The numbers back then were compelling. Video stores were considered good tenants by strip-mall devlopers, stores ramped up quickly and threw off enough cash that much of the expansion could be financed internally. In addition to absolute growth in the market, the national chains could easily take share from incumbents when they entered a market, by virtue of their broader and deeper selection of titles, preferable locations and greater marketing clout.
When growth in the rental market slowed after the introduction of the DVD, however (which shifted consumer spending toward purchases), rental operators found themselves badly overbuilt. Undoing that situation, however, proved easier said than done. As early as 2005, then-Blockbuster CEO John Antioco was calling for “thousands of stores” to be closed industry-wide. But many of those stores were sitting on long-term leases that would have to be eaten of the stores were shuttered. At the same time, high debt ratios on the chains’ balance sheets put a premium on cash generation, even at the expense of margins. The result: the stores stayed open and per-location profits plunged.
The situation has only gotten worse over the last two years as overall consumer spending on home video has declined sharply. So Blockbuster has decided finally to bite the bullet. On Monday, the company announced a new private placement debt offering of up to $340 million due 2014. The funds will be used to repay all of the chain’s current indebtedness under existing loan and credit facilities, removing the immediate debt overhang on its balance sheet. On Tuesday, it took the next logical step by announcing and accelerated plan to close as many as 960 of its 3,750 corporately owned stores by the end of 2010.
Although Blockbuster has been closing stores at a clip of 200-300 per year as leases came up for renewal, the reduced debt-service burden means it can afford to take a hit on existing leases and double the rate of store closings. In the long run that should drive down operating costs and corporate overhead while driving up margins at the remaining locations.
In place of the closed stores, Blockbuster plans rapidly to expand the number of automated rental kiosks it operates, from 500 to 10,000 by the middle of next year. It also plans to focus more of its efforts on its Total Access subcription program and the rollout of its video-on-demand application.
The steps Blockbuster is taking may or may not be enough to restore growth to the company and its share price. But they’re an unmistakable signal that we’ve reached the next phase in the restructuring of the video rental business, with implications not just for retailers but for the studios as well. Simply put: renting DVDs can no longer generate enough cash or margin, given current or likely levels of consumer demand, to sustain a large real estate overhead. Consequently, we’re seeing a fundamental reordering of the cost structure of the business.
Big box is out, Redboxes are in. Clerks (Clerks?) are out, automation and convenience are in. Three-dollar a night rentals are out, dollar-a-night rentals and Netflix subscriptions are in.
In short, the video rental industry is going as virtual as possible for a business that still involves the exchange of physical goods. While that’s taking cost out of the system it’s also rearranging the value chain, in ways with which the studios are yet to figure out how cope, as reflected in their growing hostility toward Redbox and Netflix.
Wishing things would stay the way they’ve always been is rarely a profitable response to innovation, however.