Those buying into the melting ice cube myth about Coinstar Inc (CSTR) may have gotten the cold shoulder at the Wedbush Securities California Dreamin' Consumer Conference on December 12, 2012. Wedbush analyst Michael Pachter said that he may agree eventually with the shorts that CSTR is a melting ice cube, it's just that "the ice cube is located at the point of the North Pole. So it's going to take a long time for the ice cube to melt."
It was the comments out of Coinstar's CFO Scott Di Valerio, however, that really may have left the skeptics in the cold. Di Valerio's remarks in their entirety can be accessed here, but there were a few take-aways that I believe are particularly noteworthy for market participants to fully understand:
Content Cost is Per Subscriber, Not Upfront
The most relevant insight is that the newly detailed Redbox Instant joint venture between Verizon and Coinstar is structured so that the JV only pays for content on a per subscriber basis without any large upfront fees. This is a very big deal as it eliminates much of the risk to Redbox Instant and results in positive gross margin to the JV from the very first subscriber.
Just to highlight how important this is, let's look at how Netflix (NFLX) has structured its digital content deals to date. They have typically agreed to large upfront payments for content regardless of the number of Netflix subscribers. This is a strategy that can work out if Netflix is able to grow their subscriber base quickly during the content license period but is risky if this does not occur. The structure of the Redbox Instant JV is much more flexible and less risky, and is a testament to the deal-making abilities of those involved. It probably also doesn't hurt that the JV had the leverage of two partners (Coinstar and Verizon) which together already spend significant sums buying content in different forms from the studios and content providers.
The poor fellow (possible short?) at the conference asking the question was so surprised that Redbox Instant was able to structure such an attractive deal that he asked Di Valerio three different times and got a consistent and clear answer from the CFO each time.
Cash Flow Stabilization
The second key insight is that the JV will pay Redbox/Coinstar a fee each month per subscriber regardless of whether or not that subscriber takes advantage of their 4 nights at the kiosk. So even if the subscriber doesn't use any nights at the kiosk, Coinstar still gets paid for these, implying a 100% margin to Coinstar for these unused nights. This has the beneficial effect of stabilizing Coinstar's revenue and cash flows that in the past (Q3 2012 for example) have been somewhat variable depending on what the movie release slate is during any given quarter.
Reduced obsolescence risk and more stable cash flows via the Redbox Instant JV should translate into some degree of multiple expansion for Coinstar which currently trades at a P/E of around 10. If the P/E expands to just 14 times Bloomberg expected 2013 EPS of $5.19, this would imply a stock price for Coinstar of $72.66. This would result in a 40% return based on December 12, 2012's closing price of $51.96.
Disclosure: I am long CSTR.
Additional disclosure: I am long CSTR options.