Blockbuster's
Broadband Future
AUGUST 4, 2000
STREET WISE By Sam Jaffe
Recently, it looked like the Net
would kill the video-rental business, but this giant
is adjusting
Less than a decade ago, the
video-rental business was a hot-growth industry. On
Main Street USA, the video store quickly became as
ubiquitous as the neighborhood diner and dry-cleaner.
But then the Internet arrived and started to threaten
the video-rental industry.
That was bad news for Blockbuster
Inc. (BBI) and even worse news for its shareholders.
The hardest hit was Viacom Inc. (VIA), which owns 80%
of Blockbuster's shares. Today, Blockbuster's stock
price is languishing at $10.94, which gives it a
market capitalization of only $1.9 billion. Pretty
darn low for a company that made $4.5 billion in sales
last year.
Investors appear to think it
deserves such a valuation because the company's core
business -- renting videos -- faces eventual
extinction as broadband Net access starts becoming a
reality across the land. Soon consumers will be able
to download the movie of their choice over their cable
modems and watch it whenever they want. That
eliminates the drive to the video store and the need
to return the movie.
PAY-PER-VIEW PLAYER. The good
news is that Blockbuster has finally identified the
threat and seems to be -- for the first time --
adjusting its ways in response. "They haven't
just turned the corner," says PaineWebber analyst
Aram Rubinson, who has a buy rating on the company.
"They've built themselves a new corner."
The centerpiece of Blockbuster's
strategy is to establish its brand name in the
pay-per-view field. This business, expected to be
worth $10 billion a year next year, according to CEO
Joseph Antioco, is growing rapidly as cable and
satellite subscribers get used to ordering movies over
their TVs. But more important, the move gets
Blockbuster a foot in the door for the next generation
of pay-per-view, which will use the Net to deliver the
Holy Grail of at-home-entertainment: movies on demand.
If Blockbuster can somehow be a part of this new
technology early on, it'll open up all kinds of
revenue opportunities.
To establish the Blockbuster brand
in pay-per-view, the company has entered into
strategic partnerships with several major players in
the industry. By far the most significant agreement is
with DirecTV, the satellite-TV company. In return for
branding the pay-per-view channels with the
Blockbuster logo and sharing some of the pay-per-view
expenses and revenue, Blockbuster will sell DirecTV
equipment in its stores.
ONE BIG HOLE. In addition, a
possibly far-reaching deal was recently reached with
Enron Broadband Services, which will allow Blockbuster
to supply videos on demand via the Net to Enron
customers. Enron (ENE), which owns one of the largest
fiber-optic networks in the world, will be one of the
first communications companies to launch a widespread
video-on-demand service. Blockbuster can score big if
the program is a success. A smattering of other deals,
including a partnership with America Online (AOL),
could add to Blockbuster's momentum into the online
world.
Still, the strategy has one huge
hole: cable TV. Blockbuster has yet to make an
agreement with AT&T (T) or any of the other major
cable players to provide it with access to cable
lines, which could become the dominant means for
consumers to get broadband access. If Blockbuster
continues to be shut out of the cable business, its
plans for interactive TV could get stymied. But the
company does always have its video revenue to fall
back upon.
Rather than tumbling, as many
expected with the emergence of the Internet, video
sales have continued to climb, albeit slowly, the past
few years. Since 1997, Blockbuster's revenue has grown
about 15% each year, almost all of that coming from
video rentals and sales. The company surprised
investors with its second-quarter earnings report,
released on Aug. 1, when it announced a gain of 8
cents per share. Analysts who follow the company
expected it to earn only 6 cents per share. Even more
exciting than the better-than-expected earnings was
the increase in same-store sales. Compared to the
second quarter of 1999, Blockbuster's existing stores
increased sales 11% in the same period this year.
GLOBAL BUILDUP. Leading the
charge was a dramatic jump in DVD sales and rentals,
which now account for 7% of overall revenues.
"The numbers are excellent," says analyst
Maureen McGrath of ING Barings. "There is good
momentum in the core video business, and DVD is
building at a greater rate than the industry
expected."
The greatest challenge facing
management now will be to consistently deliver
profits, quarter after quarter. The recent quarter was
only the second one in the past three years that
hasn't produced a loss. The good news is that previous
losses were usually due to heavy capital spending on
new stores. Blockbuster continues to expand
aggressively internationally -- it built 127 outlets
in the second quarter, many of them in Latin America
-- but it was able to make a profit anyway. In fact,
its biggest money-losing unit was the new interactive
division. If you exclude that subsidiary's costs on
Blockbuster's earnings report, the company would have
produced 24 cents per share in profits.
With such a stable revenue stream
and a relatively bright online future, it's surprising
that Blockbuster still sells for a price-to-2001
earnings ratio of 13. The company's stock has
recovered 20% from its June low of $8.88. But it could
still be a slow, steady climb before it starts to
fulfill its potential. For one thing, CEO Antioco has
already warned that the third quarter could be a rough
one, thanks to a scarcity of big movie titles coming
out on video the next three months.
Blockbuster will also have plenty of
potholes to steer clear of as it merges onto the
information highway. That's why PaineWebber's Rubinson
has his optimistic sights set low. His price target on
the stock is $15. "I think this one needs to walk
before it runs," he says. But for a company that
once appeared destined for the cutting-room floor, the
outlook is far from gloomy.
Jaffe
writes about the markets for Business Week Online
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Edited by Beth Belton
Copyright 2000, by The McGraw-Hill
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