What Do You Do When Your Market Is Going Away?

This is a question movie rental giant Blockbuster (BBI) is trying to answer. So far though, the company is at a loss for words. BBI shares lost 12% of their value Tuesday as the company lost more than twice as much money as expected in its second quarter. Blockbuster’s CEO predicted a return to profitability in Q4 and for all of fiscal 2006, but that will be a tall task.

With the advent of online DVD rental services and movies available on-demand from your local cable operator, the storefront-based rental market is going away. It might not be overnight, but instead little-by-little over the course of many years, but it is still going away.

Is it completely farfetched to think that 10 years from now you will be able to get Blockbuster’s entire movie lineup straight from your cable box? If this happens, and you can be sure companies like Comcast (CMCSA) have this idea in mind, Blockbuster’s stores and DVD mail order service are rendered useless.

Blockbuster’s Q2 2005 sales dropped 2% to $1.4 billion. The revenue breakdown was as follows: rentals 73% (down 5% vs 2004), merchandise sales 26% (up 12%), and late fees 1% (down 87%). Included in rental sales were the company’s 1 million online customers, who will now pay $17.99 per month. BBI raised the price from $14.99 this week since it wasn’t making money at the lower price originally targeted at taking market share from NetFlix (NFLX).

Now granted, merchandise sales were the only category up year-over-year, but Blockbuster has huge compeititon in this area. Best Buy (BBY), Wal-Mart (WMT), Circuit City (CC), Target (TGT), Amazon (AMZN), and the list goes on. All in all, how BBI expects to make money going forward is questionable.

As for the $7 stock, Blockbuster’s market cap is $1.35 billion, but they have more than $1.2 billion in debt and cash in the bank is falling precipitously. Blockbuster needs to figure out how to change their current business model to a profitable one in order to justify a $2.5 billion enterprise value.