Movie Gallery, Blockbuster and Netflix's Race To the Bottom

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Includes: BBI, MVGRQ, NFLX
by: Michael Zielinski

The main players in the movie rental business have had a rough time this year. Year to date, Movie Gallery (MOVI), Blockbuster (BBI), and Netflix (NASDAQ:NFLX) are down 89%, 22%, and 32% respectively. Collectively, the three companies have lost over $900 million in market cap.

Movie Gallery chose to focus on in-store movie rentals and never pursued online rentals or downloads. In 2005, they bought out larger competitor Hollywood Video saddling them with $1 billion in debt. The company has watched their revenue dwindle in the face of competition from online rentals and struggled under their heavy debt load. Their most recent quarterly filing cites liquidity problems and doubts about continuing as a going concern.

Blockbuster was late to the online movie rental business, but caught up quickly by emulating Netflix's service with an added benefit. Subscribers could return movies to physical stores instead of waiting a few days to send and receive by mail. They recently acquired Movielink, allowing them to match Netflix's movie download feature. Although Blockbuster has made great progress in competing with Netflix, this hasn't translated into profitability. In fact, the shift to online subscriptions has pushed up costs and helped to swing the company to a quarterly loss.

Netflix was a pioneer in online movie rentals, early to define the space and defend their turf. Back in 2005, Netflix actually beat Walmart. Nowadays, competition from Blockbuster is proving much more challenging. In the most recent quarter, Netflix reported their first ever net subscriber loss. During the same period Blockbuster added 600,000 subscribers. Netflix is currently profitable, but recently announced price cuts on their most popular subscriptions. This will impair their margins and further escalate the battle with Blockbuster.

The dark horse in the movie rental space might be movie downloads. Do we really need to send plastic discs back and forth to watch movies? In the future, the concept may seem silly. While both Blockbuster and Netflix have invested in download features, both seem to be devoting most of their attention to winning the DVD rental-by-mail market. The area seems ripe for a new upstart to enter and once again upend the way we get our movies.