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Analyst: Rental Discs to ‘Be Around’ for Years

5 Aug, 2013 By: Erik Gruenwedel

Netflix continues tightrope balance act between low prices and content quality

It may be a streaming world, but rental discs continue to be a home entertainment mainstay, according to Wedbush Securities analyst Michael Pachter.

The analyst contends Redbox and home video stores will see an improved third quarter with the slated release of eight titles with box office grosses $100 million each. That compares to just three titles during the previous-year period with similar box office tallies.

Industry observers contend box office to be a significant driver of disc rentals and sellthrough as consumers gravitate toward movies with the highest theatrical appeal. With third-quarter box office up an estimated 43% year-over-year, and Netflix hemorrhaging disc subscribers largely through indifference on the part of management, Pachter says Redbox is poised to benefit the most going forward.

“We believe that the bull thesis is correct: DVDs are going to be around a long time, and a large percentage of the population will seek to rent at the lowest possible price,” Pachter wrote in an Aug. 5 note. “We believe that the vast majority of [price-conscience consumers] will prefer to see new movies for $1.20 a day rather than renting them for $4.99 to $5.99 through transactional video-on-demand. So long as there are DVDs, we think that [Redbox’s] business model will remain intact, and we think that the extraordinary studio profit contribution from DVD sales all but ensures that DVDs will be around for years to come.”

Netflix: Between Cheap Price and Pricey Content

Netflix’s push to grow subscribers globally while bidding ever higher for exclusive rights to third-party content and original fare puts the subscription VOD pioneer on a perpetual high-wire act, according to Pachter.

Netflix faces increased challenges maintaining its $7.99 monthly subscription fee while at the same time licensing increasingly more expensive content. In a June survey of 1,000 domestic Netflix subscribers, Wedbush found that subs primarily use the service due to its low price and quality of content. Two divergent factors that all but ensure conflict to the bottom line in the future.

“In our view, [Netflix] must choose between maintaining low prices and seeking higher profits,” Pachter wrote. “We believe that the company [in the near-term] will continue to offer low prices (which drive its sub numbers) and generate minimal profit.”

Meanwhile, should Netflix seek to boost its profitability, it will have to raise prices. A scenario the survey found doesn’t sit well with subscribers. A significant number of respondents said a price increase would make them reconsider their subscription.

Indeed, in the summer of 2011, Netflix did raise the monthly price 60% for its popular hybrid disc-streaming plan — a decision that resulted in the exodus of 800,000 subscribers and reams of bad publicity after it also (awkwardly) tried to spin off the disc rental business.

To this day, CEO Reed Hastings is loathe to consider raising prices, let alone talk about it.

The Wedbush survey suggests that any price increase will drive high churn, potentially impacting [negatively] revenue growth (and, hence, profitability), if fewer subscribers at higher prices fail to make up for the revenue lost from price-sensitive subscribers dropping the service.

“The survey makes it clear that low pricing is the key draw for many Netflix subscribers, and not content quality. However, content quantity is clearly [also] important to subscribers, as a large percentage focused on content as a reason for joining or quitting the service,” Pachter wrote.

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