Blockbuster Soars, Netflix Running Out of Steam

Includes: BBI, NFLX
by: Faisal Laljee

I feel good about getting readers out of Netflix (NASDAQ:NFLX) back at $27.50 in October. Since then, Netflix has fallen some 14%, while its arch rival Blockbuster (BBI) is up 67%. So what changed?

On Nov 1st, Blockbuster launched its Total Access program, which enables subscribers to return movies rented online to a local store and in return, pick up a free in-store rental. As soon as the trade is made, the online store knows automatically that you have returned the rental in the store and without waiting to receive it at their distribution center, they send you the next movie in your queue. So you could potentially have 6 movies out at a time while signed up for 3-at-a-time service. Additionally, Blockbuster still gives subscribers two coupons for free in-store rental of a movie or video game every month.

By doing so, Blockbuster has finally figured out a way to complement their younger online model with its older fledgling brick and mortar business. 60 days into the launch of this program, the company has already added 700,000 subscribers, which is a 47% increase over their previous subscriptions, ending the year with 2.2 million subscribers, well above expectations. Additionally, through their media campaigns outlining the benefits of Total Access over Netflix, they have managed to snatch some of Netflix's casual customers over.

Two parts of this equation that investors are not talking about are that by adding to their subscriber base and developing the Total Access program, Blockbuster has also managed to increase foot traffic to their stores, which translates to higher retail sales of DVD's, magazines, video games and movie munchies. In addition, having a sign-up terminal at the stores allows them to add subscribers who would not otherwise do this at home or over dial-up.

Secondly, by allowing their 2 coupons a month to be used for video games, Blockbuster has figured out how to make subscribers of those who prefer to kill time destroying the Nazis of Germany rather than watching Tom Cruise in MI3. Ok maybe that's not the right example seeing as how no one liked watching MI3, but you get the point. With video games costing upwards of $50 for the new PS3, Wii and XBox 360 consoles, more and more gamers are looking to rent games and buy them used - just ask Gamestop and (which by the way would be a good acquisition for both Blockbuster and Netflix).

I have owned BBI in the past with some success, but my last affair with the stock ended a couple of years ago. Since then the stock has fallen from over $10 to under $4. However, I have missed the latest move of 50% in 2 months.

So what is next for Blockbuster? Well, they are predicting to have 4 million subscribers by the end of 2007. Also, they are sitting on some good amount of real estate, which could really unlock value if they decided to start consolidating stores. Pending any short term market corrections, I expect this stock to keep moving up.

Meanwhile, Netflix (NFLX), seems to be running out of steam. Their subscriber growth seems to have slowed down considerably, and it will slow even further with Blockbuster's onslaught. Recently, Blockbuster has started to offer incentives for Netflix subscribers to switch over, yet another negative for Netflix.

But the biggest threat to Netflix, in my opinion, is Apple TV and XBox 360. Netflix CEO Reed Hastings has indicated Netflix's intentions of having a movie download service via set-top boxes, and while the Netflix movie library is unparalleled and unsurpassable, the majority of the movie rental market is comprised of mainstream movies. Such movies, along with special content that is available through XBox 360 and soon to be released Apple TV will make it difficult for Netflix to replicate their DVD rental success.

My projection for online DVD rental subscribers for Netflix by the end of 2007 is 7 million, and Blockbuster is 4.5 million. I also think that by the end of this year, the Blockbuster stock will outperform Netflix, even from these levels.

BBI vs. NFLX 1-yr chart: