But there's just one problem: what exactly is Blockbuster's competitive advantage? The large stores that the company has are more of a headache than anything else. If they really were a valuable means of moving the company into the new era, competitors like Netflix (NASDAQ NFLX) would be gunning to establish a brick and mortar presence, but they're not. Blockbuster is trying to spin its retail presence into an asset. But the $4 billion that the company lost from 2002 to 2005 exposes the stores for what they really are: a liability.
And what of Blockbuster's technological investments? They're great, but any other company can invest in new technology; and a lot of companies with much stronger balance sheets are. I'm reminded of Warren Buffett's decision to close the Berkshire Hathaway mills in 1958. The mills were antiquated and unable to compete on costs with lower-cost producers overseas. Buffett was shown plans to modernize the mills through aggressive investment, but ultimately passed. He explained the decision by saying that anyone else could modernize too, and that the cost savings would filter down to the consumer, not revive the New England textile industry. Of course, Buffett was right, and a lot of less prescient operators who did move to modernize lost their shirts.
Blockbuster is in a similar situation. It's attempting to modernize but so is everyone else, and Blockbuster is just one of many players.
What about Netflix? In a lot of ways, it's same song, different verse. Netflix's mail-order DVD business is likely to be the equivalent of Blockbuster's brick and mortar business in a few years. A look at Blockbuster's 10-year chart shows that this is not a fate investors would hope for.
In an interview with Katherine Burton for her book Hedge Hunters, one of my favorite investors, short seller James Chanos, sums it up best: "Consider the concept of having little old ladies in warehouses stuffing envelopes with DVDs. That might be a business for the next two or three years, but then it won't work. Why anyone would pay twenty-seven times earnings for that is beyond me." [Emphasis added.]
Of course, both of these companies will have ups and downs, and may even be attractive trades here -- I have no idea. But as long-term, fundamentals-based investments, investors should keep looking.
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Reader Comments (Page 1 of 1)
11-20-2007 @ 12:45PM
Gordon Blocker said...
I will say that it appears that there is a spring in the step of the store employees of my neighborhood Blockbuster. I think it is a plus when any investor can get out and see what is going on first hand with their local stores. I was surprised at the enthusiasm on the front line and when I asked they attribute their youthful excitement at management. Looking at the last 10Q for BBI, I was floored to find out how much smaller the DVD rental segment was in the income stream that I had imagined. I'm not ever sure that Netflix and Blockbuster need to be put so head-to-head in the same business. BBI has 60-70% of income in games and merchandising. I believe they are attempting to re-invent their business model. In my opinion the real estate, adapting the store layout, the possibilities of product relationships with other companies - being more "neighborhood" opens up some tremendous "high touch" opportunities for them now that some merchandising visionaries are running things. There will be bumps I am sure on the balance sheet still BUT something is happening that has an entreprenurial spice and I like it.
12-06-2007 @ 11:32PM
miladymell said...
In the past year, four Blockbuster stores within a 10 mile radius of my house has closed down. The one remaining store doesn't seem to be that busy. Their DVD selection doesn't hold a candle to Netflix. I think the people who chose to subscribe to Neflix do it more for the sheer volume of their library than for any other reason -- Blockbuster just doesn't have that large and diverse and inventory.