Blockbuster: Driving Off a Cliff?

The Hollywood Reporter had a story last week that Blockbuster (NYSE: BBI) will soon announce a movie rental set-top box. Everyone who has written about this has noted that it will compete against – among others – Apple TV (NASDAQ: AAPL).

That’s true, if you can call “eating dust” a competition.

To the extent such dedicated set-top boxes ever catch on (and I have doubts), Apple TV is Lightning McQueen to Blockbuster’s Mater. Apple is in the hardware business: you can bet it’s in this race to win. Frankly, I doubt it even cares that much about the movie revenue. But those rentals are Blockbuster’s raison d’etre.

Blockbuster still seems like a deer caught in the headlights, and has been playing follow the leader with Netflix (NASDAQ: NFLX) for some time. This recent development simply mimics the deal that Netflix announced with LG Electronics awhile back. While I wouldn’t go so far to say it is doomed (yet), Blockbuster needs a serious strategy tune-up.

First, it has to rid itself of the retail store “boot”. For too long Blockbuster has focused on driving traffic to its locations, which it naturally feels obligated to earn money on. But this is the digital age, and despite trying desperately to leverage them, Blockbuster’s locations aren’t the assets it thinks they are. Instead of trying to earn a return on real estate, Blockbuster should have been shedding stores. I understand the real estate market was pretty good last year, probably a great time to divest. Oops.

This is the same mistake Toys-R-Us made, dipping its toes into the on-line pool but afraid to jump in until it was too late.

Blockbuster does have some options left. The purchase of Movielink gives it a leg up in on-line delivery. Going to market with its own STB is a mistake, however. First, it’s not at all clear there would be much demand for the box; just look at Vudu. Second, Blockbuster doesn’t exactly present a compelling co-branding opportunity for CE manufacturers. And depending on the arrangement, the costs associated with such a move could easily outweigh any additional revenue generated.

Far better to package Blockbuster-to-the-TV as a service. True, Apple and TiVo (NASDAQ: TIVO) aren’t likely to sign on. But it could partner with multiple CE manufacturers who can build home media transfer capabilities into their DVD or Blu-ray players, using technology from the likes of DivX (NASDAQ: DIVX) or Macrovision (NASDAQ: MVSN).

These solutions (perhaps not so coincidentally called “Connected” by both firms) are licensed to CE manufacturers, vendor neutral, and built-in at the chip level. Movielink gets films to the PC, and “Connected” easily gets them to the DVD or STB, without requiring an additional box. In fact, DivX has a good relationship with LG already–wouldn’t surprise me to see Netflix go with DivX Connected on an LG box instead of with a branded version.

This makes even more sense when you consider the other advantage Movielink brings to Blockbuster: a partnership with Sonic Solutions (NASDAQ: SNIC). Sonic’s Qflix is the only legal way to burn a studio DVD remotely, which allows Blockbuster to say goodbye to much of its costly inventory. It will soon be feasible to download movies to PCs and then burn them at home. (The disc is dead, long live the disc.)

Blockbuster still has a chance in this race, but it had better get out of first gear. Fast.

Disclosure: I don’t hold positions in any the stocks mentioned in this article.

Comments

[Dan Jacome:]

They offered $6 for CC, according to the WSJ right now

2008 Apr 14 03:15 AM

[Scott Berry:]

Wow. I always thought that when you find you've dug yourself in too deep, the first thing is to stop digging.

Guess you can take the man out of 7-11, but can't take the 7-11 out of the man.

2008 Apr 14 06:02 AM

[robert99:]

I think BBI has already lost, but I am interested to see just what they think they are going to do with CC...

2008 Apr 14 07:30 AM

[buyforeclos...:]

First of all this isn't Residential real estate. Commercial real estate is actually up this year.However, that being said I am not sure if this is going to work out or not...but kudos to BB for showing some juevos and trying to get this stock to break out of the doldrums. Sure its down 12% today but 2 years from now they will look like geniuses or poster boys for the Motley fools. I think they can always divest the real property and wont lose a lot on that aspect of it.

2008 Apr 14 05:09 PM

[buyforeclos...:]

Oh...I do think the ypaid too much with a 54% premium...WAY too much! They could have made the deal happen at %5.25 if they played hardball

2008 Apr 14 05:10 PM

[Scott Berry:]

Good point on the commercial vs. residential. But it does underscore my suspicions about today's offer for CC having a value floor to it.

2008 Apr 14 05:23 PM

[billddrummer:]

CC doesn't have any real estate to speak of. Only 5 of their locations are company owned (per the FYE 2007 10-k) and only a portion of the headquarters complex is owned--the bulk of it is leased. So are the distribution centers. I don't understand why the company would look attractive from a RE leverage point of view. In addition, many of the locations are in declining areas, and if you divide the Canadian stores by revenue generated, they're only selling about $150,000/annually per location. Seems to me you could just as easily get by with storefronts.

This deal looks dumb from so many angles, I wonder what the boys at the top were smoking when they thought it up?

2008 Apr 14 05:46 PM

[beezlebub:]

there is no real property to divest...CC and BBI are both nearly completely leased.....it will cost BBI a a good chunk of change to break CC leases (CC has been trying to do this to no avail)....would you drive to the local shopping plaza, battling traffic etc along the way to rent a movie because the downtown BBI store was shuttered because its within 5 miles of an existing CC store? ideally the deal falls through....


On Apr 14 05:09 PM buyforeclosures wrote:

> First of all this isn't Residential real estate. Commercial real
> estate is actually up this year.However, that being said I am not
> sure if this is going to work out or not...but kudos to BB for showing
> some juevos and trying to get this stock to break out of the doldrums.
> Sure its down 12% today but 2 years from now they will look like
> geniuses or poster boys for the Motley fools. I think they can always
> divest the real property and wont lose a lot on that aspect of it.

2008 Apr 15 06:03 AM

[Scott Berry:]

If this isn't for real estate then there's no reason for the move at all. Neither of these has done much with their merchandizing (though Keyes may be changing that at BBI), and the box+media angle's a non-starter.

Maybe Icahn's looking for a place to dump both video and Moto phone inventory. :-)

2008 Apr 15 09:29 AM