Blockbuster Loses Latest Battle

It reports a drop in online subscribers, compared with rival Netflix's jump.
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After waging a price war against

Netflix

(NFLX) - Get Report

,

Blockbuster

(BBI) - Get Report

is now slashing payrolls amid wider losses.

Moreover, its online rental service lost subscribers during the third quarter, reflecting both a change in the Internet plan's offerings and increasing heat from Netflix, its top rival.

Blockbuster on Thursday posted a loss of $37.8 million, or 20 cents a share, for its third quarter. That compares with a loss of $27.5 million, or 15 cents a share, in the same quarter last year.

The latest quarter's results included a charge of $9.6 million, or 5 cents a share, related to severance payments and lease termination costs. Excluding that, the Dallas-based company had a loss of 15 cents a share, better than Wall Street's expectation for a loss of 18 cents, according to Thomson First Call.

Blockbuster reported a 5% drop in revenue to $1.24 billion, falling short of expectations for $1.28 billion.

While the top-line results were disappointing, the main concern raised by the report was Blockbuster's subscriber count for its online rental service. The service's subscriber count dropped to 3.1 million at the end of the third quarter from 3.6 million at the end of the second.

"The magnitude of the decline was surprising to many," says Michael Pachter, an analyst with Wedbush Morgan Securities. "Blockbuster is shifting its strategy away from growing online subscribers that weren't profitable. They had a bunch of gluttons coming to their all-you-can-eat buffet, and now they're getting rid of them."

Over the summer, Blockbuster rolled out

aggressive price cuts on its online subscription fees in an effort to reduce Netflix's early lead in the market.

The company also announced several changes in its offerings, one of which limited subscribers of its most popular Total Access plan to a maximum of five in-store DVD exchanges every month. Beyond that, subscribers have to pay an additional $1.99 for each in-store rental, allowing Blockbuster to recoup some losses from its low prices but potentially driving away some of its heavy-use customers.

The company downplayed the subscriber decline in its earnings release by reporting year-over-year growth in its subscriber count. But with its rival thriving, Blockbuster's subscriber drop marks a defeat.

With its own price cuts, Netflix reported a

blowout third quarter, reversing perceptions on Wall Street that Blockbuster was making in-roads against the online DVD rental pioneer.

The Los Gatos, Calif., company rebounded from a dismal second-quarter performance to report a third-quarter jump in subscribers and earnings that demolished expectations. Netflix also cranked up its outlook for 2007 and 2008, reflecting a dramatic swing in its public view of its own prospects.

For its part, Blockbuster attributed its third-quarter revenue declines to the closure and sale of 526 of its stores, partially offset by a $79.2 million year-over-year increase in revenues from its online rental service.

The company said it has implemented a plan to lower yearly overhead costs by about $45 million through job cuts, and it's considering outsourcing some corporate functions.

It also said it plans to report total membership numbers in the future, rather than just its online subscriber count. Blockbuster noted that it had 20 million customers around the world during the quarter, counting its business at its massive store base.

Sterne, Agee & Leach analyst Arvind Bhatia says Blockbuster is shifting the focus away from its online service because the industry suffered its first quarterly decline in subscribers in recent memory -- a sign that growth in online DVD rental may be at its peak and facing a slowdown.

"Blockbuster is going to be improving the profitability of its business rather than focusing on online subscriber growth," says Bhatia. "That's a good thing."

Shares of Blockbuster were recently down 20 cents, or 3.8%, to $5.06. Netflix shares were down 24 cents, or 0.9%, to $26.23.