The market doesn't always get it right at first. Shares of Redbox parent Outerwall (NASDAQ:OUTR) soared 12% on Monday after announcing that it was raising its rental rates.
Rentals of all of the disc-based media ejecting out of Redbox machines will be going up come Tuesday of next week. Let's go over the new daily rates.
- DVDs will go from $1.20 to $1.50.
- Blu-ray discs will go from $1.50 to $2.
- Video games will go from $2 to $3.
Now, it's not as if Outerwall's flagship business is doing so well that it's raising prices in response to a spike in demand. Redbox rental volume actually plunged 13.7% in Outerwall's latest quarter relative to the prior year's period.
This isn't a fluke. We're just not renting physical media the way we used to. There's a reason why Blockbuster Video followed its smaller peers by going out of business. There's a reason why Netflix (NASDAQ:NFLX) has seen its subscriber base on DVD plans shrink from a peak of roughly 20 million four years ago to just 6 million members today.
Raising prices for a product with waning demand seems like a disastrous business move, but Wall Street's eating it up. Mr. Market can be a silly, silly dude sometimes. Investors are dreaming of fatter margins without weighing the ramifications of pricing elasticity. If rentals are falling now they're going to plummet starting next week.
Lessons That Netflix Taught Us
We've seen the disconnect between stock moves and customer dissent in the video rentals niche before. We've seen it happen at Netflix twice.
The first head fake happened three years ago. Netflix announced that it would no longer be including streaming access with its unlimited disc plans at no extra cost, a move that that would be effectively raising prices as much as 60%. Wall Street applauded the move, sending the stock to hit what was then a new all-time high of $304.79 the following day. Customers were hopping mad, but the market didn't care. Wall Street started to care later in the year when the price increase scared away subscribers, sending the shares crashing.
We saw a similar scenario play out again at Netflix earlier this year. Netflix's decision to increase the monthly price of its streaming platform from $7.99 to $8.99 in May sent the stock higher. The stock took a big hit a few months later when Netflix missed its subscriber target for the third quarter, blaming the springtime hike for the weak net gains.
In other words, we shouldn't be surprised if Outerwall stock takes a hit early next year when its rental volume takes a big hit. It's going to happen, and even Outerwall is bracing for that probability. It announced on Monday that it's leaving its guidance intact, suggesting that the 25% to 50% spike in rates will be offset by a drop in volume.
It's milking a dying cow, and Wall Street is the only one that doesn't know that we're down to powdered milk.
There is no viable long-term future for Redbox. Outerwall's plan to go digital fizzled when it shut down Redbox Instant last month. It was too late to the game, lacking the foresight and gumption of Netflix that has billions -- $8.9 billion, to be exact -- in streaming content obligations.
Outerwall argues that this is just the second time in 12 years that Redbox is boosting its prices, but what it's not telling you is that the first time happened just three years ago. We're talking about a 50% pop in inflation on DVD rentals in three years. Video stores went out of business and Netflix has suffered sequential net defections in disc-based subscribers for years without making the product more expensive.
Wall Street's loving Outerwall as it grabs Redbox's udders for a few more tugs. I hope it enjoys the powder.
Rick Munarriz owns shares of Netflix. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.