Can Rubi Save Coinstar?

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Coinstar (NASDAQ: OUTR) remains one of the most heavily shorted stocks on the Nasdaq, owing to the belief held by many bears that the company’s Redbox subsidiary is doomed. But recently, in association with Starbucks (NASDAQ: SBUX), the company has started rolling out coffee dispensing machines known as Rubi. Can these machines save Coinstar?

Wait, does Coinstar even need saving?

The title of this piece makes an assumption: the company is in danger and in need of being saved. I freely admit that could be a faulty assumption, but it’s one many market participants have made.

Currently, over half of Coinstar’s shares have been sold short. The short interest is so high that investors might actually consider going long the stock in the hopes that any positive news could trigger a violent short squeeze.

The bear case against the company is as follows: Coinstar is heavily reliant on its subsidiary Redbox -- a system of vending machines that offer DVD rentals. As consumers increasingly switch from physical discs to digital streaming, the need for Redbox’s kiosks will vanish.

As Redbox makes for most of Coinstar’s business -- and virtually all of its growth -- technological changes could doom Coinstar.

That said, perhaps the bears are getting ahead of themselves. On the company’s last earnings call, its CFO remarked that the physical rental business is still “sitting around $5.5 billion, and is expected to grow to $6 billion over the next couple of years.”

Coinstar’s competition in the space is literally vanishing. Dish Network announced in January that it was closing another 300 Blockbuster stores, meaning that there are just 500 left in the entire country.

Digital rentals may be fine for some, but for many consumers -- those who lack cable and those without Internet-connected TVs -- disc rentals remain the preferred method for watching movies, and could for many years.

Coinstar doesn’t see itself as just Redbox

But although Redbox is such a big part of Coinstar, the company doesn't see itself exclusively as Redbox. Rather, Coinstar views itself as a leader in “automated retail.”

“I believe Coinstar will continue to lead in this growing space,” remarked Coinstar’s CEO Paul Davis on the company’s earnings call. “Consumers love it because it makes their lives easier and they’re in control. Retailers love it because it increases traffic and revenue and helps them stay competitive, and shareholders love it because it’s an enduring business that has ongoing growth potential.”

Coinstar appears to understand the bear case, and is taking steps to address it, rolling out automated coffee machines known as Rubi.

“The primary focus in 2013 will be on the Rubi business,” Davis stated. “This business continues to be a major area of focus, given its growth potential and we plan to begin the rollout in [the second quarter].”

Can Coinstar repeat its Redbox success with Rubi?

But will Rubi be successful? While consumers have flocked to Coinstar’s Redbox, perhaps they won’t take as kindly to its Rubi coffee machines.

Evidently, Starbucks doesn't see it as much of a threat. The coffee giant is partnering with Coinstar on the venture, as Rubi machines will sell “Seattle’s Best Coffee” -- a division of Starbucks.

Of course, Starbucks has a history of partnering with coffee-upstarts. Starbucks has been one of Green Mountain Coffee Roaster’s biggest partners, even though the Keurig machine might be thought of as a potential competitor. In May 2011, Starbucks inked a deal with Green Mountain to sell Starbucks Coffee and Tazo tea K-cups. If Starbucks had viewed the Keurig as a challenger to its cafes, it likely wouldn't have signed such a deal.

However, the Keurig seems to occupy a different market niche altogether: people making coffee at home or office workers who can't afford to make a Starbucks run. The Rubi machine would be somewhat in-between, as no consumer and few offices would have one.

Perhaps Starbucks is using its deal with Coinstar to test the waters. Just over a year after it agreed to terms with Green Mountain, Starbucks began making its own single-serve machine, the Verismo. Green Mountain bears have argued that competition from the Verismo could contribute to Green Mountain's undoing. Likewise, if the Rubi is successful, could Starbucks enter the market as a competitor?

Further, coffee vending machines are not new -- I walked by one every day on my college campus years ago. Readers may have seen them in the lobbies of hospitals or airports. Global Vending Machine Group lists nearly a dozen different models.

No single company has managed to make a solid business out of coffee vending, even though it has been tried. Those who argue in favor of Rubi must have faith that Coinstar’s vending know-how will allow it to succeed where others have failed.

Rubi isn’t Coinstar’s only hope

Although Coinstar is focusing its efforts on rolling out Rubi, the company has other concepts waiting in the wings: Orango will let consumers purchase refurbished electronics, such as tablets and video game consoles, from a vending machine.

Is there a market for such a machine? If Coinstar decides to push Orango, it would find itself competing with GameStop (NYSE: GME).

GameStop, perhaps realizing that its own business is threatened by technological shifts, has begun buying old electronics, refurbishing them and then selling them. On the company’s November earnings call, GameStop’s president noted that, in the stores where the refurbished electronics business has been emphasized, sales have “lifted 7%.” Evidently, that’s good enough, as the company intends to expand the initiative to other stores.

Buy or sell Coinstar?

Because of its high short interest, Coinstar could be an attractive buy in the short run. But in the longer term, things are a bit more complicated.

Someone looking to hold Coinstar shares for a long period of time should be confident that either: the company’s bears are wrong, and Redbox will not be going anywhere anytime soon; or that the company is not just Redbox, but a play on the growing trend of vending machine retail.

Both Coinstar bulls and bears should watch the company’s Rubi rollout. Success or failure in the venture could determine the company’s longer-term viability.

Joe Kurtz has no position in any stocks mentioned. The Motley Fool recommends Green Mountain Coffee Roasters and Starbucks. The Motley Fool owns shares of GameStop and Starbucks. 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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