Online Rental Investments Well Worth the Payoffs, Blockbuster Says

Q1 results were “in keeping with our plan to aggressively grow our Total Access subscriber base,” Antioco said. Investments in Total Access hit Blockbuster’s bottom line, but so did the “extremely tough” market in brick & mortar DVD rentals, he said. Blockbuster estimates in-store rental revenue fell 10% industry-wide Q1, he said. Blockbuster’s net loss soared to $46.4 million from $1.9 a year earlier on a 5.4% revenue increase to $1.47 billion. It swung to an $18.4 million operating loss from a $32.1 million profit last year. Gross margin fell 480 basis points to 51.7% from 56.5%.

But Blockbuster “significantly outperformed the competition” Q1, Antioco said, without mentioning Netflix by name. During the quarter, Blockbuster captured over 60% of “the subscriber growth in the online space,” he said. Other Q1 superlatives, according to Antioco: (1) Online subs grew 35%; (2) Online revenue jumped 116% from Q1 a year earlier; (3) Online market share rose 10 percentage points to 20%.

In the 5 months since launching Total Access, Blockbuster has nearly doubled its online sub base to 3 million, Antioco said: “We now have the fastest-growing online rental service in the marketplace and intend to keep it that way.” Blockbuster added more net subs in Q1 “than anyone in the online movie space has ever been able to add in a single quarter,” Antioco said. Blockbuster invested about $70 million Q1 to bring about those results, mainly from purchasing more of the DVDs needed to support in-store exchanges from the additional store traffic that Total Access generated, he said. Blockbuster plans to invest $100 million more on Total Access for the rest of 2007, he said. Blockbuster’s expected payoff: doubling the number of subs to “well in excess” of 4 million by year-end, Antioco said.

Given that Netflix has downgraded its projected sub growth, Blockbuster now thinks it may capture “all of the total net growth” in online rentals in Q2 and nearly 70% for the year, he said. That compares with Blockbuster’s 20% capture rate before the launch of Total Access, he said.

Blockbuster also thinks it will be very difficult for “our major online competition” to stop the growth of Total Access, “since we don’t think they have an answer to what we believe is a superior integrated service,” Antioco said. “Our competition has said they will simply wait us out until we change our proposition. They may have a long wait. We have no intention of making any changes to our Blockbuster Total Access proposition anytime soon, unless we feel these changes will fuel our growth even faster or improve our cost efficiencies or service metrics.”

It’s presumed Antioco was referring to remarks by Netflix CEO Barry McCarthy in the last quarterly earnings call in which he said Netflix was “content to grow more slowly, but profitably, while we wait for Blockbuster to rationalize their pricing, at which point we expect our growth to accelerate.” But Antioco said were Blockbuster to opt to curtail its investments in online rentals and slow sub growth, “our online service could be profitable now,” he said. “But we believe the subscribers we acquire today are setting the stage for future profitability.”

Blockbuster also is investing in Total Access because it views the offering as “our gateway to digital delivery,” Antioco said. “We want to establish an online relationship with customers today through online movie rentals and sales, so when it comes to renting and selling downloadable movies, Blockbuster is the first brand they turn to. We continue to move closer to the day when Blockbuster is a triple play -- movies through the stores, movies through the mail, and movies through a download.” It then would become the only brand capable of offering “all 3 ways to access movies,” he said.