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Thursday, May 19, 2005 

Netflix Rules

Wal-mart gave up!

Netflix Takes Over Wal-Mart DVD Rentals

SAN FRANCISCO - Wal-Mart Stores Inc. is turning over its online DVD rental business to Netflix Inc., signaling that the world's largest retailer couldn't beat the Internet upstart at its own game.

Netflix shares surged after the agreement was announced Thursday, rising $2.61, or 17 percent, to $18.11 in midday on the Nasdaq Stock Market.

Wal-Mart is offering its existing online DVD rental customers the chance to continue their subscriptions with Los Gatos-based Netflix at their current price for the next year. Those who don't sign up with Netflix by June 17 will lose their service. Wal-Mart plans to continue promoting the Netflix service on its Web site.

In return, Netflix will remind its subscribers that they can buy DVDs from Walmart.com.

The companies didn't disclose how many customers Netflix will inherit nor the financial terms of their partnership. About 70 percent of Wal-Mart's DVD rental customers pay $12.97 per month for the right to check out up to two titles at a time. Most Netflix customers pay $17.99 per month for three titles at a time. Wal-Mart charges $17.36 per month for three titles

Wal-Mart is believed to have fewer than 100,000 online DVD subscribers, said industry analyst Dennis McAlpine of McAlpine Associates. "This is a nice deal for Netflix, but it still doesn't mean Netflix will win the game," he said.

Netflix still expects to lose $5 million to $15 million this year as it tries to thwart Blockbuster Entertainment Inc.'s aggressive push into online DVD rentals, but getting Wal-Mart to drop out of the competition represents a major victory for the tiny company.

It takes Wal-Mart less than a day to surpass Netflix's 2004 sales of $506 million.

"It's a very nice endorsement," Netflix CEO Reed Hastings said during an interview Thursday.

Despite its size and merchandising savvy, Bentonville, Ark.-based Wal-Mart couldn't overcome Netflix's head start in the rapidly expanding niche of online DVD rentals. Wal-Mart concluded the service didn't blend in well with its stores, said John Fleming, an executive vice president who oversees the company's online operations.

Formed in 1999, Netflix already has attracted 3 million subscribers and shaken up the home entertainment industry by establishing a new way to rent DVDs.

"Netflix is a pioneer in this space and we have always admired what they have done," Fleming said during a Thursday interview. "We think this (Netflix partnership) will be a big win for our customers."

The Netflix service requires subscribers to create an online wish list from a library consisting of more than 40,000 titles and then delivers up the DVDs through the mail.

Netflix allows subscribers to keep the DVDs for an unlimited amount of time without late fees. Once a DVD is returned in postage-paid envelope, Netflix sends out the next selection on the subscriber's online list.

The concept caught fire as more households bought DVD players and surfed the Internet, inspiring Wal-Mart to introduce a copycat service two years ago.

After initially deriding Netflix as a passing fancy, Blockbuster is investing heavily in an online rental service that costs $3 per month less than Netflix.

But Blockbuster appears poised to raise its prices, a change that could provide Netflix with another boost. The company recently began charging some its new subscribers $17.99 per month — the same price as Netflix.

Blockbuster has budgeted $170 million for its online expansion and underscored its resolve to win back customers by dropping the late fees that inspired Netflix to launch its alternative approach. Eliminating the late fees reduced Blockbuster's first-quarter revenue by $145 million.

Blockbuster expects to have 1 million online customers by next month, but its long-delayed response to Netflix's increasing popularity irritated many shareholders. The angst sparked a rebellion by the company's largest shareholder, billionaire Carl Icahn, who last week won a battle to win three seats on Blockbuster's seven-member board.

Meanwhile, Netflix is aiming to add an additional 1 million subscribers by the end of the year.

The cutthroat competition has battered Netflix's stock, which has plunged from a high of $39.77 reached early last year.

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