Blockbuster Warning Dims DVD Case at Video Chains

Blockbuster ( BBI) sent video rental stocks reeling on Wednesday.

The nation's largest video retailer let fly a major revenue and earnings shortfall Wednesday morning, prompting a selloff in its stock and in other publicly traded video retailers, and raising questions about the outlook for the industry.

Though Blockbuster attributed the shortfall to factors "unique to this holiday season," investors were forced to consider whether the problem is the rental giant's new focus on DVD sales, or if in fact Blockbuster's unfortunate event results from some larger, industry-threatening trend -- a possibility raised by a statement issued later Wednesday morning by one of Blockbuster's competitors.

In fact, the collapse may illustrate the limitations on the "cocooning" approach to investing -- the thesis that a tense global situation and a dim economic outlook translate into a bullish outlook for stocks linked to consumers' home-based, family-oriented activities.

Many investors were taking a broad, pessimistic view on Wednesday. With Blockbuster down $5.67, or 29%, to trade at $13.73, other video store chains suffered, too. Movie Gallery ( MOVI), which reaffirmed earnings guidance Wednesday morning after Blockbuster's announcement, dropped 15% to $15.35. Hollywood Entertainment ( HLYW) was down 17% to $16.

NetFlix ( NFLX), the online-based DVD rental company, dropped 14% to $10.96.

Drop Shot

In a statement issued Wednesday, Blockbuster said fourth-quarter earnings would come in a range of 15 to 22 cents per share -- half, at best, of the 44 cents that analysts had expected, according to Thomson Financial/First Call, and below the 35 cents reported in the fourth quarter of 2001. Instead of the fourth-quarter same-store percentage revenue growth in the low- to mid-teens that Blockbuster had expected, the increase in same-store sales will be in the high single digits. The expected gross profit dollar percentage gains are falling from the mid- to high-single digits to the low ones.

Strong rental growth in the early fall "slowed significantly" starting with Thanksgiving, said Blockbuster chief executive John Antioco in a statement. The slowdown is largely due to one-time factors "including the unprecedented number of movie titles available for sale at deeply discounted prices, this year's DVD gift-giving phenomenon and a compressed holiday season which has limited consumers' leisure time," Antioco said.

"We believe the degree of the impact on rental should be temporary, although we will be in a better position to evaluate this when more normal conditions return during the first quarter of next year," Antioco said.

Unfortunately for the video retail business, the slowdown goes beyond Blockbuster. In its statement Wednesday, Movie Gallery said it had suffered a similarly unexpected dropoff in business in the three weeks after Thanksgiving, and that its same-store sales increase is falling at the low end of prior guidance.

Marginalization

Blockbuster, thus, is put in the awkward position of getting burned by the medium it is embracing. As Thomas Weisel Partners analyst Kelly Chase noted in a report issued Wednesday morning, Blockbuster over the past year has sought to revive its maturing business of ubiquitous rental stores by boosting sales of DVDs.

The DVD sale business, however, has its own problems. One, margins are lower than in the video rental business. And two, while Blockbuster dominates the rental business, mass-market retailers such as Wal-Mart ( WMT) are aggressively discounting and selling DVDs themselves. So it's not immediately clear how discounted DVDs and the DVD gift-giving phenomenon will be a "unique" set of circumstances.

"Overall, selling videos is a less profitable business than renting them," says one Movie Gallery short-seller, speaking on condition of anonymity. But DVD sales, points out the short-seller, are cutting into rentals. "Does it make sense to go out and rent it, when you can just buy it?" the investor asks.

The short-seller, who separately argues that Movie Gallery will have to make a major inventory writeoff, said he was covering most of his short position in the stock Wednesday. "The stock moves in extremes," the short-seller said. "We might get back into our position at a higher price."

Meanwhile, Blockbuster and Movie Gallery noted that the remaining two weeks of the year traditionally have a major impact on business, leaving open the possibility that results could differ from Blockbuster's new expectations. Blockbuster says it will update 2003 guidance early in the new year.

More from Technology

Elon Musk's Latest Twitter Tirade Is the Dumbest Thing on Wall Street

Elon Musk's Latest Twitter Tirade Is the Dumbest Thing on Wall Street

Flashback Friday: Amazon, Chip Stocks, Memorial Day

Flashback Friday: Amazon, Chip Stocks, Memorial Day

Some Companies Are Already Feeling the Effect of GDPR

Some Companies Are Already Feeling the Effect of GDPR

Experts Break Down GDPR Risks for Investors

Experts Break Down GDPR Risks for Investors

Netflix Ready to Surpass Disney as America's Most Valuable Media Company

Netflix Ready to Surpass Disney as America's Most Valuable Media Company