This Leading Video Rental Business Looks Cheap

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Outerwall (NASDAQ: OUTR), formerly known as Coinstar, has delivered a good long-term gain to its shareholders in the past 10 years. Its stock price rose from around $15 per share in 2003 to more than $60 per share, marking an annualized gain of 15%. The company has a leading position in the video rental market.

Because more and more people are using streaming services these days, the video rental business is expected to shrink. Netflix (NASDAQ: NFLX) has been shifting its focus to its streaming business as well. Amazon (NASDAQ: AMZN) has also entered the streaming services with Amazon Prime. With the growing streaming service industry, should investors get in Outerwall now? Let’s find out.

The leader in the video rental business

Outerwall, incorporated in 1993, is the leader in automated retail solutions, operating in three main business segments, the Redbox business, the Coinstar business and New Ventures. Most of its revenue, around $1.9 billion, or 86.3% of the total revenue, were generated from the Redbox business while the Coinstar business produced nearly $290.8 million in sales in 2012. The Redbox business was also the largest profit contributor, with nearly $386.8 million in operating income.

Outerwall has the market leading position in the DVD rental industry, with a 50.6% market share, much higher than online/by mail provider’s market share of 25.3% and National B&M Rental Chains’ market share of only 12.8%. The company expects to gain more market share, at the expense of by mail and brick and mortar providers.

Streaming business and other new exciting ventures

What investors should be excited about is Outerwall's growing streaming service with Verizon Communications, which is known as Redbox Instant by Verizon. The recent strategic partnership with Roku and Sony will enlarge the availability of the service to millions of new streaming and gaming devices within the year.

Moreover, its new venture, EcoATM is also expected to deliver a growing top-line. EcoATM, a kiosk for used phones and tablets, could generate annual revenue of $100,000 - $120,000 per kiosk. With around 800 kiosks by the end of 2013, annual revenue could reach $80 million - $96 million. Outerwall is trading around $63 per share, with a total market cap of around $1.67 billion. The market values Outerwall at only 4.25 times its trailing EBITDA (earnings before interest, taxes, depreciation and amortization).

How about Netflix and Amazon Prime?

Netflix has seen a consistent decline in the member count of the domestic DVD rental segment. The number of total members reduced from nearly 10.1 million in the first quarter 2012 to only 7.51 million in the second quarter this year. The contribution profit fell from $146 million to $109 million during the same period.

In contrast, the domestic streaming business has experienced decent growth. The total member number in the domestic streaming segment increased from 23.41 million to 29.81 million in the past six quarters, while the contribution profit rose from $72 million to $151 million during the same period. Netflix mentioned that growing members at a faster rate than expected was mainly due to timing shifts on content deals and lower spending on content than expected. Despite the expiration of its Viacom contract, Netflix expected that viewing and retention remained strong with new shows from Cartoon Network, Disney Jr., and the HUB for kids, and New Girl from Fox.

Netflix has more streaming members than Hulu and Amazon Prime Instant Video. While Amazon Prime Instant has more than 10 million members, Hulu reported that it had around 4 million paying members. Amazon Prime and Hulu have differentiated themselves by developing their own originals and licensing some exclusive content -- Alpha House for Amazon Prime and Battleground for Hulu. According to Netflix, the content prices might keep increasing, as both Hulu and Amazon have money to spend. However, with the multi-year agreement, Netflix should not worry too much about that.

Being a global leading player in online content, Amazon has a lot of advantages in attracting new members and advertising via its huge Amazon members/users network. Looking forward, I would expect Amazon Prime could grow quite fast with its well-established distribution.

In terms of valuation, Netflix has a much higher valuation than Outerwall. It is trading at $252.80 per share, with a total market cap of more than $14.90 billion. The market values Netflix the most expensive, at as much as 83.30 times its trailing EBITDA. Amazon is the biggest company of the trio. At $297.20 per share, it is worth $135.80 billion on the market. It is valued at 45 times its trailing EBITDA. Despite the high valuation, Amazon seems to be the stock for the long run with its global leading position and sticky customer base.

My Foolish take

Outerwall seems to be a good pick for value investors at its current trading price, due to its leading position in the DVD rental market, cheap valuation and growing EcoATM business. According to Barron’s, Gabelli & Co’s analyst mentioned that Outerwall is cheap in a sum-of-all-parts analysis. Excluding the Coinstar business, which could be worth $500 million, the Redbox business is valued at around 3.6 times EBITDA, and new ventures are worth nothing at its current trading price. 

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Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends and Netflix. The Motley Fool owns shares of and 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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