The Slow Death of Redbox: Why the Kiosk Colossus Is the Next Blockbuster

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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.

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.
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.

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