TELECOM Digest OnLine - Sorted: Netflix Wins First Round in DVD Rental War

Netflix Wins First Round in DVD Rental War

Gina Keating (
Sat, 24 Dec 2005 14:38:59 -0600

By Gina Keating

When the head of Netflix Inc. said rival Blockbuster Inc. threw
"everything but the kitchen sink at us," the world's largest video
rental chain responded by sending him ... a kitchen sink.

The message from last January's interchange was clear: Blockbuster,
with $6 billion in 2004 revenue and 5,500 domestic stores, intended to
own online DVD rental, an $8 billion industry pioneered by Netflix.

"This year was about Blockbuster taking a run at us," Netflix Chief
Executive Reed Hastings told Reuters at the company's Beverly Hills
offices. "They chopped price. They emptied their balance sheet."

But despite Blockbuster's costly offensive, Hastings said Netflix was
on track for net subscriber additions of 1.5 million for 2005 for a
total of 4.1 million -- the midpoint of its target range.

Meanwhile, Blockbuster, which has been roiled by management and debt
problems, saw the subscriber base at its 16-month-old online service
stall at 1 million.

Chief Executive John Antioco told Reuters that Blockbuster Online was
"proud of what it has accomplished in 2005 with over 1 million
subscribers in over a year after it was launched."

Antioco had threatened earlier this year to leave the company -- and
take a $54 million severance package with him -- during a proxy fight
launched by dissident investor Carl Icahn.


The companies also switched places in market value over the course of
an intense, yearlong price war, with Netflix -- which has no debt --
now worth $1.5 billion, compared with Blockbuster at $684 million and
more than $1 billion in debt.

"Online rental is the only thing we do, and (our) advantage is focus
and desperation," Hastings said. "So we have nowhere to go, right? It
was win or die, and that's very focusing."

Citigroup, which initiated coverage of Netflix this week with a "buy"
rating, said the company "should put added pressure on in-store
rentals, causing more locations to close.

"This creates a chain reaction that should further help (Netflix) sign
new subscribers, as consumers increasingly find themselves having to
travel farther to find an in-store rental location," the Citigroup
note said.

Citigroup put a $39 price target on Netflix shares, which now trade in
the $27 range. A year ago, Hastings had seen the price plunge from $39
to $9 on his decision to run at break-even and spend heavily to
quickly add subscribers.

The company plans to maintain this approach for at least the

"We're feeling confident of another strong quarter," Hastings
said. "We're investing very heavily in marketing this quarter. Our
view is that a very aggressive marketing investment now will help
widen the competitive gap between us and Blockbuster."

Netflix is testing lower prices in all its subscription plans to see
if the resulting subscriber growth makes up for the reduction, he


Despite holding $182 million in cash, Netflix has no plans to go
shopping in the coming year, Hastings said.

"You (make) acquisitions if your current market does not look like it
has enough room for you to grow, and our current market look
enormous," he said.

Growth will come at the expense of stores operated by Blockbuster,
Movie Gallery Inc. and smaller chains, Hastings said. These companies
saw their collective rental revenue decline by nearly 12 percent in
the third quarter, prompting them to accelerate store closings.

Netflix itself has had setbacks. The appearance of Blockbuster Online
and the threat of Inc. entering the U.S. Internet rental
market forced Netflix to halt its expansion into the United Kingdom.

The company also had to withdraw its plans to launch a limited online
delivery service for movies because of problems obtaining licenses for
films from Hollywood studios.

The competitive landscape improved in May, when Wal-Mart Stores
Inc. got out of online DVD rental and agreed to direct its subscribers
to Netflix for rental services.

As for Amazon, whose online video rental presence is limited to the
UK, Citigroup agreed with Hastings that Netflix's growth and market
dominance are increasing the barriers to entry in the United States.

"It was the shortest, most intense competitive squall that I have ever
seen," Hastings said. "The last thing on my mind was walking away from
it. I would have ridden it down to the very bottom, still fighting."

Copyright 2005 Reuters Limited.

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