I have read this blog with great interest and wanted to share some of my
thoughts. I have been following the development of the DVD kiosk industry over
the last 2 years and my assessment of the Redbox vs TNR debate is as follows:

REDBOX
——

Background
———-
Redbox started their trials with vending machines supplied by DVDPlay.
According to my sources, DVDPlay were not able to meet certain obligations and
as such, Redbox subsequently obtained rights to the technology themselves and
improved upon it through their partnership with contract manufacturer
Solectron. All of the DVDPlay machines were then replaced by the new Solectron
machines. Redbox continues to rollout new sites rapidly.

Competitive Advantages
———————-

Apart from the advantages associated with being related to McDonalds, having a
professional and experienced management team and quality partners, as mentioned
earlier in this blog, Redbox also has the following advantages:

- A scalable infrastructure that will allow them to expand rapidly and
effectively;

- A lower capital cost of acquiring machines (in my opinion) since they
manufacture them directly (via Solectron) rather than acquiring the machines
through a traditional supplier/distributor. Therefore they have the potential
for a better return on investment;

- Superior software: The user interface of Redbox machines are easy to use and
intuitive. The backoffice management software is “enterprise scalable” meaning
that a network of thousands of machines can easily be supported and monitored.
The necessary enterprise reporting functionality is also present to allow
management to make effective decisions;

- Professional website: Although the website is not a key driver of the
business, the professional design of the site is a reflection of the commitment
to quality of the company;

- Web reservations: although this is not a critical advantage, it is
functionality that Redbox has made available to customers, unlike TNR who is
not likely to be able to ever offer this option due to their system’s technical
limitations;

- Ability to pickup a movie from one location and return it to another: again,
like web reservations this functionality may not be used prolifically by
customers but at least the option is available.

TNR Entertainment
—————–

Background
———-
TNR commenced operations using machines supplied by an Italian company
Videosystem Italia (VSI) and subsequently also trialed machines from the
US-based Touch Automation. After raising 45 million dollars for an aggressive
expansion plan, TNR has recently undergone a change in their management and
scaled back their aggressive expansion plans as described in the following
articles:

http://www.videobusiness.com/article/CA6490436.html?nid=2705
http://eastbay.bizjournals.com/eastbay/othercities/houston/stories/2007/09/03/story9.html?b=1188792000^1514546

Competitive Disadvantages
————————-
In my opinion, TNR has absolutely no competitive advantages over Redbox. Its
disadvantages are as follows:

- An infrastructure which is not easily scalable. The VSI machines are not
very sophisticated, both from a customer perspective and an enterprise
perspective. The system is very basic by today’s standards and only allows a
maximum of 300 machines to be networked and managed together. As such the
system is not “enterprise scalable” and cannot easily support the management of
thousands of machines. It is presumably for this reason that TNR hired IBM to
integrate the SAP software package to manage their backoffice operations.
However, given the basic nature of the VSI software, it is unlikely that TNR
have been able to achieve the desired level of integration with the SAP
software. As for the Touch Automation machines, their software certainly
appears to be more sophisticated than VSI’s, however I understand that their
machines have been prone to mechanical glitches.

- A higher cost of capital of aqcuiring the machines: Since TNR does not
manufacture their own machines their acquisition costs are likely to be higher
than Redbox, even if we take into account volume discounts on large orders;

- Basic software (VSI machines): The user interface is adequate but not as user
friendly as Redbox. As mentioned above, the backoffice software is also based
on very outdated technology making it difficult to manage the machines at an
enterprise level;

- Amateur Website: Despite the fact that TNR have raised millions of dollars in
funding, it amazes me that they have not made the effort to develop a
professional-looking website. Again, this may not be a key driver of the
business but impressions do count and the Redbox website certainly portrays a
more professional impression.

- Lack of web reservations: web reservations have been in a status of “coming
soon” for at least the last 2 years on the TNR website. The reality is that
the standard VSI reservation system is functionaly and technically too basic
for the North American market and I assume it is for this reason that TNR has
not implemented it. It appears unlikely that TNR will develop a new
reservation system of their own either;

TNR Exit Strategy
—————–

Previous discussions have put forth 2 exit strategies for the TNR venture
capital investors: An acquisition by Redbox or an IPO. My assessment of these
two strategies are as follows:

1) Acquisition by Redbox
————————
The only benefit to Redbox of acquiring TNR would be to takeover their location
contracts. However, with TNR’s recent scale back of expansion plans, I believe
such benefit is significantly diminished. Furthermore, in order to ensure a
seemless integration with the Redbox network, the TNR machines would have to be
replaced with Redbox machines (as was the case when Redbox replaced their
originally deployed DVDPlay machines), which would not be justified from a cost
perspective. Ofcourse, Redbox could just manage the TNR network as a separate
entity but this would not be the most efficient option. Additinally, it is
unlikely that Redbox would value TNR high enough to allow the VC investors to
realise the large “exit profit” that they would be targeting. The reality is
that the TNR financials will not justify a huge valuation, for reasons I will
explain in the next point.

2) IPO
——
An IPO is the preferred way to raise additional funds while also allowing the
initial VC investors to exit with a “spectacular return”. Because of all of
the “hype” surrounding the DVD kiosk industry the VC investors may well be able
to exit at a profit via an IPO, at the expense of uninformed individual
investors. However, it is my opinion that after such an IPO, once the dust
settles, the general investment community will realize that the TNR valuation
is simply not justified and the stock price is likely to fall below the IPO
price. TNR may well be generating a significant amount of REVENUE now but what
is more important, is OPERATING PROFIT (as Mr. Oliver pointed out earlier) and
CASH FLOW. Taking into account the high capital cost of the machines, the
practical limit in the number of rental transactions that can be achieved per
month, the low movie rental prices and the cost of content, achieving an
operating profit that also provides an adequate return on investment is a tough
balancing act that requires a very efficient operation. I believe that this is
why TNR has recently scaled back their aggressive growth plans to focus on
optimizing profitability. Simply placing a kiosk in every location of a
supermarket chain as quickly as possible doesn’t translate into optimal
profitability. I believe current investors of TNR have realized this and are
now focusing on trying to improve the financials in order to extract the
greatest value when it is time to exit.

CONCLUSION
———-

In my opinion the ultimate winner will be Redbox because they have the
management, technology and infrastructure to support a rapid expansion while
also optimising profitability. It is again my opinion that TNR has been
“over-hyped” and that their financials are not as healthy as Redbox’s.
Furthermore, for the reasons I have mentioned earlier, I believe that if TNR
continue to deploy machines supplied by VSI they will remain at a significant
disadvantage to Redbox.

For now, it will be interesting to continue to watch developments. Time will
tell…

I’m not sure what the future holds as far as Redbox or TNR in New York, but I do know that DVD Station has a kiosk located in Grand Central and that MovieBank has 8 stores in the New York area.

If it makes you feel any better, I can tell you that San Francisco hasn’t really gotten DVD kiosks yet. So far the only place you can rent from them are at Safeway stores that operate under the DVDplay brand and a few DVDStation kiosks scattered around town.

Because of the importance of distribution agreements, there will be plenty of room for everyone in this market to grow. With McDonald’s owning a piece of Redbox, will Burger King even consider using Redbox? I doubt it, I think they’d be more comfortable using another brand.

The power of the kiosk model is that you can take many many businesses and place a video store inside of them. Someday I believe we’ll see kiosks in banks, malls, department stores, liquor stores, of course Supermarkets and perhaps most importantly coffee houses. Some businesses will be better suited to kiosk distribution then others, but because of the sheer number of partners that are out there I think that many will profit from the fall of the traditional video store.

As this industry expands, I hope that we don’t continue to see TNR stay private though. I believe that the public is salivating for an opportunity to support this industry with their own dollars and the first one with a pure IPO will have a huge lead. Raising $20 million here and there certainly allows for orderly growth, but if TNR (or anyone for that matter) was armed with a contract with Starbucks and $250 million in cash, I think we could see a legitimate national threat take on Blockbuster.

When Coinstar announces their earnings later this week, all the analysts will be able to talk about will be Redbox, Redbox, Redbox, even though their price increases on their candy machines is a much more material factor to their earnings. DVD Kiosks are hot and the public wants in.

To date the money has been allocated to the private VC funds that are more then willing to assume these risks to achieve the spectacular returns of going public or selling out to a larger business, but at some point I would love to see an IPO by a pure DVD kiosk company. I believe that this would not only increase the speed at which TNR or any another company could deploy their products, but that it would also give private individuals an opportunity to get in on a white hot industry while it’s still on the ground floor.

As far as Redbox vs. TNR goes, I’m not sure that it’s a zero sum game at this point. I think that the real issue is that all companies need quite a bit of capital to expand and that is the real limitation here. If TNR were to just fully leverage their Kroger relationship, we’d see another Movie Gallery, if not Blockbuster. I too think that the kiosks, VOD and DVD by mail will mean curtains for the Blockbuster and Movie Gallery, but they’ll experiment with kiosks themselves when all is said and done.

My take on the kiosk market is that it’s the wild wild west right now and that regardless of if you are 1 or 2, there is plenty of room for growth, IPOs and alternative revenue streams. In the end I’m not sure who will be the winner, but Redbox has done a very good job of leading the industry and I expect them to maintain that spot for at least a few years. More then that it’s just to hard to tell with so many unknowns in the industry.

I wasn’t aware of smaller acquisitions that TNR is making, but would be interested in finding out more details about who they may have quietely bought up.

A tidbit that you might not know though is that Redbox owns an option on DVDXpress. They have about 150 kiosks and the option is for another two years I believe. DVDXpress has started testing a monthly rental program similar to what Netflix has done only for kiosks. I believe that this is the future of the industry and that DVDXpress is a testing ground for Redbox. Hopefully, Coinstar will give us more details on their upcoming conference call.

In the meantime, thanks for commenting as always everyone is more then welcome to contact me directly at Davis at davisfreeberg dot com. Rememember you can always stay anonymous.

Davis

My comments start with TNR. Are their kiosks making an operating profit, or are expansion funds being used to generate the “increasing recenues” that their “supermarket partners” are realizing. I’m not sure I am buying into their hype, although it appears that the investment community is, so my opinions don’t really count. I’m just glad I am not a partner in one of the companies pumping money into TNR. How can an informed investment community get excited about putting capital into TNR when Red Box announces an almost concurrent expansion? Who do I like, Red Box or TNR. The answer is Red Box. And pay careful attention here, I may have a few tidbits you aren’t aware of. Yes, TNR can expand with Kroger. And Red Box has McDonalds. But did you know that Red Box will also wind up with WalMart. Or did you know that RedBox is doing a beta test with Wal-Mart which runs through the end of this year and involves 40 some geographically dispersed DVD kiosks. So we have TNR in supermarkets with Kroger its principal growth channel, and we have Red Box with McDonalds and its thousands of US locations, and Wal-Mart with their 4,300 US stores. What I see is TNR positioning to merge into or be acquired by Red Box. And I have some reasons for saying this that I am not at liberty to disclose, one of which has to do with a failure on TNR’s part to capitalize on some obvious leverage opportunities with the supermarkets that they have established relationships with. When deciding who wins a shoot out or if Red Box is TNR’s exist strategy, remember one thing. McDonalds is the best operated retailer in history. Walmart would rank second. So Red Box has No. 1 and No. 2 retailers. TNR, can’t compete on the basis of quality of retail partners. Think back further, to the first run up of a really exciting movie rental concept – Blockbuster Video. When Scott Beck and Wayne Huzienga put Blockbuster together, where did they recruit all of there executives. Can you say “McDonalds”. You couldn’t sell me a nickels worth of TNR stock, but I will buy Red Box stock when I have an opportunity to do so, provided that it doesn’t dilute its value through an incestuous relationship with Red Box. And also is everyone overlooking VOD, and didn’t Netflix announced 5.7 million members now. And Blockbuster is touting 2 million by years end. Whether in stores or in kiosks, the fixed based movie rental companies, other than Red Box, are going to suffer. I see VOD, Netflix, and DVD kiosks are aggregately comprising the “swan song” for Blockbuster Video. And BB looks healthy compared to Movie Gallery. And don’t both BB and MG have loan calls coming up in the not distant future. Let me tell you who may be the beneficiary of all this. No, I don’t think so. I see the opportunity in all this, and I plan on capitalizing on it. So thanks to all the foregoing. Oh, and did you know that TNR is using a shot gun strategy to try to acquire smaller DVD kiosk operations, which could do nothing for them except increase revenues, at the expense of manageability.

Sam Oliver