Searching For a Happy Ending

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

Americans love a good movie and continue to spend a considerable amount of their disposable income on filmed entertainment.  Consulting firm Price Waterhouse Coopers estimates that the overall media industry will grow at a 4.6% rate over the next few years, reaching $555 billion in sales in 2015.  While technology has changed the industry’s delivery methods, people are still hitting the theatres in droves.  Research firm IMBb estimates that the domestic box office has generated $10.5 billion in gross receipts in 2012, a 3% increase over the previous year.

Saying goodbye to the video store

The effects of technology have made the biggest change in the at-home market, as the retail video store chains have gone bankrupt or curtailed their operations.  The convenience and speed of pay-per-view cable, DVD-by-mail, and online offerings challenged the status quo, leading to massive market share losses for the former heavyweights, including Blockbuster and Hollywood Video. 

The industry is now led by Netflix (NASDAQ: NFLX) and CoinStar (NASDAQ: OUTR) in the physical DVD space, with additional competition from Amazon (NASDAQ: AMZN) and DISH Network (NASDAQ: DISH) in the streaming arena.

Who’s going to win?

Netflix is the world’s largest internet subscription service offering DVD-by-mail and streaming services to over 30 million members in the U.S. and select international markets.  Its streaming service can be delivered to 800 different devices, including PCs, game consoles, TVs, and internet video players.  In FY2012, the company’s revenues have risen 14.4% as it has continued its global expansion into the Nordic countries and the U.K.  Operating margins have fallen sharply, though, due to rising content and marketing expenses.  Netflix is following the script from its U.S. experience, hoping that initial losses from acquiring mass scale will translate into large future profits.

Amazon has grown from an online bookseller into the largest e-commerce marketplace by offering millions of products through its namesake website.  It has used its size and scale to pursue related opportunities in the IT services, fulfillment, and video streaming areas.  Through Amazon’s Instant Video service, customers have access to a library of almost 145,000 titles and the company has also entered the production business with pilots for 6 original comedy series.  In FY2012, revenues have increased 30.0% company-wide, but operating profits have declined as Amazon continues to invest heavily across its business lines.

DISH Network has had an enviable position as one of the two large satellite TV providers, with a current subscriber base of 14.0 million customers.  However, growth in its core business has leveled off and fights with its content providers have intensified recently.  In FY2012, revenues have been flat versus the prior year period, while operating income has fallen due to a large legal settlement and rising subscriber costs.  DISH bought Blockbuster out of bankruptcy in 2011 to diversify its offerings in the video distribution segment.  The company currently offers 100,000 titles through its @Home DVD-by-mail service and 10,000 titles through its On Demand streaming service.

Looking for respect

The most interesting player could be CoinStar, the owner of 42,400 RedBox kiosks in 34,600 locations throughout the U.S. and Canada.  Its machine’s ease of use and in-store placement at most of the major mass merchandisers eliminated the need for a separate trip to the video store.  While revenues are shared on both the front-end with the retailers and on the back-end with the content providers, margins are solid since the kiosks are fully automated and require minimal maintenance. 

In its latest fiscal year, CoinStar’s RedBox segment reported revenues and operating income of $1.6 billion and $169.5 million, increases of 34.7% and 74.0%, respectively, versus the prior year.  Operating margins reached a record high as comparable sales rose 18.3% and the addition of video game rentals led to higher average transaction prices.  Despite competition from video steaming providers, the number of customer transactions at the kiosks gained 28.0% to reach 684.0 million for the period.

In the first nine months of FY2012, CoinStar’s RedBox business has continued to exhibit strong growth, with increases in revenues and operating income of 27.3% and 60.6%, respectively, compared to the prior year period.  The company benefited from a higher number of kiosks in use, primarily due to its purchase of NCR’s business, as well as a 16.0% jump in comparable sales. 

Despite the good results, management knows that customers will eventually gravitate toward streaming and online services, which will negatively impact the RedBox business.  Fortunately, they found a strong partner in Verizon and their joint venture, known as RedBox Instant by Verizon, will launch in the first quarter of 2013 with an $8 monthly subscription price for unlimited streaming of movies.  Of course, CoinStar also has a solidly profitable, but declining coin counting segment that is supporting its investments in new product development.  With a stock price valued at a 10 P/E multiple at recent prices and a proactive management team, the company is a “star” worth betting on.

rghanley owns shares of CoinStar and Amazon. The Motley Fool owns shares of and Netflix. Motley Fool newsletter services recommend 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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