On February 22, 2010, Wal-Mart (WMT) announced a definitive agreement to acquire privately owned VUDU, Inc., a leading provider of digital technologies and services that enable the delivery of entertainment content directly to Internet-connected high-definition televisions and Blu-ray players. VUDU was launched three years ago as a seller of ‘’set top boxes’’. This format was subsequently dropped, and it now relies on proprietary compression technology that is, or shortly will be, embedded in high-definition televisions manufactured by about five companies. Notably, though, Sony (SNE) and Panasonic (PC) do not intend to include the VUDU software in their high-end TVs. The amount of the offer, as well as VUDU’s recent financial performance, was not disclosed, since Wal-Mart indicated that the transaction would not be material to its near-term earnings. However, given previous interest in the acquisition of VUDU expressed by Amazon.com (AMZN), Best Buy (BBY), Comcast (CMCSK) and EchoStar (SATS), industry sources have speculated that the price would likely reach $100 million.

One of Wal-Mart’s key incentives for the transaction, over and above revenues derived from the prospective VUDU subsidiary, is enhanced sales of Internet-ready televisions and disc players. Entertainment is Wal-Mart’s second largest category, accounting for 13% of domestic sales in both of the last two years; 51% are derived from groceries. The company’s previous attempt to deliver movies digitally, with the help of Hewlett-Packard (HLP), floundered due to a lack of customer interest. In 2008, Wal-Mart exited that year-old business. Also, its digital music download store, launched in 2004, has badly lagged Apple’s (AAPL) iTunes and even Amazon’s MP3 offerings.

Currently, NetFlix (NFLX), with about 14 million subscribers and annual revenue running at almost $2 billion, is the largest online entertainment subscription service in the United States. Moreover, this top-line figure is  about twice the 2006 level and we expect it to increase at a double-digit rate this year and next. NetFlix’s main competitive advantages versus  Blockbuster (BBI), which is facing severe liquidity problems, and newer rivals, such as VUDU, Amazon, and Apple, is its subscription base. That is, for a monthly fee of $8.99, NetFlix customers  have access to the company’s huge inventory of DVD’s and, increasingly important, unlimited streaming of available movies and television shows. Competitive offerings are generally based on a “pay-for-play’’ format, which for the frequent user appears to be far more expensive. NetFlix’s main challenge, at present, is obtaining more content for its streaming video services. To that end, it is in the process of signing agreements with movie studios that entail a 28-day delay in the release of DVDs on the part of NetFlix in exchange for the streaming rights to the studios’ older movies.

In sum, we don’t think Wal-Mart’s prospective purchase of VUDU would  meaningfully impact either its financial results or that of NetFlix’s in the next year or so. A main caveat would be if Wal-Mart uses its financial clout to influence the decision of movie studios regarding the release of their archives or current output. At this juncture, this does not appear to be a concern. With regards to the fate of the VUDU acquisition, the initial time for completion was speculated, by the business press, to be a matter of weeks. Given that more than two months have elapsed since the announcement and the fact that Wal-Mart appeared to outbid some savvy (in the digital area) companies,  it is possible that the bid may be altered. Meanwhile, NetFlix should continue to reap the benefits of the strong upward demand for the digital downloading of movies and television programs. We also think it is well positioned to withstand competition from newer entrants into this field.