Enron & Blockbuster

The Best Deal That Never Happened

Enron & Blockbuster

The Best Deal That Never Happened

2020 was the year of many new concepts: working from home, social distancing, and wearing masks outside Halloween. Platforms like Zoom and Slack have become our impromptu offices for the time being. One industry has become ubiquitous in our daily home lives: Video on Demand (VoD). There is now a plethora of content available to consumers in 2020. The industry is becoming increasingly crowded with companies such as Netflix, Hulu, Disney+, Apple TV+, Discovery+, and Prime Video. Each seeks to monetize their own content catalogs for a monthly fee. Though subscriptions are not a must, as platforms like Twitch and Youtube can provide endless entertainment for free right to your device. What many people do not know however, is that this technology for VoD was almost rolled out over 20 years ago. If this partnership had succeeded then it truly would have been ahead of its time in delivering content to consumers on a mass scale.

“The Cambridge digital interactive TV trial… involves installing a set-top box, which looks like a smaller version of a video recorder, to the cable feed to the television set in people’s homes. Users then have access to a variety of interactive services from a control centre in Cambridge. The ‘on-demand’ services available include movies, education, games, news from ITN, documentaries and weather from Anglia TV. Subscribers can access and control these as and when they wish using a remote control.”

The first real movement for consumer VoD started in the U.S. in October of 1992. Bell Atlantic (formerly a part of AT&T) formally announced trials of their at-home video service. The trial was originally tested with 400 employees and had a catalog of 100 programs. This “electronic video-rental” system had expanded to 920 households by 1995. However, the trial was put on hold pending infrastructure expansions for fiber optic networks, practicality was not a strong suit for this new technology. It cost Bell Atlantic around $1,000 ($1,755.93) to set up each household while subscribers of the “Stargazer” service were only paying on average $10-$15 ($17.08-$25.61) a month for content alone, as there was no monthly membership fee. The technology was well liked by both the consumers and the visionaries of the company. It was understood that this was the future, but the economics for the company and the average consumer made it unrealistic for the time being. After all, many American households already had a CD player or VHS, and were happy with perusing the aisles of Blockbuster. In the 1990s and early 2000s internet speeds stymied much of the growth for this industry. Before fiber optics were widely available for information transmission, the early internet traveled through copper phone lines, as they already had an established infrastructure. Although it was theorized that these copper phone lines did not have the bandwidth to support such video, advances in compression and Asymmetric Digital Subscriber Line (simply DSL with faster download speeds and slower upload times, hence the “Asymmetric” nature) allowed VoD to be brought to a consumer’s television through the use of a specialized modem.

Across the pond, the British Telecommunications (BT) VoD trial began in spring of 1994 and by autumn had been installed in 2,500 households in the UK. Unfortunately, regulatory issues surrounding BT’s licensing slowed their entrance to the market (P.24). Around the same time in 1995 the Cambridge Interactive TV trial was taking place as well. That year 250 homes would have their “iTV” technology installed. Cost was a large factor just as in the U.S., this new technology was expensive. It was calculated that the cost of providing BT’s VoD technology would be around £1000 (£1,936.93) per customer based on a volume of 50,000–100,000 subscribers. But was the service worth the cost? At this time BT was caught in an awkward position; they knew that the ADSL system would only provide the bare minimum VoD service, but they had greater plans. BT envisioned “potential applications, apart from videos, include home shopping, educational and training material, electronic publishing, information services and video games”(P.5). All these new programs would require a more robust fiber optic network, which was not available yet. BT themselves acknowledged these networks were needed to make the program economically feasible. The ADSL VoD service was simply their placeholder for the time being, meaning Bell Atlantic and BT were unfortunately too early to the race. They made the entrance into the industry with deep pockets and resources, however they entered at a time in which the new technology was coupled with high costs and low demand. What cannot be understated was how impressive the feat was for the early to mid 1990s, as this was over 20 years before the first Youtube video and Netflix stream.

“Warburg also predicts that given 1.13 million VOD subscribers by 2000/2001, each viewing 3.5 films per month at £2.50 a throw, BT will have total revenues of £268 million (BT predicts a £500 million per annum market by the same stage). It will not enjoy positive net cash flow until 2003, by which time accumulated losses will be £476 million.”

The Deal:

In January of 2000 Jeff Skilling unveiled Enron Broadband Services (EBS). The primary goal for EBS was to control and trade the capacity for bandwidth, similar to what Enron did previously with oil and gas¹. Unfortunately for Enron many of the telecommunications companies were not interested in working with them. As they saw it, allowing Enron the ability to lease and trade on their lines would only serve to undermine their own profits². Additionally Enron’s VoD technology would cost around $500 ($755.60) per customer alone, even for the hubris of Enron this venture was gargantuan in nature. The resources, time, and competition from the likes of cable made entry into this market not just uncertain, but rather foolish; EBS entered the industry with a $500 million a year burn rate³. EBS was doing real work compared to the parent company, with engineers and coders working to make the technology more accessible, cheaper, and stable. Their M&A / Venture Capital arms were also doing leg-work to bring in companies who would help their mission along. They were even committed to laying their own fiber optic networks. However, with the dot com bust in spring of 2000, Skilling determined it was far easier and cheaper to lease existing lines from the plethora of floundering tech companies rather than lay it themselves⁴. When EBS was initiated, it was under the assumption that it was going to cap losses and generate revenue fast. Executives promised analysts that losses for the new business would be capped at $60 million for the year 2000⁵. EBS was never in the position to start generating income that quickly, therefore they needed to perform some creative accounting involving complex depreciation gymnastics and fraudulent asset sales of their “dark fiber”. Enron also had a little luck going into the third quarter of 2000, they had invested in a tech start-up called “Avici Systems” in which they realized a $150 million gain on its IPO. Remarkably, their initial investment was only $15 million⁶. Going back to April of that same year, Enron executive David Cox negotiated a 20-year agreement with Blockbuster for a VoD home service⁷, at the time, Blockbuster was in its prime. They turned some good financials for 2000 with revenue up 11.1% to ~$5 billion from 1999 due to increased overall DVD and VHS demand (P.20). Operating losses of $65.2 million were attributed to the first full year of operations for blockbuster.com (P.37).

“We are also exploring initiatives designed to integrate the capabilities of blockbuster.com with our future entertainment-on-demand services.”

For Blockbuster, the deal was too good to pass up. They already determined that VoD was too expensive and technically difficult for them at the moment, but Enron made it clear they would be doing the heavy lifting. Under the terms of the agreement, all Blockbuster needed to do was secure content for the catalog and allow use of the Blockbuster name and stores for the marketing. The job of bringing the technology to homes was Enron’s side of the bargain. They would receive $1.00 ($1.51) for every film sold and almost all the rest was given to Blockbuster⁷. Enron was desperate to make a splash and keep the stock soaring higher. The news was well publicized. Almost immediately the deal had problems. First, Blockbuster had trouble securing content as studios did not want to hand over any intellectual property to a distribution channel they did not control. Several months after the deal Blockbuster had only one studio on board⁸.

“For the first time, customers will be able to choose form a large library of movies through their TV screens and enjoy VHS-quality or better with VCR-like control (pause, rewind, stop)"

-Enron Press Release⁷

By 2001, the service was supposed to be fully introduced in four U.S. cities. Yet, problems plagued Enron too: negotiations with phone companies to use their lines for the service stretched out much longer than anticipated, or rather promised. Enron claimed they had the phone companies “in [their] pocket⁸”. Regardless, by the end of the year the service was working slightly. The original timeline planned to have the service fully introduced in four major U.S. cities by 2001⁸, in reality Enron could only test regionally with tiny phone providers as they did not yet have contracts with the major phone companies. Only 300 households were set up by year end 2000⁹, even then the service was not close to what was envisioned; the promises of a large library of content was lacking due to Blockbuster’s inability to keep up with Enron’s lightning fast rollout, and the test market reflected that. The average household only watched 1.8 films a month which was less than half of what Enron expected⁹. The revenues from the project hardly justified the costs to pursue it further. Still, executives needed a way to monetize this deal to reflect positive results. They came up with “Project Braveheart⁹”, an operation by which executives would make EBS seem more profitable through monetizing the loss-plagued Blockbuster deal. Through a series of complex and fraudulent transactions Enron ended up booking a $53 million gain for EBS through Project Braveheart which met the analysts expectations for a $60 million operating loss¹⁰. Not a single real dollar of profit was brought in from this transaction. After booking the “profits” Enron ended their 20-year contract effectively shuttering the service and its future rollout. Their press releases blamed Blockbuster’s aforementioned inability to secure content that scuttled the deal. Blockbuster allegedly informed Enron that negotiations over content would take time and that Enron’s plans were too zealous for the project within the time they had¹¹. Blockbuster also accused them of not providing quality service citing glitches and security holes which scared studio partners. After announcing the termination of the partnership Enron stock dropped to around $60 a share from previous highs of around $80.

“Through this transaction, Enron was able to record revenues of $53 million in the fourth quarter of 2000 and $58 million in the first quarter of 2001. These represented the vast majority of EBS’s reported revenues for both periods. In fact, the Blockbuster contract generated no revenue for EBS and was terminated on March 9, 2001.”

What was lost:

For the average consumer this deal would have been huge, it was ahead of its time. Enron and Blockbuster had the opportunity to revolutionize the industry for VoD some 5–10 years before other major players stepped in. The deal fell apart for many reasons: an inability for Hollywood studios to commit to content, the failure for Blockbuster to negotiate for said content, along with Enron’s troubles with telephone companies and cost commitments. This is a clear case of overpromising and under delivering, both companies made grandiose promises about their own abilities and when the time came to perform, they floundered. Now this is not to say that this deal would have saved Enron from collapse (Blockbuster, maybe), but rather if this deal worked it would have given a lightning boost for the connectivity of the internet era and jump started the VoD industry. It would have been a win for the consumer more than the companies themselves. Enron was the first mover in this space in terms of scale, but being revolutionary does not always translate to profits. Life on the cutting edge acts both ways and for the average American this deal meant the future, sooner.                                                                                                

If you enjoyed this post please consider subscribing, I promise you will not regret it.

Additional Sources:

¹ — McLean, B., & Elkind, P. (2006). The smartest guys in the room: The amazing rise and scandalous fall of Enron (p. 284). New York: Portfolio.

²— McLean, B., & Elkind, P. (2006). The smartest guys in the room: The amazing rise and scandalous fall of Enron (p. 287). New York: Portfolio.

³— McLean, B., & Elkind, P. (2006). The smartest guys in the room: The amazing rise and scandalous fall of Enron (p. 287). New York: Portfolio.

⁴ — McLean, B., & Elkind, P. (2006). The smartest guys in the room: The amazing rise and scandalous fall of Enron (p. 288). New York: Portfolio.

⁵— McLean, B., & Elkind, P. (2006). The smartest guys in the room: The amazing rise and scandalous fall of Enron (p. 289). New York: Portfolio.

⁶— McLean, B., & Elkind, P. (2006). The smartest guys in the room: The amazing rise and scandalous fall of Enron (p. 290). New York: Portfolio.

⁷ — McLean, B., & Elkind, P. (2006). The smartest guys in the room: The amazing rise and scandalous fall of Enron (p. 291). New York: Portfolio.

⁸— McLean, B., & Elkind, P. (2006). The smartest guys in the room: The amazing rise and scandalous fall of Enron (p. 292). New York: Portfolio.

⁹— McLean, B., & Elkind, P. (2006). The smartest guys in the room: The amazing rise and scandalous fall of Enron (p. 293). New York: Portfolio.

¹⁰ — McLean, B., & Elkind, P. (2006). The smartest guys in the room: The amazing rise and scandalous fall of Enron (p. 296). New York: Portfolio.

¹¹ — McLean, B., & Elkind, P. (2006). The smartest guys in the room: The amazing rise and scandalous fall of Enron (p. 297). New York: Portfolio.