Blockbuster (BBI, news, msgs) shares sank to a record low of 25 cents this week after the video rental chain warned it may be forced to file for Chapter 11 bankruptcy protection.
Blockbuster is staggering under a heavy debt load as it tries to fend off competition from DVD-by-mail company Netflix (NFLX, news, msgs) and DVD vending machines operated by Coinstar (CSTR, news, msgs). Blockbuster is taking steps it hopes will forestall this situation. It has closed about 1,300 stores and wants to shut hundreds more. But the Dallas company noted March 16 in a 10-K filing with the Securities and Exchange Commission that a bankruptcy filing is a possibility within the next year or two.
Barrons.com has been skeptical of Blockbuster's chances. And while there's not much to say to investors besides "stay away," this week's news does bring Netflix into focus. If Blockbuster were out of the way, to what extent would Netflix benefit?
Though a Blockbuster bankruptcy would surely help Netflix, its demise may not be as compelling as some might think. After all, Blockbuster has been fading for so long that it has ceased being a serious threat to Netflix. What does concern the Los Gatos, Calif., company are DVD-dispensing kiosks like Redbox, operated by Coinstar, on-demand movies offered by cable TV providers and online movie services from the likes of Amazon.com (AMZN, news, msgs) and Apple (AAPL, news, msgs).
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Blockbuster
The answer is not simple. As noted, Netflix faces increased competition from rivals providing movies directly to customers' computers, game consoles and TVs. (The DVD-in-the-mail part of Netflix's business, while still strong, is seen as inevitably ending in favor of direct streaming.)
Netflix doesn't pay a dividend, and though it has $320 million in cash, it also has nearly $240 million in debt (not a particularly overwhelming amount for a company with a market value of $3.8 billion).
A flurry of analysts downgraded Netflix to "neutral" earlier in the month, when the stock hit $70, the Street's average price target. Shares hit an all-time high of $71.74 on Wednesday and are up 70% over the past year.
In January, we suggested investors take profits in Netflix after the company announced strong fourth-quarter results.
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Netflix
One-quarter of its customers are already capable of directly streaming its offerings, and many new TVs and other home-entertainment devices are preloaded with Netflix's Watch Now option.
The rise in preloaded, Web-enabled electronics is a major driver of a bullish call on Netflix by analyst Jeff Rath at Canaccord Adams. He sees the company gaining "aggressive new subscriber adds due to the digital transition."
This model, which increasingly favors direct streaming, is suppressing subscriber acquisition costs, currently at the second-lowest levels in Netflix's history, according to Brigantine Advisors analyst Steven Frankel. Streaming should beef up Netflix's already healthy margins. The company's return on assets and equity, at 18% and 42%, respectively, are also robust.
While Netflix has focused solely on the domestic market, it plans to branch out with its first international offerings (streaming only) later this year.
Netflix also is the only subscription-based model in the industry -- the rest, à la iTunes, are pay per view.
Investors who buy today will likely do well, but we'd prefer a degree of comfort and recommend purchasing shares on pullbacks.
This article was reported by Teresa Revas for Barron's.
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