Friday, May 20, 2005 - Wal-Mart to End Movie Rentals Via the Internet

When Icahn won seats on the Blockbuster Board, it was clear that the company would likely stop the price war with NFLX. That has happened. Blockbuster has raised its price. Now, in a deal reminiscent of the deal made between Yahoo and EBay in Europe, WalMart will close its on-line rental business in exchange for NFLX advertisements on its site.

The terms have not been stated, but, in the Yahoo-EBay deal, Yahoo received advertising revenues for 5 years while EBay paid to "own" this market. Chances are that Wal-Mart will make more money off the advertisements than they made in the rental business. The price of the advertisement may explain why NFLX down-played the benefit to NFLX. The company did not raise its guidance with this major competitor out of the way.

There are rumors and speculations that suggest another reason. For sometime, Blockbuster and NFLX have feared the possibility that Amazon would take the business. Blockbuster and NFLX feared they would be squeezed between WMT and AMZN. Now the rumor is that AMZN and Blockbuster are in talks to team-up. AMZN has the skill of operating on-line stores. They do it for a number of brick and mortar companies. These deals have been profitable for the stores and AMZN.

AMZN has traded sideways for a long time while its revenues have continued to climb. Blockbuster now has a cost cutter in charge. My earlier prediction that the company would play a better game of tit for tat is already inherent in the on-line price increase. It is almost always a mistake to try to buy a market with prices well below your major competitors. If a market is worth winning, it should be won with great service offered at competitive prices. There is almost always room for two or more players in any market if operating margins are maintained. NFLX deserves a lot of credit for refusing the meet the blockbuster price. The price spread may have slowed the recruitment of new subscribers but few subscribers are going to leave a good service to join an inferior service at a lower price.

Blockbuster is loaded down with short sellers. I believe a deal with AMZN would be good for both companies. The new Blockbuster management will squeeze cash out of the service to help pay down the large debts and give the real estate values of the company time to appreciate. The company does not need to grow but simply needs to increase earnings through lower costs. My family does not own Blockbuster. We own NFLX, YAHO, EBAY, AMZN and WMT. However, we believe Blockbuster is a much better buy than at any time in the recent past. If there is a deal in the works with AMZN the stock should see a significant bounce. If the company does not do a deal with AMZN but gradually grows on-line subscribers at a competitive price, NFLX and BBI will make money. My family added to our NFLX shares when the Icahn deal was announced, we have been well rewarded. From here we plan to hold long-term.