Outerwall: New Name, New Business?

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

Goodbye, Coinstar. Hello...Outerwall (NASDAQ: OUTR)?

This week Coinstar went through a name change, reflecting its diversified set of businesses. The company operates several vending businesses from Coinstar to the beloved Redbox, with its hands in a few new upstart projects.

Does this new name change reflect a new era?

New blockbusters

Outerwall's current product mix is showing some age. A potential end to the U.S. penny threatens Coinstar. Redbox is built atop DVDs and BluRays, physical media that is losing to on-demand online services like Netflix.

The company is rapidly seeking out a new product to be its cash cow. Redbox contributed $386.7 million to the company's operating profits in 2012, yet it required a cash infusion of only $1.1 million in maintenance CapEx. The aging business is spinning off tons of cash, cash Coinstar doesn't have anywhere to invest.

The company is desperately seeking the next big vending product. Let's take a look at some of the new products in the pipeline.

Rubi

This coffee vending product is the star of its new ventures portfolio. Rubi has an exclusive contract with Seattle's Best, a subsidiary of Starbucks (NASDAQ: SBUX) to sell cups of coffee with the press of a button (Read: Rubi just borrowed one of the world's best brands and locked it down for itself).

The partnership with Starbucks makes Rubi and immediate leader in the space. Where other single cup servers are known for lower quality, off-brand products, Rubi sells only the Seattle's Best name. No other vending company can use the same coffee in its machines.

Outerwall claims big potential for this one-cup coffee vender. The economics are particularly impressive, with 25 average daily vends at an average price of $1.30. Total revenue per unit came in at an average of $12,000 in 2012.

Though $12,000 doesn't compare to the $50,000 in revenue of the average Redbox in 2012, the margins in coffee are enormous. The average DVD survives for only about $30 in rental revenue at Redbox, which doesn't leave much for profits. Coffee, however, costs just pennies per cup.

Outerwall can leverage its existing Redbox locations for quick placement of its Rubi units. It placed units with Wal-Mart and Sam's Club, plus a number of well-known, high-traffic national retailers.

All in all, Outerwall believes the company is fighting for an addressable market of $800 million, and it's going for it. The company claimed 80 locations in January, with plans to invest heavily, taking the product to new markets. After bringing out a second version of the Rubi, the unit can hold twice as much coffee and vend two sizes (12oz and 16oz) to add marginal profitability. The company's big investment shows this product has huge profit potential given Outerwall's goal of 20% annual returns on invested capital for its mature businesses.

ecoATM

This may be the coolest product in Outerwall's lineup. The company recently agreed to buy the remaining 77% of ecoATM it didn't own at a valuation of $350 million.

The company turns used electronic devices into cash. Those that have little or no market value are recycled for free.

The product is genius. The company offers a convenient way to dispose of a broken or outdated phone and give its customers cash on the spot. The safety features (customers must provide an ID for scanning and supply a fingerprint to sell their phone or MP3 player) are in-line or above those of most pawn shops. A spokesperson commented that only 1% of the phones it purchases each year are stolen.

Analysts have high expectations for ecoATM, expecting operating margins in line with GameStop's (NYSE: GME) used phone business (30%+) and a market potential in the hundreds of millions of dollars. More specifically, one analyst wrote that he expects revenue to double to $200 million by 2015. That would add $.40 per share in net income per his analysis, with growth in line with the 30-40% compound annual growth at GameStop. Each ecoATM is estimated to generate $200,000 in sales each year.

The company is differentiated by being the only national brick and mortar service that pays cash for broken devices.

The market for this product is enormous. In the first quarter, global smartphone sales reached 216 million units. Meanwhile, customers are slowing their upgrade cycle, and used phones are retaining more and more of their value. One would only expect the used phone market to grow in value as phone innovation slows.

Future beyond DVDs

Outerwall's name change reflects its new future as a micro real estate company, but its valuation does not. The company trades at just 7 times TTM free cash flow, giving it a free cash flow yield of greater than 14%.

Outerwall has the potential to be the leader of automated services for years to come. I'm keeping my outperform pick on CAPS in place. Investors are letting it go too cheap, ignoring the potential in its up-and-coming products, and placing much too importance on cash cows that still have years of cash flow ahead of them.

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Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends 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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