March 5 2008: 3:16 PM EST
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Don't count Blockbuster out

Whenever shifts in technology and consumer behavior seem to threaten its core business, the longtime king of movie rentals still manages to stay afloat. Here's how.

By John Simons, writer

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(Fortune) -- Blockbuster Inc. is like a slasher-flick villain that just won't die. In spite of what appear to be deep and devastating blows to its business - the rise of Netflix and mail-order movie rentals, in-home use of DVRs and video-on-demand via cable, and Apple's (AAPL, Fortune 500) recent introduction of online film rentals - Blockbuster adapts and lumbers onward.

Blockbuster will announce earnings Thursday for the fourth quarter of 2007. A consensus of analysts who cover the company expect Blockbuster to post earnings per share of 19 cents on projected quarterly revenue of $1.45 billion. The Dallas, Texas-based movie rental and retail company operates over 6,000 stores in the U.S. and around the world. In recent years, the business has undergone a transformation, expanding its offerings beyond in-store VHS, DVD, and video game rentals. The company now operates a combination mail-order and online movie rental business, which has been further enhanced by the company's acquisition of Movielink last August.

By some measures, the movie-at-home business has been thriving. According to Digital Entertainment Group, Americans spent $1.4 billion renting DVDs in 2001; that grew to $7.5 billion in 2006. Yet Blockbuster - despite being one of the largest players in the business - has been conspicuously incapable of capitalizing on that growth. Between 2001 and 2005, Blockbuster posted five consecutive years of net income losses. In 2006, Blockbuster eked out a tiny net income of $54.5 million on revenues of $5.46 billion.

Then growth flattened in 2007, in part because of the rise of online downloads and video-on-demand services offered by cable providers. In the last year, Blockbuster's (BBI, Fortune 500) shares have plummeted 54 percent to its current per share price of $2.93. The S&P 500 has dropped just 3 percent over the same period.

Even so, a handful of observers believe Blockbuster has a chance to do well - if only in the next few years. The company's new Movielink subsidiary is key. The online movie download service was created in 2002 by a group of major movie studios including MGM Studios, Paramount Pictures, Sony Pictures, Universal Studios, and Warner Bros (which, like this Web site, is owned by Time Warner (TWX, Fortune 500)). Those studios poured a reported $100 million into creating the service's infrastructure while spending very little to promote it.

In the midst of poor uptake from consumers, Blockbuster stepped in and purchased the operation for $6.6 million in cash, according to the company's SEC filings. The purchase was a major coup for Blockbuster's new CEO Jim Keyes, who succeeded longtime chief executive John Antioco last July. Although Movielink cannot yet be called a success, it does give Blockbuster the digital rights to some 6000 films, and provide an infrastructure for digital downloads that presumably will be necessary in the near future.

In the midst of slashing costs, closing stores, and cutting jobs to remain competitive, Blockbuster is also experimenting with store redesigns. Keyes is looking to establish a strong brand presence in brick and mortar, online, and mail-order movie rentals and sales. For all its efforts in the online realm, Michael Pachter, an analyst with Wedbush Morgan Securities in Los Angeles, sees a large opportunity for growth in Blockbuster's brick and mortar stores this year due to competitor Movie Gallery's (MOVIQ) Chapter 11 struggles and it recent decision to close more than 900 stores throughout the U.S.

"Blockbuster should benefit from Movie Gallery customer defections, lasting through the end of 2008. The 'tailwind' from Movie Gallery store closings should bolster same store sales at Blockbuster, and the pace of store closings should accelerate in the spring," Pachter wrote in a note to investors Wednesday morning.

Last week, JP Morgan analyst Barton Crockett upgraded his Blockbuster rating from "neutral" to "overweight" arguing that the company fourth quarter 2007 should be in line with consensus expectations or better, and that the company's 2008 guidance will top consensus views as well, thanks to the company's "cost cutting and reasonable solid demand for video rental," Crockett told investors in a February 28 communication.

Crockett, however, warned that his call "is short term, because we are concerned long-term about competitive threats from Netflix (NFLX), kiosks and new home video technologies. We do not know if new store formats, expected to be widely deployed in the second half of 2008 or 2009, will work." And so while doubts remain about Blockbuster's long-term viability, no one can deny that the company has a history of defying such doubts.  To top of page

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