Blockbuster (BBI) is a great example of what can go wrong when you don't understand how an industry is changing and then try desperately to catch up. From late 2001 to early 2002, Blockbuster was the most popular place to rent videos. Its shares were selling for close to $30 each, and its market capitalization was about $5.75 billion.
But there was a growing trend toward renting movies over the Internet. Blockbuster made a big mistake by not noticing how important it was becoming to rent videos over the Internet. The price of each share has steadily gone down until it is now between $3.80 and $4.20. Once a large-cap company, Blockbuster is now a small-cap company that is struggling to find its way. The company has started renting DVDs over the Internet, but it has a lot to catch up on.
Blockbuster has lost money for the last three quarters in a row and is struggling to grow its sales, which are only expected to grow by 1.1% in fiscal 2006. It's estimated that its earnings will grow by only 2.5% per year over the next five years, which is sad.
Blockbuster also has to deal with its huge debt load of $1.27 billion, which gives it a debt-to-equity ratio of 2.73:1 and makes its balance sheet look weak. When you add in low working capital, you can see why the financial risk is so high. Blockbuster is losing money and its sales aren't growing, so it will be hard for it to get back to where it used to be. It's not likely to happen.
Blockbuster's main competition is Netflix (NFLX), an online DVD rental service that started out in May 2000 and traded at close to $40 in 2004 before dropping to $10 in 2005 before a rally.
Netflix saw that the future of renting DVDs was online, not in "brick and mortar" stores. Blockbuster, on the other hand, decided to keep things the way they were. Blockbuster is losing money, but Netflix has been making money for the last three quarters in a row. It has 4,2 million subscribers, and that number is growing. Its sales are going up and are expected to go up 32.5% in fiscal 2007, while Blockbuster's sales aren't going up at all.
Blockbuster has joined the market for renting DVDs online, but it is a long way behind Netflix. Also, Netflix runs Wal-Mart Stores' (WMT) online DVD rental business. This is because Wal-Mart decided to shut down its own online DVD rental business and let Netflix run it instead.
At 36.73 times the estimated EPS for FY06, Netflix is not cheap. But if it keeps growing quickly and makes the $1.11 per share that is expected for FY07, the price seems more fair. Netflix is under a lot of pressure to do well, but it is on the right track.
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