Redbox Runover in the Works?


It's been a tough two years for video-rental-loving consumers, with a number of neighborhood stores run by Blockbuster and Hollywood Video parent company Movie Gallery closing shop as the companies went bust under intense competition from Netflix (NFLX) and those ubiquitous Redbox kiosks.

Now there's apparently trouble brewing at Redbox, with President Mitch Lowe announcing his resignation and parent company Coinstar (CSTR) revising its second-quarter revenue outlook downward late last week.

Here are some key signs Redbox consumers and investors should watch to gauge whether we're headed for a Betamax-style rerun in the video rental industry.

Redbox's Big Bet on DVDs

Redbox's business is all about renting out actual DVDs from vending machines at bargain-basement prices of as low as $1. It expanded on that notion this year by adding video game kiosks that rent games for $2 a pop. But industry analysts say Redbox's strategy zigs, while its competitors zag.

Redbox is operating on the belief that DVDs are here to stay, and is rapidly populating the nation with its vending machine kiosks. Meanwhile, rivals like Netflix, (AMZN), and Apple (AAPL) are aligning their businesses toward a streaming-video model that allows customers to access videos at anytime on a variety of devices as small as a smartphone.

Call it the ultimate couch potato play, where consumers no longer have to trudge to the local video rental store.

Discs Aren't DOA Just Yet

Redbox will be viable until the DVD goes away. As long as someone is willing to buy a DVD, there will also be DVD rentals, says Michael Pachter, a Wedbush Securities analyst.

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Pachter estimates the DVD will be around for another 10 to 15 years and notes that demand for DVDs among consumers is still great.

Netflix, for example, has about 5 million customers on DVD-only subscriptions and another 20 million on a combo DVD-and-streaming subscription, meaning 80% of Netflix's business is on some form of DVD-related subscription, Pachter says.

But the DVD is facing stiff competition as the telecommunications carriers and cable companies expand their networks and more Americans sign up for broadband service.

Cloud Control -- the Future of Movie Viewing

A consortium of movie studios, distribution channels like Netflix and Comcast (CMCSA), and device makers like Sony (SNE) and Samsung is gearing up to launch this year an uber online video service in the cloud.

The Digital Entertainment Content Ecosystem (DECE) consortium plans to use an UltraViolet (UV) technology standard to deliver a service that allows consumers to purchase movies online and transfer them among a dozen devices that can be shared by up to six family members or friends who access a UV member's online household account.

This model allows greater freedom than other online movie purchases that restrict transfers to two devices, as in the case of Amazon, or online rental services like Netflix that allow only one device to access the streaming service at a time.

However, a consumer has to have broadband to make these online services work, and there are 100 million Americans who lack broadband service, according to a Federal Communications Commission report. As a result, these consumers are left relying on DVDs to see movies in their homes or on their PCs.

Even those who believe the DVD rental model will stick around for a while should be aware of other threats to the business.

As Studios Stall, Rentals Fall

Movie studios are becoming more demanding in their dealings with Redbox and other DVD rental shops, structuring a deal last year that called for a 28-day delay in offering the DVDs for rental after they've gone on sale. The studios were looking to squeeze in more time to sell the DVDs before releasing them for rental.

The unexpected impact of the 28-delay on Redbox's movie rentals during the holiday season hurt its parent company's revenues and earnings in the fourth quarter. Its shares took a 24% hit on that fourth-quarter warning.

Investors also need to watch for reductions in title selection and further changes to release timing, as the studio's UV efforts kick into gear sometime this year. As Redbox parent Coinstar prepares to report its second-quarter results today, investors got a hint last week that things weren't going well when the company issued preliminary results that showed its overall revenues are slowing, with only 27% growth expected in the quarter.

While the preliminary figures didn't break down revenue between Redbox sales and Coinstar's other business lines, one would expect to see Redbox benefit from the demise of bricks-and-mortar store locations of behemoths like Blockbuster and Movie Gallery's Hollywood Video.

The company may be expecting to pick up disgruntled Netflix customers who refuse to incur as much as a 60% price hike to subscribe to both DVD and streaming video rentals under a combo deal that takes effect Sept. 1.

However, should that not come to pass, and Redbox sales erode, kiosk expansion could also slow and consumers would see signs of fewer red kiosks in front of retailers and grocery stores.

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Motley Fool contributor Dawn Kawamoto does not hold shares in any of the companies listed, but is known to catch a Netflix every now and then. The Motley Fool owns shares of Apple.