Coffee and Change
Norman is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The recent introduction of the coffee kiosk by Coinstar (NASDAQ: CSTR) in partnership with Starbucks (NASDAQ: SBUX) is a good sign that Coinstar has begun to harvest some of their seeds in the New Venture segment as it seeks new avenues for revenue growth. Historically, the bulk of revenues for Coinstar has been generated by their Redbox segment. While the Redbox revenue growth has been rapid, it has been slowing down, relatively speaking. Management provided guidance of $2.25B in annual revenue for 2012 which translates to a 22% sales growth rate for 2012. This is down from historical sales growth rates of 59%, 39%, and 29% from 2009, 2010, and 2011, respectively. This suggests that Redbox is starting to achieve saturation with their automated kiosks, or as noted by the CEO, they’re within a five-minute drive of 68% of the population. This combined with the single digit revenue growth rate of the Coinstar segment may suggest that the days of heady sales growth for CSTR are coming to an end.
But that would be a premature assessment. There’s still plenty of opportunity for organic top-line sales growth. Additionally through acquisitions such as NCR, and joint ventures, Redbox also has room for non-organic growth to maintain their sales momentum and earnings growth. Redbox hasn’t made a concerted foray yet into international expansion. And there’s still more market share to capture domestically. Redbox currently owns 37.8% of the market in DVD rentals and is well positioned to capture more as the prolonged economic downturn continues. Consumers will seek more ways to stretch their dollar as discretionary income declines. Additionally, the increases in both the Coin transaction fee and the Redbox daily rental fee suggest that there’s still some pricing power that can be tapped in the future. Finally, profitability has been increasing within the Redbox segment as they improve operational efficiencies such as the implementation of a single billing system. The Coin segment, while it only comprises 15% of total sales, has gross margins of nearly 50%. And the Redbox segment has steadily improved gross margins by 150 bps year over year since 2009 to 27.4%.
From a finance perspective, Coinstar has a strong balance sheet and income statement. Their interest coverage ratio has increased from 3.0 in 2009 to 8.0 in 2011. This means that their operating income is 8x their debt service, a good indicator of financial health as they’re not at risk of defaulting on their debt. Looking at measures of solvency, the current ratio has increased from 0.77 to 1.36 from 2010 to 2011 and cash on the balance sheet has increased from $183M to $341M in the most recent 10-K or $329M in the most recent 10-Q (March 31, 2012).
There are of course some investment risks to be aware of. Most importantly, the Redbox segment is highly dependent upon its relationships with the major studios. If you consider a DVD rental at $1.20/day, a portion of the rental revenues goes to the retailer (ie. Wal-Mart, McDonalds) and a portion goes to the studio for licensing the content library. Extrapolating from their segment gross margin, roughly 73% or $0.87 of the $1.20 goes to the partner retailers and studios. This isn’t factoring in multi-day rentals, average basket size, or other more granular metrics. Continuing this rough approximation, Redbox sees roughly $0.33 of the $1.20 before SG&A, D&A, debt service, and income tax expense are taken out. In cases where Redbox can’t get the content directly from the studio like Warner, they have to source the content from other channels, such as direct retail. If this occurs, then the margins for Redbox shrink as they implement this unfavorable workaround by paying retail prices. Because of this, the studio relationships are critical to Redbox’s ability to continue margin expansion. Close attention should be paid to the content license agreements and their respective end dates in Note 18 in the most recent 10-K. The two most sound relationships that Redbox has are with Sony and Paramount, as they’ve both been granted restricted stock. But if any content licensing agreements aren’t renewed or relationships with the studios deteriorates (ie. they increase the 28-day delay to 56-days), that would be a significant red flag as Redbox would have to do more workarounds like Warner which negatively impacts segment profitability.
Similarly, just as there are studio relationships, there are retailer relationships as well with Wal-Mart (NYSE: WMT), Walgreens (NYSE: WAG), and Kroger (NYSE: KR) being the three most significant relationships per Note 13 of the most recent 10-K. Any deterioration of these relationships with the retailers will also be an investment risk.
Another investment risk to consider is the future of the DVD rental medium. As high-throughput broadband becomes more pervasive and streaming and video-on-demand technologies mature, the automated retail kiosk may soon face obsolescence as consumers look to other channels to consume their video entertainment. However, this is another reason why the diversification of the automated kiosk platform into coffee is a positive for Coinstar. Instead of having an 85/15 revenue split between Redbox and Coinstar, the coffee kiosk may allow Coinstar to have a more balanced revenue mix across its segments as the New Ventures investments begin to generate revenue and ultimately contribute to bottom line net income.
Overall, even taking the risks into consideration, the aforementioned characteristics make CSTR an attractive business for investment. It’s a company with strong cash flow from operations, solid top line sales growth, healthy margins, and should warrant further analysis to determine if it's suitable for your investment portfolio.
Norman Tang does not own shares in any of the companies mentioned in this entry. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.
