Apple to Offer Movie Rentals?

| About: Apple Inc. (AAPL)
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Next to the Beatles, the most common Apple (NASDAQ:AAPL) iTunes rumor has got to be movie rentals. From the day the first video iPod appeared there has been speculation about it. Now, there is actually evidence beyond "unnamed sources" to suggest it may be a reality soon.

The most definitive proof a rental service may be in the works was accidentally discovered this weekend by a user trying to report a problem with iTunes. David Watanabe published a screenshot on photo sharing site Flickr that showed an iTunes drop down menu of subject headings that included a rental subsection. According the reports spreading virally around the net, the image, which explicitly references rentals, was taken from live iTunes installations and confirmed by other users as well. It has since been removed.

The idea of an iTunes rental store, and its impending arrival, has been widely reported and speculated on for the better part of two years. As recently as this past June, the Financial Times and Wall Street Journal reported Apple was in talks with several movie studios to offer rentals at a price of $2.99. They reported Paramount (owned by Viacom (NYSE:VIA)) was in favor of such a service but GE's (NYSE:GE) Universal Studios was opposed. Speculation has been rampant enough that some were even betting the rental store was going to be revealed at last weeks press conference.

While last week wasn't the time, four factors beyond this recent development add to the likelihood it's finally on its way.

I. Product Convergence has Set the Stage

With last weeks rollout of the new iPod family, all of the Apple products, except the diminutive Shuffle, are now capable of playing video. From the Nano, to the new iPod Touch, to Apple TV, to the Mac lineup, any of the devices can support video from the iTunes store. With the store being viewed as a feeder to drive hardware sales, it would make sense that changes to support the new line up (beyond just the newly launched WiFi and ringtone enabled store) are due.

II. Seasonal Retail Events Influence Timing

The holiday shopping season is fast approaching and Apple will look to move as many units of their products as possible; that's arguably especially true given earnings guidance for a decrease in per share earnings for this quarter resulting from the product shift in the iPod line. A rental store could be a useful tool to spur demand for hardware and encourage upgrades to the new products.

III. Competitive Positioning – Grabbing Territory Early

The battle for video distribution is starting to accelerate. Last week Vudu joined the market with their on-demand set top box. Microsoft (NASDAQ:MSFT) is already there with video rentals available through their Xbox Live platform. Amazon (NASDAQ:AMZN) and Tivo (NASDAQ:TIVO) are there with a partnership for Amazon's Unbox video service. Then there are rental giants Netflix (NASDAQ:NFLX) and Blockbuster (BBI) which are accelerating their developments (Blockbuster via their purchase of Movielink). Even Sony (NYSE:SNE) is rumored to be entering the fray having just launched new Walkman products focusing on portable video.

None of these competitors are, as yet, solidly established but all of them may use Digital Rights Management technologies that will not be compatible with Apple's products. Also, consumer purchases tend to offset each other (e.g. if I buy an iPhone I am not likely to buy a competing product for some time).

In order to prevent competitors from getting established, or preempt consumer purchases of competing products, it's increasingly in Apple's interest to stake a claim on territory in the rental market and remove customers incentives for going elsewhere or investing in other devices. It's even possible, given the strength of the iTunes brand, they could build an early competitive advantage that vaults them ahead of the rest of the pack.

IV. Studio Licensing

Arguably the biggest hurdle to bringing rentals to the store is the licensing deals with the movie studios. At issue is a complex balance between rights management concerns, revenue sharing, and the need of the studios to insure an online rental offering doesn't cannibalize their income streams from DVD sales and rentals.

It's been months since stories about these negotiations last broke. At that time GE's Universal Studios was considered one of the most vocal critics. Now, NBC Universal and Apple are on the outs (Universal recently announced they wouldn't renew their contract). That could be an opportunity to move ahead with one less roadblock.

Timing is also a possible incentive (though it could become a road block too). The studios are coming off a blockbuster summer at the box office and expect to see solid returns on home sales and rentals from summer releases during the fall and winter quarters. If licensing terms with Apple can be reached that addresses their concerns (notably that it doesn't eat into anticipated DVD sales and rental income), it could bode well.

One possibility is that the studios may allow iTunes rentals but limit the offerings to older titles. Another is a segmented offering in which the studios test the offering with a limited number of titles and expand over time subject to market behavior and adoption.

Conclusion

There are a lot of caveats, the same stuff that has fueled speculation for months, but the latest news is suggestive. The fact that rental related content made it into iTunes is the best evidence yet that an arrival may be soon. Like the Beatles coming to iTunes, rentals are less a question of if than of when.

Disclosure: none