Coinstar Gets No Respect

By Chad Henage - January 31, 2012 | Tickers: CSTR, NFLX | 0 Comments

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I'm not sure why the market doesn't seem to get Coinstar (NASDAQ: CSTR). I agree with some who have said that Coinstar should change their name to Redbox since that is where the majority of the profits come from. I know that detractors would say that Redbox is all about dispensing DVDs, Blu-rays, and video games and that all of those types of media are moving to digital. My response is when? Today most of those formats are alive and well and despite the idea that they are dying off, the facts just don't show this to be the case. 

Think about it this way -- if movies and television are going digital and this is going to hurt Coinstar (aka Redbox), why are there about 20 million streaming customers for Netflix (NASDAQ: NFLX), about 1.5 million paying Hulu Plus subscribers and not more? The simple reason is while years from now these physical formats might be replaced, there are still millions and millions of households that are not set up that way. Nearly every house I've ever been in has a DVD player; only a tiny fraction of people that have a DVD player are also set up with the capability to stream content.

The death of the DVD is not coming as soon as people think. In addition it's difficult to imagine Blu-ray quality streams being consistently used given the bandwidth this would take up. Since Blu-ray disks hold a multiple of the data that DVDs do, you are talking about gigabytes to stream one movie. DVDs and physical media will decline, but not near as soon as many people are projecting.

Given this backdrop let's look at Coinstar and their closest competitor Netflix to see what we find.

The P/E for Netflix is based on the highest positive earnings projection for '12. Since Netflix is on average expected to report a loss for '12 this is being generous. Where growth projections are concerned I believe analysts are low on both companies. Clearly if Netflix is successful in winning back customers their growth rate is likely to be higher than 17.88%. I also believe that Coinstar can grow faster than 18.79%. Coinstar has beaten earnings estimates by an average of nearly 37% in the last four quarters. With slight misses on revenue taking Coinstar investors for a ride, what has been missed is this company has a history of crushing estimates.

Another factor that bodes well for Coinstar stockholders is their cash flow. The company has produced an average of $43 million in positive free cash flow in the last year. Coinstar also has the benefit of a strong balance sheet. Their debt-to-equity ratio is 0.75 so the company is not taking on too much debt to operate the business. 

One concern about Coinstar is their ability to continue to grow without saturating the market. Since there are nearly 32,000 Redbox kiosks, this might seem to be a problem. Just for point of reference, there are over 36,000 grocery stores, and over 146,000 convenience stores in the U.S. alone. Since grocery stores and convenience stores seem to be a natural fit for Redbox machines, Redbox has about 17.6% penetration. Clearly it is going to be a while before Redbox hits the saturation point even in the U.S.

Looking at all of these numbers, it appears Coinstar sells at a relatively low price, has good positive cash flow, a decent balance sheet and is only in about 18% of its addressable market. With a fair value this stock should be worth at least $70. If the company reports another positive earnings surprise in just a few days the stock might finally gain some respect after all.

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