Can Coinstar Weather the Shorts?

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

Specialty retailer Coinstar (NASDAQ: OUTR) is one the most widely shorted stocks in the equity exchanges. The company with the Redbox and Coin kiosks has seen roughly 43% of its float being sold short. Numerous investors have stated that the shift towards digital media consumption will hurt the company's business model badly. However, the company has a lot going for it, and its fundamentals are still well in place, which increases the likelihood of a short squeeze in the near-term. 

Decent profits and cash flow

In 1Q13, the revenues of automated retailer Coinstar stood at $575 million, and the company generated net income of $22.6 million. The company’s operating cash flow stood at $41 million. The company’s cash position stood at $507 million, and had debt outstanding of $647 million at the end of 1Q13.  

Coinstar repurchased shares worth $47 million and has $342 million remaining in authorized limits to repurchase additional shares. The company’s management pointed to a target range of repurchasing $100 million shares on an annual basis. As the company’s total market cap is roughly $1.6 billion the share repurchase program should be beneficial for shareholders. 

Redbox controls almost half the DVD rental market

Revenues from Redbox grew only 1% on a Y/Y basis, and stood at $507.9 million; the number of rentals stood at 198 million. Net revenue per rental stood at $2.56, which was slightly lower than expectations due to a stronger mix of one-day rentals, which leads to lower revenue for Redbox.

Redbox had an operating margin of 18.1%, which represents a decline from the 1Q12 operating margin of 21.6%. Redbox’s operating margin saw a notable decline mainly due to higher content acquisition costs and a lower quantity of releases in the box office.

Same-store-sales for the Redbox segment were down 11.8%, as certain regions of the company saw more installations of kiosks, which led to cannibalization. According to data from NPD Video Watch, Redbox now controls 48% of the physical DVD market, as consumers shift their focus to online entertainment viewing along with large closures of brick and mortar stores. 

Partnerships in coin

The company's coin business hasn't seen much growth with flat revenues in Q1 2013. The average size per transaction grew to $39.22, but the number of transactions declined by 2%. The operating margin stood at 28.5%, on operating income of $18.6 million. 

The coin segment saw net new installations of roughly 400 new kiosks in the first quarter of 2013. The segment got into an agreement with a rival firm, TD Canada Trust to install 350 TDCT branded kiosks for coin-counting purposes, and those installations were completed at the beginning of Q2 2013.

The coin-counting segment struck a deal with PayPal that will give more flexibility to Coinstar users. Customers can access their funds through Paypal, which enables the customer to have more options by providing an e-payment alternative in 1,800 kiosks as of 1Q13 and PayPal will contribute to market this initiative. 

Newer revenue outlets

The company is planning to introduce loyalty programs for its high frequency customers, defined as consumers who make four or more visits in a quarter. These high frequency customers make up roughly 25% of Redbox’s customer mix, but contribute 60% of total revenue for the segment.

Blu-ray discs now make up 14.2% of Redbox’s total revenue. In the future, Blu-ray will be a core part of Redbox’s growth strategy as the number of households with Blu-ray compatible devices increased to 51 million households in 2012, according to DEG. The company's video game rental volumes surged 16% on a Y/Y basis in 1Q13 and made up 5.1% of total revenues. 

Coinstar's management is implementing procedures to enhance the capacity of each kiosk by increasing the number of slots in place by more than 80 discs in the kiosk. This will enable the company to leave the discs in the kiosks for a longer time-frame, and without increasing the product costs; this might drive revenue per kiosk. 

The company is expecting its Rubi coffee business to be a key driver for the company’s revenues. And the team is planning a sizable expansion for this coffee-vending business from 100 kiosks in six markets to more than 1,000-2,000 kiosks in 15 markets, primarily through the grocery channel.

Video streaming

The company's CEO recently stated in a media event that the company is very excited about the company's partnership with Verizon (NYSE: VZ) for the Redbox Instant business. And it will be serving up entertainment through online video streaming as well as four DVD credits from various Redbox kiosk outlets.

Coinstar is clearly trying to slowly transition its user base of DVD enthusiasts to over-the-top streaming just like Netflix (NASDAQ: NFLX) did. Video streaming giant Netflix has been slowly transitioning its DVD-by-mail customers to the online streaming outlet. As a result, Netflix now has more than 36 million global subscribers for its streaming business, and roughly 8 million DVD consumers in the U.S.

However, Redbox's value proposition is a little different, it enables users to watch movies barely 30 days old for a few dollars only. And its streaming business is largely geared towards movies, which differs from Netflix, Amazon and Hulu, all of which are leaning more towards serialized TV Shows. Coinstar made an additional capital contribution of $14 million in Q1 to the JV with Verizon, and its share of losses from the start-up amounted to $6.4 million from its 35% ownership and the other 65% is owned by Verizon.

Ripe for a short squeeze

For 2013, the company is expecting Y/Y growth of 9%-17% for the top-line to end at $2.39-$2.55 billion. Coinstar laid out projected investments of $180-$205 million to its businesses and hopes to earn free cash flow of $185-$205 million.

While the Physical DVD market is getting smaller, the decline came down to single digits in the last quarter. Redbox has largely been a beneficiary of the closures in local DVD stores, as well as Blockbuster stores. The company has sales growth, is generating decent amounts of free cash flow, and is expanding with new kiosks in Canada.

The company's value proposition is simply enabling consumers to watch new release content from Redbox. Coinstar's recent strategic partnerships with TD Bank and PayPal represent great positives for the company as well. If the company meets its near-term expectations, which it will likely accomplish, the stock is ripe for a short squeeze. 

 

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Ishfaque Faruk has no position in any stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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