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This column was updated Thursday, Aug. 2, with the Expert Picks section at the end. Brush is adding both stocks to his tracking portfolio based on insider buying.
It's a typical Hollywood drama: two titans battling, drawing blood. And audiences are loving it.
Only in this case the two titans are the major DVD distributors, Netflix (NFLX, news, msgs) and Blockbuster (BBI, news, msgs). They are locked in a heated price war for customers, and movie audiences are applauding because it means they are getting great deals.
The battle, of course, is taking its toll on both companies and their shareholders, and everyone's worried about how long it will last. "At current speed, they are both headed for a major crash," says Jefferies & Co. analyst Youssef Squali. For instance:
- Last quarter, because of pressure from Blockbuster, Netflix saw its subscriber base decline for the first time. Netflix cut marketing expenses, so net income grew 50% to $26 million, but the company slashed estimates for the year because of the damage.
- The price war will probably cost Blockbuster $200 million this year. It reported an operating loss for the second quarter of $13.7 million, compared with an operating loss of $2.1 million for the year-ago period. But it has ramped up Internet-based subscribers to 3.6 million from 1.4 million a year ago.
How long this drama will continue is not clear, which explains why both stocks are down more than 30% since January. Investors hate uncertainty. But uncertainty can also spell opportunity if you can predict a story's ending.
Here's my guess: I agree with Cantor Fitzgerald analyst Derek Brown that both companies will survive. They'll morph into very different companies five years from now. The price war will subside -- sooner rather than later -- and the stocks of both companies will go up as a result. The tricky part with this part of the story is the timeline.
Citigroup (C, news, msgs) analyst Tony Wible doesn't think Blockbuster, the aggressor in price cutting, will raise prices again until the end of 2008. Other analysts believe Blockbuster is already showing signs of cracking, and I'll side with them.
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Here's how to play it: For investors who don't mind being early and sitting in a position that goes nowhere for months, or moves against them somewhat before gaining, now's the time to buy both stocks.
If that's not you, then wait for more signs Blockbuster is pulling back from battle before buying. Watch for price increases or other tweaks to its online offerings that make it less competitive. You'll miss some of the upside, but there will be less frustration in the meantime.
The plot line
In case you haven't been following the plot line, here's a quick summary:For much of the 1990s, Blockbuster made a good portion of its profits from late fees. Those fees ticked off one movie fan named Reed Hastings so much that in 1997 he set up his own DVD rental company, Netflix, with a compelling promise to never charge a late fee. Instead, customers pay a monthly fee for DVDs delivered by mail. They return DVDs by mail whenever they want, at which point they get another one through the mail.
- Video: Blockbuster bets on Blu-ray
Netflix has been such a huge hit that Blockbuster decided earlier this year that it had to take drastic steps to fight back. Blockbuster cut prices for its comparable online offering. More importantly, its Total Access plan lets online customers swap movies at stores, which cuts turnaround times because they don't have to mail them back and wait for a new movie to come through the mail. The upshot: Avid movie fans using Blockbuster view three to five times more movies a month as Netflix customers for the same price. That's meant huge growth for Blockbuster, but at a big cost.
Continued: 'Giving away the store'
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