Profit from the Blockbuster-Netflix war

"By literally giving away the store, they have gained online subscribers at the cost of big financial losses," Netflix's Hastings said during a company conference call July 23. His most recent response to Blockbuster's strategy has been to cut monthly fees by $1 and slash marketing costs to stay profitable.

"Netflix is in hunker-down mode," says Squali, the Jefferies analyst. "They are waiting for Blockbuster to tire itself from losing money to add subscribers. At some point shareholders will be asking for returns, and they are not going to get the appropriate returns by having Total Access lose that kind of money."

Détente in sight

It looks like Blockbuster may already be cracking. A customer using the $17.99 Total Access plan, which allows three movies out at a time, now can't return more than five movies a month to stores. (After that, the customer would have to pay a new fee of $1.99.) To get unlimited exchanges at stores, the customer would now be charged $24.99 a month.

"Last week they showed their hand a little bit, and they should be increasingly more rational over the next two or three quarters," Squali says.

• Talk back: Do you prefer Netflix or Blockbuster for price and service?

Despite the signs that Blockbuster is easing off, analysts such as Squali, Brown at Cantor Fitzgerald and Douglas Anmuth at Lehman Bros. (LEH, news, msgs) are telling clients to wait before buying Netflix stock. All have hold ratings on the stock.

"Total Access is not sustainable over long period of time," Brown says. "But I don't know if that is two weeks, two quarters or two years."

Brown concedes, however, that Blockbuster has signaled it is "likely to be closer to two quarters than two years." I'd rather be a little early and buy shares before the détente begins getting priced in.

The ultimate endgame

Once the price wars are behind them, both companies can turn all of their attention again to getting where they want to be in five years. Netflix hopes to offer its full range of entertainment via the Internet for viewing on TV. Its customers can already see the early stages of this in a feature called Watch Now, which they can use to view 3,000 offerings on their computers.

The company says it will begin offering a way to watch downloaded programming on TVs next year -- but that the service won't be ready for broad implementation for five or 10 years. One major obstacle is that Hollywood studios are reluctant to grant electronic distribution because broadcasters see this as a competitive threat.

Will this online delivery render Blockbuster's brick-and-mortar video stores useless? I wouldn't bet on that because a retail expert named James Keyes recently took the helm at the company. He's the man who helped revive the ailing 7-Eleven convenience-store chain, which had looked like it was on the road to ruin in the late 1980s and early 1990s.

• Video: Blockbuster bets on Blu-ray

His trick was to use technology to track what customers wanted the most and to get it to them more quickly. At Blockbuster, this could mean anything from selling movie merchandise and "impulse items" around the time of a big release to getting better at stocking the right DVDs for sale.

"The opportunity to rent and sell a much broader assortment of product through those stores is virtually unlimited," Keyes told me last week. "The biggest change you will see will be in the stores themselves."

Expert Picks

Uncertainty about when the price war between Blockbuster and Netflix might end has significantly damaged both stocks and left investors on the sidelines waiting for signs the battle may end. Since I wrote this column on this theme, Blockbuster CEO James Keyes has provided a fresh clue about the timing of a possible detente between the two companies. On Wednesday, Aug. 1, InsiderScore.com reported that Keyes purchased $3 million worth of Blockbuster stock for an average price of $4.42. I know insiders typically buy for the long term -- they are not traders -- but I'll take this as a sign that Blockbuster may be backing off in the price war sooner rather than later. So I'll add both Netflix and Blockbuster to my Expert Picks model portfolio.

At the time of publication, Michael Brush did not own or control shares of any companies mentioned in this column.

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