One More Sign That DVDs Are Dying

To DVD or not to DVD is no longer much of a question. Consumers are dissing optical discs, preferring to stream video across a growing number of devices instead.

That's not merely a matter of opinion. Industry tracker Digital Entertainment Group reported earlier this year that physical media sales slipped 8 percent to $7.78 billion last year. Things are even worse for companies in the business of renting you the discs. DVD rental subscriptions plunged 19 percent last year.

Against this backdrop, Outerwall's (OUTR) Redbox has been surprisingly resilient. It's been able to post consistent top-line growth at Redbox as it grows its army of automated video-disc vending machines, acquires smaller players and makes the most of other outlets for DVD rentals drying up. However, that's about to change: Redbox is on the verge of being proven mortal.

Bigger Than a Redbox

Redbox took full advantage of the death of brick-and-mortar chains over the years. As Hollywood Video, Movie Gallery and Dish Network's (DISH) Blockbuster shuttered stores, Redbox kiosks sprang up.

Redbox has also benefited from Netflix (NFLX) migrating to streaming as its delivery platform of choice. Netflix continues to rent DVD and Blu-ray discs, but its marketing emphasis has been on streaming. That shows. There are now more than 48 million streaming subscribers worldwide. On the other hand, the number of accounts relying on Netflix to mail out optical discs has gone from 10 million two years ago to just 6.7 million today.

After years of growth, Redbox is now in the midst of what could be its first quarter of declining revenue. Outerwall is forecasting revenue for this quarter to come in between $546 million and $576 million. The $561 million midpoint is dangerously close to the $554.2 million it posted a year earlier, and when you factor in ecoATM, Coinstar and other high-tech vending machines that Outerwall is building out in anticipation of the day when DVDs don't matter, we could still be staring at a dip in Redbox revenue for the period.

"Our second quarter 2014 guidance reflects significantly lower box office and fewer titles than the second quarter of 2013," Outerwall CFO Galen Smith is quoted as saying in last week's earnings release. "However, we continue to expect that rents and revenue per kiosk will be up year-over-year in the third and fourth quarters."

The implication is that rentals and revenue per kiosk will decline this quarter.

Thinking Outside the Outerwall

Redbox suffered a brutal 11.8 percent plunge in same-store sales during the first quarter of last year. Overall revenue still grew as Redbox expanded its base, tacking on new machines and taking over the Blockbuster Express business.

%VIRTUAL-article-sponsoredlinks%Growth will be harder from here on out. There isn't a lot of unexploited real estate left upon which to introduce new rental machines where they won't cannibalize nearby kiosks. There aren't any other physical retailers renting DVDs that can close down to give Redbox market share. Outerwall made the most of the shrinking pie in DVD rentals by carving out a thicker slice. Now all it's left with is a pie that will continue to get smaller as consumers turn to streaming and binge-viewing older TV shows instead of renting new movies on DVD.

Outerwall pins some of the blame for its problems on a weak slate of theatrical releases from last year hitting the market this quarter, and that's why it's hopeful for a bounce during the latter half of the year. There's some validity to that, but the bigger trend points to fewer people buying or renting DVD and Blu-ray discs.

When is the last time you fired up your disc player? The answer probably isn't what Outerwall and Redbox want to hear.

Motley Fool contributor Rick Munarriz owns shares of Netflix. The Motley Fool recommends and owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days.