Hollywood vs. Redbox

In these brutal economic times, one huge hit has been kiosk retailer Redbox, which offers $1-per-day DVD rentals. That's great news for consumers and even better news for Coinstar (CSTR), which last year bought control of the rapidly expanding Redbox. Until lately, Coinstar was better known for coin-counting machines that swap change for redeemable vouchers. Viewed as a recession play by investors, Coinstar's stock is up more than 80% this year.

The company's strategy of renting DVDs for a buck a day via some 18,000 vending machines located in Wal-Mart (WMT), Kroger (KR), and other stores generated $343.6 million in DVD revenues during the first half of the year. That's double last year's level. Redbox stocks a typical vending machine with 700 DVDs. Consumers can also reserve and prepay for titles online and return them at any Redbox kiosk.

Angry Giants One problem: Universal Studios and Fox worry that cheap rentals will cut into limping DVD sales and have barred third-party distributors from supplying Redbox with their releases as early as other retailers get them. On Aug. 12, Redbox filed a lawsuit against Fox in a Delaware court aiming to lift the distribution ban, and has an existing suit against Universal. Both studios contend they have the right to control distribution of their products.

"Having our movies rented at $1 is grossly undervaluing our products," Chase Carey, president of Fox's parent company, News Corp. (NWS), told analysts during a recent conference call. Some worry that $1 rentals could speed the fall in DVD sales, which Adams Media Research predicts will tumble 9% this year. At the same time, vending machine rentals will accelerate as Redbox and others roll out more kiosks.

For Paul D. Davis, a former Starbucks (SBUX) executive who joined Coinstar last year and became CEO in April, the DVD riches come just in time to revive a company that had stumbled after moves to diversify into businesses such as wiring money to foreign countries. Last year, those stumbles prompted a proxy fight from Shamrock Holdings, the Roy E. Disney-owned fund, which eventually settled for a seat on the board. "They told us that they would develop that DVD business, and they have been true to their word," says Shamrock CEO Stanley P. Gold. In February, Coinstar bought out the remaining 49% equity stake in Redbox it didn't already own from McDonald's (MCD, which co-founded the kiosk chain. "We have 20 years of working with retailers and in servicing kiosks, and we see plenty of upside for us to grow," says Davis.

Consumer Craving Coinstar is striking deals with some studios, though not Fox and Universal. Coinstar agreed to pay Sony (SNE) up to $460 million for the right to distribute for five years the studio's DVDs on their initial release date. Sony decided to do the deal because "it was something that the consumer was craving," says Sony Pictures Home Entertainment President David Bishop. Lions Gate Entertainment (LGF) has also agreed to supply new releases to Redbox over five years for $158 million.

Redbox CEO J. Mitchell Lowe says his machines continue to stock films from all studios, including Fox and Universal, even if his employees occasionally have to buy new releases from traditional retailers. He also has compiled data that show consumers who rent from Redbox are just as likely to buy DVDs later as those who frequent Blockbuster Entertainment (BBI) or Netflix (NFLX). "Once we get the facts out, we figure other studios will sign on with us as well," says Coinstar CEO Davis. If they do, DVD kiosks may end up reshaping the economics of Hollywood.

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