How Dish Network's Blockbuster Buy Is Paying Off

| About: DISH Network (DISH)

Since October 28, 2011 I have been screaming about how big of a "game changer" Blockbuster could be for Dish Network (NASDAQ:DISH). The stock has performed well, and returned a gain of 15% to my portfolio since I made the call. But with the Blockbuster experiment leaving several questions, and few answers, some are wondering if the experiment will provide the answer to separate Dish from other providers. Its a valid question but maybe the acquisition of Blockbuster had expectations that were too high in an industry that is constantly changing with the advancements in technology.

Dish Networks announced earnings last week, and for the most part, results were solid. The company posted revenue of $3.63 billion compared to $3.2 billion in 2010. It also posted net income of $312.7 million and an EPS of $0.70 compared to $251.8 and $0.56 year-over-year. Therefore, the company's top and bottom line numbers were solid and above expectations. But there are still several issues associated with the company's earnings. Its debt is still way too high with a large number of liabilities and questionable cash flow.

The Motley Fool posted an interesting article which looked at the company's cash conversion cycle, CCC, which may be helpful in fundamental analysis. It further illustrates weaknesses in converting outgoing cash into incoming cash. Yet aside from the strong top and bottom line numbers and the questionable balance sheet and cash flow, there lies several questions with the integration of Blockbuster for future growth.

The first sign that Blockbuster is paying off is the company's new subscribers. Dish added more than 20,000 new subscribers which is a huge upgrade from its 150,000 customer loss in the year prior. Some attribute the growing subscription base to the Blockbuster acquisition. Dish was offering deals during the quarter to capitalize on Netflix's (NASDAQ:NFLX) angry customers, and because of the Blockbuster acquisition, Dish offers a service that its largest competitor DirecTV (DTV) can not offer. Therefore, I imagine its conversion rates are quite high for signing up new subscribers.

The fall out of Blockbuster was kind of sad for people such as myself who grew up with a Blockbuster on every corner. Now you rarely see a Blockbuster, and when you do, it's always empty. However, in 2011 Dish announced that it was going to continue operating 1,500 of the stores, but the company recently said that it plans to close as many as 500 stores. Therefore, the question to ask is should investors be worried, and is this a sign of a failing Blockbuster experiment?

I don't think closing Blockbuster stores is a sign of trouble for Dish but I can understand why it would concern some investors. The luxury of Dish buying Blockbuster, in a bankruptcy auction, is that Dish would gain access to its large asset base of DVD's, games, blu ray, and streaming services that Blockbuster could provide. These features would allow Dish to offer a service that no single company could provide, unless DirecTV were to purchase Netflix.

Let's break down the Blockbuster acquisition into two benefits for Dish: streaming and DVD rental. It basically offers the same services as Netflix, although some may argue Blockbuster is better. One of the largest reasons for Netflix's demise has been investor speculation of falling profits due to increased costs for streaming. Well, the streaming service of Blockbuster is faced with similar issues, although not the same. And higher programming costs have already began to take effect on several of Dish's competitors. Therefore, we can see several speculative issues in streaming, so let's take a look at the other side of the equation which is DVD and Blu-ray rentals.

Below you will see a chart which shows the market share of the DVD and Blu-ray rental industry courtesy of NPD Group market research firm. The research shows what most would assume, Blockbuster has the smallest market share of the "big three" in this particular industry. And most likely, Redbox's market share will become even larger in the coming months, thanks to its purchase of the Blockbuster rental kiosks for $100 million which was previously owned by NCR Corp. The market share for this industry is wide open, but it appears as though Redbox is making strides to become the dominant player while Blockbuster and Netflix are faced with higher costs of employment, cost and replacement of goods -- and let's not forget stamps.

Redbox 37%
Netflix 30%
Blockbuster 17%
Click to enlarge

Redbox will most likely control the DVD rental industry in the next 5 years but since Dish is a cable satellite provider my guess is that it cares more about streaming. Unfortunately, there are high costs associated with this business and its future regulations are still unknown. However, I do believe this to be a positive for Dish Networks over the long-run. We are a society that is becoming more accustomed to immediate gratification and getting things whenever we want.

One of the primary reasons that Redbox has done so well is because customers can simply drive down to their local Walgreens (WAG) or McDonald's (NYSE:MCD) pay $1 and rent a movie. We don't want to wait for a movie to arrive by mail when it's so simple to get it from a Redbox. Therefore, I don't see how Redbox doesn't control this particular business as it continues to acquire additional assets and grow throughout the U.S.

I think it's still too early to tell if the Blockbuster experiment will be a success. There are obvious problems but there are also many benefits that we are already seeing. We have already witnessed much better than expected earnings and an increase in new subscribers, in which I believe Blockbuster was a major contributor in attracting new customers. We still don't know for certain which direction Dish will take Blockbuster, but there is a strength in the streaming service and the opportunity for a larger piece of the DVD rental market share.

Overall, I am encouraged by the company's latest earnings report but feel as though more time is needed to know for sure the success, or failure, of the Blockbuster experiment. Because when it's all said and done, the company paid a very small amount, $320 million, to acquire a company with property that is unlike any other company in the industry. Therefore, at this time we can summarize by saying there are problems, a lack of clear direction, but there are new subscribers, and much better earnings which I believe is worth a little patience before drawing conclusions.

Disclosure: I am long DISH, MCD.