Blockbuster Bankruptcy: Good or Bad for Netflix?


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Blockbuster (PINK:BLOKA), which competes in the business of movie rentals, has filed for Chapter 11 bankruptcy. This has resulted in clouds of uncertainty hovering over the future of the company. Netflix’s (NASDAQ:NFLX) shares have gained recently due to a combination of Blockbuster’s bankruptcy filing and Netflix’s new streaming service in Canada.  We recently wrote that growth in Netflix’s streaming service will be important for the company.

How Blockbuster emerges from bankruptcy can have a signficant impact on the competitive landscape for movie rentals, impacting not only Netflix, but media players like Comcast (NASDAQ:CMCSA) and Time Warner Cable (NYSE:TWC) as well.  Whether or not Blockbuster’s bankruptcy is good news for Netflix depends on a few factors:

(i) Blockbuster’s ability to use new capital to build digital capabilities that can rival that of Netflix
(ii) Blockbuster’s ability to transition brick-and-mortar customers to its digital platform as it closes down some stores
(iii) Whether film studios are able to leverage Blockbuster to negotiate more competitive digital licensing terms with Netflix

Below we explore some of the facts and possibilities that lead us to believe that Blockbuster may emerge as stronger competitor to Netflix leading to potentially slower subscriber growth and higher costs for Netflix.  You can see below how sensitive Netflix’s stock is to subscriber growth.

Debt burden relieved and capital to support continued operations available

Blockbuster’s filing for bankruptcy doesn’t state that the company will be shutting down its business. Chapter 11 implies protection from the debt and debtors essentially remain in control of the company’s operations. Thus, Blockbuster will be able to get rid of  about $900 million in debt [1].  Moreover, Blockbuster’s senior note-holders have agreed to support the restructuring plan and provide $125 million [1] of debtor-in-possession financing to help the company operate while in bankruptcy.

Blockbuster focuses on digital distribution

It is likely that a restructured Blockbuster, largely free of debt, will be able to operate more efficiently and compete better with the likes of Netflix as it focuses more on digital distribution.  The shift in Blockbuster’s strategy and greater focus may end up being detrimental to Netflix’s long-term subscriber growth.  Rocco Huang, Assistant Professor of Finance at the Michigan State University’s Broad College of Business and a contributing member of the Trefis community, puts it succinctly:

Previously, Blockbuster wanted to be everything at once (i.e. store, kiosk, online). Now Netflix will have a serious, lean, mean, and focused competitor, a competitor suddenly relieved of all debt burdens and very possibly other heritage liabilities (e.g., commitments in unprofitable store locations) as well.

Store count reduction?

How many stores Blockbuster is likely to close down as it shifts to a digital strategy is an important unknown.  Blockbuster is elusive about this, stating in a recent press release:

As part of the recapitalization process, the Company will evaluate its U.S. store portfolio with a view towards enhancing the overall profitability of its store operations. Currently, all 3,000 of the Company’s stores in the U.S. will remain open.

Professor Huang believes that most of the Blockbuster’s stores will remain open with the exception of a few money-losing ones. “The headlines today about Blockbuster’s “demise” are really misleading”, he states.  In comparison, a recent Reuters report suggests that some analysts covering Blockbuster expect the company to close hundreds of stores as part of the change in strategy.

We do expect Blockbuster to reduce its store count over time,  but more importantly, how it manages the transition will be crucial.  The last thing Blockbuster wants to do is hand its brick-and-mortar customers over to Netflix as it builds out its digital capabilities.  We expect that Blockbuster will focus on creating a strong digital platform in advance of significant store closures in order to maximize customer retention.

Studios may end up the real beneficiaries

Films studios have a strong interest in making sure that the video rental business remains competitive.  The studios negotiate content licensing terms with distributors like Blockbuster and Netflix.  A revitalized Blockbuster, more focused on digital content, can provide the studios with greater negotiating leverage against Netflix.  This can trickle down to Netflix’s content licensing costs and have a negative impact on the company’s stock.  You can modify our forecast for Netflix’s Content Acquisition Costs below to see how sensitive Netflix’s stock is to this key cost driver.

You can see the complete $85 Trefis price estimate for Netflix’s stock here.

Note:
[1] Blockbuster Reaches Agreement on Plan to Recapitalize Balance Sheet and Substantially Reduce its Indebtedness

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