Video-Rental Industry Faces Tough Times New Competition, Shortage Of Hit Movies Blamed For Declining Revenues, Cutbacks

After a trip to a video-rental store for a copy of the movie “Fools Rush In,” Mary Wallace went home empty handed to watch television.

“The video stores have been doing better in having more copies, but they’re usually out,” said the 24-year-old veterinary student after leaving a Blockbuster Video store.

More consumers like Wallace are forsaking video chains, frustrated with stores filled with third-rate films and perpetually out of desirable hits. Instead, they’re watching movies on pay channels or buying tapes from discounters such as Wal-Mart Stores Inc. And amid over-expansion in the $15 billion industry, chains such as Blockbuster, West Coast Video Entertainment Corp. and Moovies Inc. are closing stores and putting plans to open new stores on hold.

“There were some great economics in this business and collectively everyone has wrecked them,” said George Shipp, analyst at Scott & Stringfellow. “For investors, there’s been a lot of missed expectations.”

Shares of the six publicly traded video-store operators have plunged an average of 44 percent in the last 12 months. Among the worst performers is Movie Gallery Inc., the nation’s No. 2 chain with about 860 stores, whose stock has slid about 70 percent.

Recent casualties include Viacom Inc.’s Blockbuster Entertainment Group unit and Moovies, both of which have cut expansion plans. Others, such as Movie Gallery, faltered because they expanded too fast through acquisitions, analysts say.

The latest flop is Hollywood Entertainment Corp., which a week ago told some analysts that same-store sales were lower than expected. Investors dumped the stock, causing it to plunge 26 percent in one day.

Analysts and investors say video rentals have slowed amid a poor crop of Hollywood films and competition from big retailers, where tapes often cost just a few dollars more than a rental. For the first time this year, consumers will spend more buying tapes than renting. On top of that, many consumers now get their entertainment on the Internet, from cable TV or satellite broadcasting.

One former Movie Gallery investor who recently sold the shares said he’s going to steer clear of the business.

“We have no compelling reason to get back in,” said Mastrapasqua & Associates analyst Hunter Connelly.

Investors have good reason to be wary. Spending on video rentals is expected to rise at just a 0.4 percent annual rate by 2006, down from 2.4 percent this year, according to Paul Kagan Associates.

Much of the industry’s problems can be blamed on saturation of VCRs. The number of households with VCRs is expected to rise just 1.7 percent next year, after increasing as much as 80 percent in some years during the 1980s, according to media investment bank Veronis Suhler & Associates.

Meanwhile, other forms of entertainment are gaining customers. For example, spending on pay-per-view cable TV rose 18 percent to $358 million in 1996, Veronis Suhler said.

Blockbuster and others also have been hurt because more consumers are buying videos, which generates lower profit margins than renting. For the first time this year, purchases of tapes - estimated at $8.19 billion - will surpass rental spending of $8.07 billion, Veronis Suhler said.

Moreover, when rental demand for a title fades and stores sell extra copies, they often find prices undercut by discounters such as Wal-Mart, analysts say.

“These companies are now finding out they have to compete with the Wal-Marts of the world,” said Joan Bogucki, analyst at Needham & Co.

The video chains made plenty of mistakes on their own. Some expanded too fast and outside core markets. Others erred by adding music, posters and other merchandise in their stores.

Blockbuster, for example, is trying to return to its roots of renting tapes after a strategy of offering candy, snacks and T-shirts in its stores failed to justify the added costs.

“Blockbuster, as the industry leader, has provided what I would consider limited leadership in the last couple of years,” Shipp said.

Movie Gallery, meanwhile, expanded outside small and midsized towns, where it had little competition.

“It was a classic case where the company had a great strategy, and they set their goals beyond their reach,” said Connelly of Mastrapasqua, which recently sold its shares of Movie Gallery. “They went into real estate they weren’t familiar with and overpaid for some acquisitions.”

West Coast Entertainment, owner of the Palmer Video and West Coast Video chains, in early July said it will postpone a $110 million bond sale because of concern about the video industry.

“We have to deal with the perception that there’s nothing good in the video store,” said Steven Apple, vice president of corporate development at West Coast. He said the company may try again to sell debt when the market improves.

Of course, a strong crop of movies in the theaters this summer, including Sony Corp.’s “Men In Black,” Viacom’s “Face/Off” and Time Warner Inc.’s “Batman and Robin,” could give the industry a boost later this year when the films reach video stores, analysts say.

Summer box-office revenue in the U.S. and Canada this year rose to a record, estimated at $2.15 billion, according to Entertainment Data Inc. That’s about $70 million higher than last summer.

Yet, analysts said it will take more than just a summer of popular films to get the industry moving again.

The chains “need to up the ante for consumers by offering more selection, more service and more fun for less money,” said Pacific Crest Securities analyst Laura Richardson.