This Company Is No Netflix

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

In many cases trying to take on a category leader is a foolish (small f) move. A company with a first mover advantage can be difficult if not impossible to unseat. They have brand awareness, they may have customers that feel loyal to the service, and generally they are well financed. However, you can't assume that category leaders shouldn't be challenged. After all, where would Lowe's be if they didn't take on Home Depot? Where would Amazon.com (NASDAQ: AMZN) be if they didn't take on Walmart? This is the type of showdown that is developing in the streaming market. Netflix (NASDAQ: NFLX) seemingly is the clear leader, but Coinstar (NASDAQ: OUTR) has teamed up with Verizon (NYSE: VZ) and this new entrant offers a challenge that Netflix hasn't dealt with before.

Some would have investors believe that this partnership between Coinstar and Verizon is a fool's errand. In fact, just such an opinion was offered by Rocca Pendola of The Street.com in his recent article, “Sell Coinstar It Can't Beat Netflix.” He offered some of the common concerns about a new competitor in the streaming field. He said that Netflix is the pioneer in the field, and that there is, “no use getting into the business unless you have a hook and massive core revenue to subsidize streaming. You're not going to beat Netflix.” With all due respect to Rocca, I would have trouble penning a sentence that has so many incorrect assumptions.

His comment assumes that Coinstar and Netflix don't have a hook to gain new customers. How about the over 90 million Verizon Wireless customers, and each customer of the over 35,000 Redbox kiosks? To me that represents a pretty big hook. Verizon has the opportunity to market this service to its highly profitable wireless subscriber base. Coinstar has the ability to market this to anyone who has ever used a Redbox machine. One issue is each of Redbox Instant's competitors has a specific goal behind their services, Rocca wondered aloud why Verizon would get involved with Coinstar.

Amazon uses streaming as part of Amazon Prime to try and “rope customers into its larger ecosystem.” He also mentioned Google and their YouTube site, as a way the company, “drives advertising revenue.” He knows that Netflix is the streaming pioneer and is well known, but why would Coinstar and Verizon get into this business?

Coinstar stands to offer a service where customers can stream titles from home, they can also benefit from new releases at the thousands of convenient Redbox kiosks, and these same kiosks also offer video games. By adding streaming to the mix, Coinstar offers something that neither Netflix, Amazon, or Google can match. Verizon, on the other hand, is always looking for ways to increase its income from wireless customers. I can easily see Verizon offering this streaming and physical service as an add-on to wireless bills. Since the service gets you unlimited streaming and 4 Redbox rentals per month, for a price less than Netflix, customers are getting a lot for very little. It seems this service could be a real threat, but Rocca suggests that if this fails that Redbox is toast.

I'm sorry, but nothing could be further from the truth. First, Redbox represents 85.49% of Coinstar's revenue and 82.57% of operating income. In the company's last quarter, revenue at Redbox was up 17.9% and operating income increased 21.20%. In addition, the company added 3,900 new kiosks and same-store sales were up 4.2%. In addition, the company said that a higher concentration of Blu-ray and video game rentals was one of the factors behind their strong results. Since neither Netflix nor Amazon offers video games, that rental market is Redbox's for the taking. The Blu-ray market is vast, and for $0.80 more than a regular DVD rental, customers who have a Blu-ray player can treat themselves to a high-definition version of the movie they want to watch. I would also make the argument that those who see Coinstar as just a bunch of DVD rental machines are sorely missing the company's core competency.

Coinstar has the potential to change physical retail because of the efficiency their kiosks offer. Think about it, a single Redbox machine can vend hundreds of DVDs, Blu-rays, and video games. How many retailers could use this type of technology to decrease costs by offering the same selection in a much smaller footprint? Starbucks has already seen the light, and Coinstar's Rubi concept will open “a few thousand kiosks in 2013”. The Rubi kiosk will vend Seattle's Best coffee at a competitive price and could be a new growth driver for the company. Coinstar is also testing machines that vend used electronics, gift cards, event tickets, and more. In fact, if big-box retailers like Best Buy, Target, and Walmart used Coinstar's expertise, they could cut huge sections out of their stores like CDs and DVDs by offering these items in a kiosk format. This would allow much smaller stores with the same selection as current format stores. Now for the final piece of the puzzle, Rocca says that you need, “massive revenue to subsidize streaming." 

To my knowledge, massive revenue has never been the most important factor in the success of a company. How many companies in the dot.com bust were expected to have “massive revenues” and disappeared? Maybe what investors should focus on is massive free cash flow. After all, if I have massive revenue and thin margins I still might not make much money. This is where Verizon is critically important to this venture. Verizon generated almost $2 billion in free cash flow after dividends in the last twelve months. Netflix generated $17.87 million in free cash flow during this same timeframe. Which company would you rather have backing your streaming service? 

The bottom line is it's still very early in the streaming game, and Netflix can't be assured of coming out on top. The stock is currently even more expensive than Amazon at over 240 times 2013 EPS estimates. With the company expected to grow by 21.28% in the next five years, the stock's value makes Amazon look cheap by comparison. Amazon sells for nearly 145 times 2013 EPS projections, but is expected to grow by 32.54%. If you want to take a risk on a high-flying stock, Amazon seems clearly to be the better choice.

However, if you want a real bargain, look at Coinstar. The stock sells for just over 10 times 2013 earnings estimates, and analysts expect growth of over 16.6%. The fact that Coinstar has beaten estimates in four of the last four quarters by an average of 19%, makes me believe the company could grow even faster. If the deep pocketed partnership of Coinstar and Verizon works out, this could be the cheapest Coinstar stock is for the next several years. This company is no Netflix, and that is a very good thing for investors.


MHenage owns shares of Verizon Communications. The Motley Fool recommends Amazon.com and Netflix. The Motley Fool owns shares of Amazon.com 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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