A Possibly Undervalued Streaming Play?
Callum is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Coins into Dollars
Have you ever gone to a 7/11 and seen a line right behind a red box that looks like a vending machine. Have you ever had a large jar of change laying around your home, and you took that to your local supermarket to turn it into paper money. If you have, or if you have seen someone do it, you have seen Coinstar (NASDAQ: CSTR) in action. Coinstar has 2 main operations. One of them is turning coins into dollars, and taking a small (around 8%-10% depending on the location) cut. The other is its movie and videogame rental service through its Redbox system, where it makes money renting out new movies and video games. The Redbox system is a great service, as is the Coinstar coin exchange system. But is Coinstar worth your money?
Valuation and Metrics
Coinstar trades at a reasonable 9 PE (TTM) with a PEG ratio of .48 and a price to book value ratio of 2.5. This is a company projected to grow its EPS by 18% over the next 3 to 5 years. Over the past 5 years it has had an average EPS growth rate of 40.5% and an average revenue growth rate of 28% over that same time period, which is very impressive when this growth is only being priced at a PE of 9. Its gross margin over the past 4 quarters is 31.8%, with the most recent gross margin being 32.96%. It is always good to see margins grow, even if it is just a small expansion.
Competition
Who competes with Coinstar in the coin exchange sector? Only banks really, but no one else has as large and widespread of a system as Coinstar. This gives them a huge advantage, because without competition they can keep charging their 8-10% rate. Banks may be free or have lower fees, be they don't have the convince factor that Coinstar does. In my personal opinion, I would feel sort of foolish walking into a bank with a jar of coins and going up to the teller asking for cash. But at Coinstar, that feeling goes away. I feel comfortable going up and putting all my change in this machine, even if I know that it is going to take a cut.
Cummins Allison also provides coin counting services, but that is primarily for casino's and banks to count and sort money, not for everyday consumers walking through a grocery store. TD Bank also offers some coin counting services, but it charges a 6% cut for non-customers and doesn't have nearly the presence that Coinstar has. There are a few competitors here and there, but more or less Coinstar dominates this coin counting space on the everyday consumer side. Remember to take into account that this is only 14% of Coinstar's revenue.
In the other space, the "more interesting one," Coinstar competes with many different companies. Its Redbox system competes with Netflix' (NASDAQ: NFLX) DVD rental and streaming service and Comcast's (NASDAQ: CMCSA) On Demand service. It got even more intenese and competitive when Coinstar teamed up with Verizon Communications (NYSE: VZ) to offer their own streaming service, which is called Redbox Instant (which Coinstar owns 35% of). Netflix, on the day this news was announced, dropped 3.6% (but recovered a bit later in the day). Comcast is a cable company and it is far more diversified than Netflix, so Netflix is the primary competition here, but Comcast is trying to get a bigger foothold in the rapidly growing Online Entertainment Streaming space. It wants to leverage its buyout of NBC Universal to offer more content on its On Demand service. For instance during the Olympics it’s On Demand service covered every event and streamed them all live. About 75% of Comcast's customers use On Demand, which is significant when you consider that amount to about 16 million subscribers. The reason why I added Comcast as a competitor is because of that; even though those 16 million subs could also have a Netflix account or Redbox Instant, they are less likely to want to go out a buy it if they are already getting their streaming needs met.
Netflix is the biggest competitor to Coinstar's Redbox and new streaming service, because it competes in both areas. Netflix currently has 23.9 million streaming subscribers (as of Q2 2012) in the US, which Coinstar hopes to take away a few. Netflix is seeing rapid growth in the number of streaming users, but its DVD rental service is eroding away. In Netflix's Q2 2012, it saw a decline of 849,000 subscribers to its DVD rental business, which brings that total down to 9.2 million in the US. This is very, very good news for Coinstar. If less people are getting their DVD's mailed to them, then they are more likely to go use Coinstar's Redbox system. If Netflix keeps losing DVD subscribers like this, Coinstar has plenty to gain. 86% of Coinstar's revenue comes from its Redbox system, so when one of its biggest competitors starts to die off, expect good things.
Coinstar has increased its share of the DVD/Blu-ray rental service by 7% over the past year to 38.5%. To be fair, one huge headwind is that the overall DVD/Blu-ray rental service is contracting and losing share to streaming services. Some say that DVD/Blu-ray rentals will become a thing of the past due to streaming services. This is why Redbox Instant is so important to Coinstar. Amazon Prime is also a big competitor to Coinstar's upcoming Redbox Instant, so that is another headwind to consider in the already crowded streaming space. Amazon recently acquired the content of Epix, which Netflix had earlier touted as a big win for itself (then later retracted that statement saying it wasn't a big deal that Amazon had the content). It is hard to tell if Redbox Instant will be a success, but Verizon has a lot of money and power to shift around.
Final Thoughts
Coinstar has a lot of headwinds to face, such as the declining DVD/Blu-ray rental market and heavy competition in the streaming space, but trades at a cheap valuation. It has shown strong growth over the past several years, and I think that it can continue to grow at a 10%+ rate going forward, which would command a higher valuation than a PE of 9. Both EPS and PE expansion should push this stock higher. The DVD/Blu-ray rental market is contracting (and could possibly become irrelevant in a decade), but as long as Coinstar continues to eat up market share, it can more than make up for the declining market (for at least a few years) through more market share and price increases. The decline in DVD/Blu-ray rentals is something you have to keep an eye on if you own or want to own Coinstar. The Coinstar coin counting system will continue to generate cash at a decent pace.
The big wonder is how effective will Redbox Instant be (which Coinstar owns 35% of) in the already crowded market. If Coinstar can capitalize on its 38.5% market share of the DVD rental market and Verizon's size, then I become very interested. But if Redbox Instant is a flop, then I'm bearish in the long term. That remains to be seen, but for now I'm interested in Coinstar and think it is at least worth taking a look at, but I wouldn't set any money down on it yet until I see what Redbox Instant can provide.
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