Video Rentals: Citi Favors Blockbuster Over Netflix

Includes: BBI, NFLX
by: Eric Savitz

Blockbuster (BBI) shares are rallying - and Netflix (NASDAQ:NFLX) shares continue to sell off - following Tuesday’s Blockbuster announcement of a price cut in online-only video rental service.

Wednesday morning, Citigroup’s Tony Wible was helping things along. Wible raised his rating on Blockbuster to Buy from Hold. He says risk/reward in the stock is improving as the costs of the company’s Total Access program are fully priced into the stock, which was down 45% from mid-March through Tuesday’s close.

Wible also says that the threat of “day and date” same-day availability of DVD sales and video on demand “looks more minimal near term.” In test markets where cable providers offered same-day availability, video rentals declined 2%, a shift Wible calls “nominal.”

Meanwhile, he contends “box office visibility is improving.” In fact, he thinks there are so many big movies coming this summer that consumers won’t be able to see them all in theaters.

We see the summer shaping up to be an extremely strong season that could be so jam-packed with competing title debuts that growth is likely to be artificially suppressed as moviegoers will likely find it especially difficult, if not nearly impossible, to cycle through all the popular releases while they are showing on the big screen. As a result, we forecast a rental 'spillover' effect that will carry through to the fall and winter, whereby a la carte in-store movie rentals are likely to increase during 3Q and 4Q.

Wible also says that “while it seems counterintuitive,” the Blockbuster by Mail program will cut the costs of the Total Access program by reducing in-store content costs; he says it could help BBI gain market share in rural areas from NFLX.

Blockbuster will also focus on cost-cutting, Wible says, by “focusing on cutting compensation and occupancy costs.” He writes that “real-estate rationalization should remain a top priority through selective store pruning and lease restructurings.”

Tuesday, Wible cut his rating on Netflix to Sell from Hold. “The price cuts will likely increase the competitive pressures on NFLX and make it significantly more difficult to sustain earnings, especially in light of [first quarter] guidance, in which NFLX trimmed top-line guidance but maintained earnings. We expect that NFLX will eventually have to match the price cuts or lose significant share to BBI,” he wrote. He cut his NFLX price target to $15 from $25. He cut his EPS estimates for Netflix to 61 cents from 76 cents for this year, and to 64 cents from $1.07 for 2008.