How Business Blockbuster Miscalculated

Blockbuster (BBI) is a perfect example of what can go wrong when you misread the industry trends and then realizing it, try desperately to catch up. In the period from late 2001 to 2002, Blockbuster was the leader in the video rental business. Its shares were trading at nearly $30 a share and its market-cap was at around $5.75 billion. But there was a trend developing towards movie rentals via the Internet. Blockbuster failed to recognize the growing significance of Internet video rentals, a very poor miscalculation on its part. The shares have steadily declined to the current $3.80 to $4.20 channel. Once a large-cap, Blockbuster is now a small-cap and struggling to regain any sense of direction. The company has entered into the Internet DVD rental business but it has a lot of catching up to do. Fundamentally, Blockbuster has lost money in the last three straight quarters and struggling to grow its revenues, which are forecasted to increase a mere 1.1% in fiscal 2006. Its estimated five-year earnings growth rate is a mere 2.5% per annum, which is pitiful. Blockbuster also has to deal with its massive debt load of $1.27 billion or a debt-to-equity of 2.73:1, which suggests a weak balance sheet. Couple this with poor working capital and you understand the high financial risk. Faced with stagnant revenue growth and losses, Blockbuster faces a difficult upside battle to regain its lost glory. The odds are stacked against it. In the face of Blockbuster is online DVD rental company Netflix (NFLX), which debuted in May 200, trading at close to $40 in 2004 before sinking to the $10 level in 2005 before the rally. Netflix saw the future for DVD rentals and it was online and not via the “brick and mortal” route that Blockbuster decided to maintain. In direct opposite to Blockbuster, Netflix is profitable and has been for the last three straight quarters. It has 4.2 million subscribers and growing. Its revenues are growing and expected to surge 32.5% in fiscal 2007 whereas Blockbuster is seeing non-existent revenue growth. Blockbuster has entered into the online DVD rental arena but it is well behind Netflix. Moreover, Netflix also operates the online DVD rental business for Wal-Mart Stores (WMT), after the retail giant decided to shut down its own online DVD rental unit and instead let Netflix run it. Trading at 36.73x its estimated FY06 EPS, Netflix is not cheap. But if it can continue its strong growth and earn the estimated $1.11 per share for the FY07, the valuation becomes more reasonable. The pressure is clearly on Netflix to deliver but it is on the correct path. Note: you are welcome to post this article on your site if it is financial related. You must cut and paste the bio and make sure the web site link is live. Also please e-mail me to let me know. As investors, and we all are investors these days, it is important that we understand the idiosyncrasies of the Stock Market pricing data we use to help us in our decision making efforts. On Wall Street, investing can be a minefield for those who don’t take the time to appreciate why securities prices are at the levels that appear on quarterly account statements. At least four times per year, security prices are more a function of institutional marketing practices than they are a reflection of the economic forces that we would like to think are their primary determining factors. Not even close… Around the end of every calendar quarter, we hear the financial media matter-of-factly report that Institutional Window Dressing Activities” are in full swing. But that is as far, and as deep, as it ever goes. What are they talking about, and just what does it mean to you as an investor? There are at least three forms of Window Dressing, none of which should make you particularly happy and all of which should make you question the integrity of organizations that either authorize, implement, or condone their use. The better-known variety involves the culling from portfolios of stocks with significant losses and replacing them with shares of companies whose shares have been the most popular during recent months. Not only does this practice make the managers look smarter on reports sent to major clients, it also makes Mutual Fund performance numbers appear significantly more attractive to prospective “fund switchers”. On the sell side of the ledger, prices of the weakest performing stocks are pushed down even further. Obviously, all fund managements will take part in the ritual if they choose to survive. This form of window dressing is, by most definitions, neither investing nor speculating. But no one seems to care about the ethics, the legality, or the fact that this “Buy High, Sell Low” picture is being painted with your Mutual Fund palette.