I believe Blu Ray/Digital Copy will be emphasized more and more in the future.

Additionally, competition appears to have stiffened from Amazon (NASDAQ:AMZN), which purchased LoveFilm (the “Netflix of Europe”). While Netflix has exhibited relentless growth, any hiccup in earnings growth this year could hurt investors who are buying the stock at $200 – I have been following a strategy of shorting NFLX on the bigger spikes, then buying back and even going long a bit of the stock, when it hits $180 or so, to hedge some short Jun, 2011 $210 calls I put on as an overall market hedge.

NFLX could follow the Livermore pattern of rising above a big psychological number ($200), causing it either to move up to $220 to squeeze short sellers, or to fail at $200, which would likely be a near term top for the squeeze higher. I would not recommend shorting the stock without some short puts against it, or a calendar spread as NFLX is the ultimate Wall Street darling right now. However, at a 67 trailing multiple, NFLX could be chopped down to size if the company can’t renegotiate the Starz deal on favorable terms, or if they cannot convince other studios to sell NFLX streaming rights to their content at a reasonable price. With the stock at $200 investors should be cautious, but shorts should wait to see if the stock breaks $210 before moving into a bearish trade. If the company can’t hold $200, I would think $190 would be the next stop from here.

(CSTR): Coinstar was taken to the woodshed recently when it announced that 2011 EPS would be between $2.8 and $3.2, which was lower than previously announced. The company has displayed tremendous growth but said that the 28 day window for new releases was hurting business. Coinstar has displayed strong historical growth and certainly offers a strong value proposition versus watching a movie at a theatre. With Americans tightening their belts, CSTR’s $1 a night rate is going to be very popular for years to come and if the economy slows down, DVD and Blu Ray rental should do well. CSTR trades at a reasonable 13X forward earnings and a relatively low multiple to free cash flow given their high growth rate.

(NASDAQ:HAST) -- Hastings Entertainment is a cheap discounter in the packaged media space trading at a 47MM valuation. The company has around $7MM remaining in their share repurchase (after the last Q) from the buyback which was authorized on July 31st. With the closure of Movie Gallery, I would almost argue that a drop in price helps long term shareholders. I'd rather see the management team buy shares back in the $5's and hopefully $4's instead of the 7's when CEO John Marmaduke announced a $10MM share repurchase on July 31, 2010 – shares closed at $7.25 that day, and management apparently felt the shares were undervalued at that price. This is a low float stock that has dropped quite a bit from the April highs. Management can now repurchase stock for less than half of tangible book value and at 3-4X free cash flows which should help the company's book value grow to over $12 per share this year.

Blu Ray revenue increased 53% this year but meanwhile everyone is predicting the end of Optical Disk revenues as if will occur tomorrow (again – it happens every year), but Movie Gallery was a 2.5BN chunk of disc revenue that is now gone, which is bullish for Hastings and masks the fact that many consumers prefer browsing physical product to staying home all day streaming movies. Brick and Mortar Blu Ray sales are up 34% this past year and many people don't want to wait 28 days for Redbox and Netflix rentals, which helps will help Hastings with their reasonable price points, large selection, and low late fees – catalogue rentals are priced at $.50 cents per day, which is the lowest price point in the industry.

Clearly headwinds exist, but over the longer term Blu Ray should level off the decline in Disk revenue and Hastings could leverage its clothing, food, electronics, books, and comics businesses to make up for some of the coming declines predicted in disk sales (I personally think sales will increase a bit over the next few years). Hastings is a large player in used packaged media which is tremendously underappreciated by Wall Street in my opinion - if you remember Blockbuster and Movie copied Hastings in that area but were too late to the party and did not diversify or deleverage in time. Physical media was supposed to die suddenly every year since 2004 -- the fact that Blu Ray sales are making up for a good portion of this decline in disc sales (which aren’t down very much when adjusted for the closure of MOVI), while used and discount catalogue at Hastings provides a competitive advantage -- more titles for a lower price.

In ten years, physical media should still be popular, and Hastings will have ample time to restructure and diversify its offering. With free cash flow of 15MM or so last year, a $47MM price tag is a great bargain. Hastings is buying back stock at half (47%) of tangible book value which is accretive for shareholders if Hastings can stay nimble and focused -- $7MM of repurchases could erase 1.3MM shares at these prices, which would make the current price of $5.3 translate to a $39.75MM market cap, or one times EBITDA and 39% of tangible book value. In other words, share buybacks at Hastings are creating $1 of book value for every $.50 cents invested at current prices if you believe in the company's cash flow and shareholder equity statements, which I do. has substantial potential and as a shareholder I would be happy to see more cash flow directed to the website in the future -- eyeballs mean profits for a company like Hastings.

In short, I feel this industry is moving to streaming at a much slower pace than analysts realize – living in New York, your choice for home entertainment is either Redbox or Netflix, but in many smaller towns across the country mom and pop stores could last much longer than anyone previosly anticipated, which is good for the studios as they can keep their higher margin Blu Ray product growing at a pace that is fast enough to offset the overall decline in packaged home entertainment. Clearly, the industry is in flux, so make sure to employ a rigorous due diligence process before investing in this space.

Chart forHastings Entertainment Inc. (<a href='' title='Hastings Entertainment, Inc.'>HAST</a>)

Disclosure: I am long HAST, BBY.

Additional disclosure: short NFLX calls/puts