In November 2007, Redbox had exciting news: Its brick-red DVD vending machines were in more locations nationwide than industry leader Blockbuster.

“Redbox offers a level of service and convenience that our competitors simply can’t provide,” Redbox founder and then-CEO Gregg Kaplan said at the time, boasting of the company’s 6,000th automated kiosk installation.

Today, Blockbuster is essentially dead, living on as a token brand name under Dish Network. Kaplan is now a partner with Pritzker Group Private Capital. And Redbox — with its parent company, Outerwall, still making healthy profits on relatively cheap DVD rentals of new releases — is shrinking, ultimately destined for the same fate as its erstwhile foe.

“It’s a certainty that at some point consumers will no longer be renting movies out of Redbox kiosks,” says Piper Jaffray analyst Michael Olson. “It could be five years from now or 15 years from now. But at this point, it’s about managing the decline.”

Redbox’s revenue for the fourth quarter of 2015 dropped 17%, to $407 million, as movie rentals plunged 24% year over year. For 2016, Outerwall expects Redbox rentals to decline 15%-20%, and the company plans to remove up to 2,000 underperforming kiosks after ending last year with 40,480.

Former Redbox CEO Mark Horak, shown here at last year’s Press Play: Variety Home Entertainment and Digital Hall of Fame event, departed the DVD rentals company after less than two years in the job.
Rob Latour/Variety/REX/Shutterstock

Outerwall blamed a variety of factors for Redbox’s ongoing woes. Those included “successive quarters of weak content” and the effect of price hikes enacted in December 2014, which increased the daily rental rate for standard DVDs from $1.20 to $1.50.

But the fundamental factor pushing Redbox downward is that people are increasingly consuming entertainment on digital outlets like Netflix, Hulu, iTunes, Amazon, Comcast and other pay-TV ops rather than via DVD. Just as Redbox hastened Blockbuster’s demise, the kiosk operator is losing share to services that offer more convenience, value and selection — with instant viewing across multiple devices.

“We are facing challenges from changes in the marketplace and how consumers access content in various formats,” Outerwall CEO Erik Prusch acknowledged on the company’s earnings call this month. “Levers that worked in the past, such as investing in more content or certain marketing promotions, are no longer sufficient as a counterweight.”

Investors have punished Outerwall’s stock, pushing it to a six-year low of $27.04 per share on Feb. 6 after the company’s weaker-than-expected 2016 outlook for Redbox. Some analysts believe the reaction is overwrought, arguing that Redbox has a sustainable position with its broad network and low-cost model. Movie titles are available on Redbox at some 33,000 locations, including Walgreens, Walmart, Kroger and 7-Eleven stores, typically 28 days after release on disc and digital sell-through, and before they hit subscription services like Netflix.

Redbox’s business peaked in 2013 — and now faces years of declines as DVDs slowly fade from the home-video scene.
Source: Company Reports

Short of piracy, there’s no less expensive way to watch, say, Disney’s “Bridge of Spies,” 20th Century Fox’s “The Martian” or Sony’s “Hotel Transylvania 2” than an overnight rental from a Redbox machine.

“There’s a big delta between a buck fifty for a Redbox DVD and $6 or $7 for (a new release rental on) VOD,” says Eric Wold, an analyst with B. Riley & Co. “It’s going to be a huge cash-generating company for quite a while.” Wold maintains a “buy” rating on Outerwall stock.

Indeed, despite lower sales, Redbox posted an operating profit of $255.9 million for full-year 2015. The unit’s operating margin was 14.5% last year — up from 13.6% the year earlier and 13.1% in 2013.

Redbox has raised fees only twice in 13 years, and Wold suggested the operator has some pricing power that would allow it to further boost revenue per rental. “Movie theaters raise prices every year,” he noted.

Outerwall’s Prusch, on the earnings call, said Redbox is testing higher price points, but didn’t provide details. “We’re going to continue to look at price as one of the levers that we have with the business,” he said. In Q4, net revenue per Redbox rental was $2.98, compared with $2.73 in Q4 2014.

“It’s a certainty that at some point consumers will no longer be renting movies out of Redbox kiosks. It could be five years from now or 15 years from now. But at this point, it’s about managing the decline.”
Analyst Michael Olson

With Outerwall’s market cap now below $500 million, down from more than $2 billion four years ago, one possible scenario for the company is to go private. Last week, activist investor Engaged Capital disclosed that it had amassed a 14.1% stake in Outerwall. Engaged has urged Outerwall to consider selling itself to a private-equity buyer, per a Bloomberg report. The premise is that a new owner would be able to further streamline operations and potentially separate Redbox from Outerwall’s Coinstar business and the money-losing ecoATM recycling kiosk unit. “Outerwall welcomes the opinions of its shareholders, and is always open to constructive input toward the goal of enhancing shareholder value,” the company said in a statement.

Redbox declined to make executives available for an interview for this story.

Prusch, a former wireless-industry exec whom Outerwall named CEO in July, has promised to make changes at Redbox to maximize profitability. In December, he booted out Redbox president Mark Horak, a former top exec at Warner Bros. Home Entertainment, who had been with the company for less than two years. Among Horak’s moves was to pull Redbox out of Canada, where it had 1,400 kiosks, in early 2015.

But Prusch’s hands are tied in building a bridge for Redbox to a streaming-video future — for one thing, it already tried and failed to make the leap. In March 2013, Outerwall, in a joint venture with Verizon Communications, launched Redbox Instant, a Netflix-style subscription service with about 6,000 movies. After meeting with little traction, the companies shuttered the new venture in October 2014. Verizon has since invested heavily in go90, a free, ad-supported mobile video service.

“Redbox’s customers have tremendous price-sensitivity,” says Peter Csathy, CEO of investment and consulting firm Manatt Digital Media. “Moving them onto a monthly subscription plan just didn’t work.”

Redbox’s business peaked in 2013 — and now faces years of declines as DVDs slowly fade from the home-video scene.
Source: Company Reports

Blockbuster also was unable to navigate the shifting digital tides. Notoriously, the retailer passed on the chance to buy Netflix in the early 2000s. The struggling company filed for bankruptcy in 2010; Dish bought Blockbuster a year later for $320 million, but eventually closed all remaining stores and shuttered its DVD-by-mail biz. Separately, in 2012, Outerwall (then known as Coinstar) paid $100 million to acquire NCR’s DVD kiosk business—which had operated under the name Blockbuster Express — and folded it into Redbox.

Despite both Blockbuster’s and Redbox’s reliance on physical DVDs, analysts see huge structural differences between the two models that were the very reasons Redbox outflanked its rival. “Blockbuster was inefficient,” Wold says. “They had a big retail footprint, and Redbox was the much cheaper option.” Redbox now enjoys the network effect of having 40,000 boxes, which would be out of the question for a would-be competitor to consider replicating. Netflix, for its part, still runs its dwindling (but still profitable) DVD-by-mail business in the U.S., with 4.9 million subs at the end of last year.

Another point in Redbox’s favor: Major studios now see the DVD kiosk service as a sizable source of revenue for their home-video divisions. Over the past 12 months, Redbox renewed short-term licensing deals with Universal, Paramount, Sony, Warner Bros. and 20th Century Fox (with Disney the only significant holdout). In recent years, Outerwall has been one of the biggest wholesale buyers of DVDs and Blu-ray discs, after Walmart. “The studios don’t want Redbox to go away,” Csathy says.

It wasn’t always this way. Redbox started life in 2002 under the wing of McDonald’s Ventures, and once it gained a large user base, Hollywood execs fought the company because they thought 99¢ DVD rentals would destroy their sell-through businesses. When Fox, Warner Bros. and Universal refused to sell DVDs to Redbox until 28 days after home-video release, Outerwall filed antitrust lawsuits against them in the late 2000s before coming to terms with the studios in 2010.

“Going back to the origin of Redbox, there was a ton of resistance. The studios hated it,” says John Calkins, former exec VP of digital distribution at Sony Pictures Entertainment.

Sony was the first big player to reach a distribution agreement with Redbox to stock its titles. The decision to do so was influenced by the classic “prisoner’s dilemma,” according to Calkins: “If we didn’t do it, somebody else would be in that box.”

From here on out, the industry stands to reap less coin from Redbox: While 2016 box office grosses for Redbox titles are expected to be $10.2 billion, an increase of 3% over 2015 based on company estimates, Outerwall is predicting a double-digit decline in rentals for the year.

“I don’t think it will hit a wall and people will stop using Redbox all of a sudden,” Piper Jaffray’s Olson says. “But the war they’re waging is one they will lose longer term.”

Source: PwC’s Entertainment & Media Outlook report, June 2015