One of the Best Values in the Market

By Chad Henage - November 11, 2012 | Tickers: AMZN, CSTR, NFLX, VZ | 0 Comments

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Forget what you think you know because it's all wrong. That's what I want to scream at investors who are shorting Coinstar (NASDAQ: CSTR). The company has consistently garnered attention from short-sellers, and for a while was proving them all wrong. However, in the company's recent quarter, long-term investors lost their heads and sold though results were still very good. While there were some short-term challenges, the company is still growing by leaps and bounds, and as much as the death of physical DVDs has been talked about, it isn't imminent by any means. Let me walk you through Coinstar's earnings report and show you why I think this could be one of the best values in the market.

Coinstar Earnings – No Question the Olympics Hurt Results:

Coinstar operates Redbox and the namesake Coinstar machines. However, the company is constantly looking for ways to expand, and some of its new ventures could be serious profit contributors in the future. In a quarter where the Olympics disrupted virtually every other entertainment company except NBC, Redbox still turned in very good growth. The company's total revenues increased 15.5%. While reported EPS was down 3.39%, $0.16 of this was due to the negative impact of converting the old Blockbuster Express kiosks over to Coinstar. Without this item, earnings would have increased.

Redbox is Still The Growth Driver:

Redbox represents 85.49% of Coinstar's revenue and 82.57% of operating income. This division reported revenue up 17.9% and income increased 21.20%. The company added 3,900 new kiosks, grew same-store sales by 4.2%, and net revenue per rental increased 15.1%. Coinstar also pointed out that industry research by Screen Digest, “expects physical rental revenue to grow to $6 billion by 2016.” In addition, the company said that a driver of their higher revenue per rental was a higher concentration of Blu-ray rentals and video games. The Redbox division faces multiple online viewing competitors such as Netflix (NASDAQ: NFLX) and Amazon.com (NASDAQ: AMZN). Netflix and Amazon both offer unlimited streaming video for $7.99 and $6.58 per month respectively, but they can't compete with the new releases Redbox has available.

This is a key differentiator for Redbox, and customers know that they can get hit movies from Redbox before they can watch them on either Netflix or Amazon Prime if at all. While it's true that customers could choose to rent a movie from iTunes, Vudu, or even On-Demand, usually these options have much higher price points than the $1.20 that Redbox charges for a DVD or $2 or so for a Blu-ray. With over 35,000 kiosks installed, Redbox is convenient to most customers, and as the network grows this will be even more true. Customers also can browse the selection of local Redbox machines from home on the Redbox web site, and even reserve their movie or game to pick up from the machine of their choice. The bottom line is, the majority of Coinstar is driven by Redbox, the service is growing, seeing excellent same-store sales trends, and this service is soon to expand into Netflix and Amazon's territory.

Redbox Instant by Verizon:

Redbox Instant by Verizon (NYSE: VZ) is the joint venture between Coinstar and Verizon to offer a streaming video option to compliment the Redbox kiosk operation. The venture is 55% owned by Verizon and that's a good thing because Verizon has the cash flow to fund it. Unlike Netflix which loses money every time they enter a new international territory, Verizon generates a ridiculous amount of cash flow. In just the last three months, Verizon produced over $5.6 billion in free cash flow. This deep pocketed partner is why Netflix and Amazon both should be very worried about Redbox Instant. In addition, unlike Netflix and Amazon, Redbox Instant is acquiring content on a per-subscriber basis. This allows the venture to more closely match content acquisition with subscribers, and also limits the amount of expenditures up front. Once this service is up and running it will offer something that no competitor can match. Customers will be able to stream shows from their Internet connected devices, and if they want more current content, they can find it at their local Redbox.

Coinstar and Other Ventures:

While the company's namesake service isn't a growth driver, it still generates positive free cash flow. Coinstar sales were up just 2.8%, and operating income increased 0.13%. The most significant new venture for the company is their Rubi coffee kiosks that offer Starbucks Seattle's Best coffee. The company has seen a slower rollout because of not wanting to disrupt its retailer's business with the upcoming holiday season. That being said, the company expects “a few thousand” kiosks in 2013.

The Company's Financials are Impressive:

With Redbox driving growth, the company's operating cash flow increased 30.85% year-over-year. Free cash flow was up an even more impressive 42.19%. While Coinstar does not pay a dividend, management did repurchase 1.16 million shares at an average price of $51.07. With shares trading for about $46.50 today, investors have a chance to buy at prices below what management just paid.

Conclusion:

When you boil it all down, Coinstar looks very good, but there is a huge kicker. The stock is ridiculously cheap. Based on analysts estimates for 2013, shares trade for about 9 times earnings. However, those same analysts are expecting better than 17% EPS growth in the next few years. While I might be skeptical of these projections, Coinstar has beaten earnings each of the last four quarters by an average of 19%. By comparison, both Netflix and Amazon sell for at least 130 times next year's projected earnings. Though both companies are growing faster than Coinstar, I don't believe their higher growth rates warrant a valuation that is at least 1,300% higher. A cheap stock that is growing fast should attract a lot of attention. The fact that the company is expanding its offerings beyond standard DVDs should allay worries about the demise of the format. Short-sellers are going to be proven wrong on this one, and the recent drop in the stock gives long-term investors a great chance to acquire shares at a price they won't be at for long.

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