On December 17th, Compass Point came out with a research note pointing to the possibility of a short squeeze in Coinstar Inc (CSTR). The purpose of this article is to review what exactly are the key tenets of the short thesis on Coinstar and to consider the merits of each given what we know today.
Short Point #1: Q3's Numbers Prove that Redbox is Doomed
Counterpoint #1: Redbox' revenue numbers for Q3 were lighter than consensus. There was a very good reason for this. Per the Prepared Remarks for the Q3 2012 Earnings Relapse: "The primary factor was 23% fewer new theatrical titles which equated to a 34% reduction in units of product going into the kiosks compared with Q3 2011."
Now if we use the Segment Supplement 2012 Q3 to look at the revenue per kiosk in Q3 12 vs. Q3 11, we see that it actually increased from $11,706 to $11,936 (divides quarterly segment revenue by number of kiosks at start of the Q). Any business that can actually generate more revenue while reducing its inventory units by 34% is anything but doomed.
Short Point #2: Redbox same store comp numbers are skewed due to the price increase put into effect in Q4 2011
Counterpoint#2: As long as price elasticity remains a viable tenet of microeconomics, it holds that price increases will always result in some degree of demand decline. The key measure is what happens to total revenue and profitability after a price increase. In the case of Redbox, a 20% price increase resulted in a single digit (5-8%) decline in rental days. As the owner of a business, this is an attractive outcome as revenue increases while the cost of delivering that revenue actually decreases (lower units = lower COGS), resulting in significantly improved overall profitability.
Short Point #3: Redbox same store comp numbers are skewed due to dual kiosk installations
Counterpoint #3: Dual kiosk installations at a single retail location are simply a reflection of demand strong enough to warrant additional inventory stocking at that location. This is akin to increasing shelf space or floor space at a traditional retailer. If Lululemon (LULU) increased the size of a store to accommodate more inventory due to strong demand, would anyone argue that this is not a true reflection of increased same store sales? To spin this as a negative truly stretches the credibility of the short argument
Short Point #4: Coinstar will get in trouble when demand eventually starts to decline for its core Redbox offering
Counterpoint #4: This is probably the one point that gives the most comfort to short sellers- that if they simply wait long enough, eventually they will be right. But it is not that simple. Traditional retail companies have long-term lease obligations and a significant amount of labor attached to each store location. As such, when demand declines and their revenues decrease, they do get in trouble and start losing money. This is not the case for Redbox which has neither impediment (long-term lease obligations or high fixed labor costs per location). The highly flexible, highly variable cost nature of the Redbox business model means that it can remain remarkably profitable throughout the entire demand decline cycle.
This is a key point that is missed in the short thesis and is worth repeating. Coinstar's Redbox segment will continue to make a lot of money throughout the demand decline by managing (decreasing) the number of kiosks in operation as well as the amount of disc-inventory that is purchased for each kiosk.
In conclusion, the short thesis on Coinstar consists of a handful of lazy and tired arguments that are not being proven out by the quarterly numbers. There were 11.7 million shares sold short as of the most recent report, representing around 39% of available float. This, combined with an aggressive company share repurchase program and the prospect for a blow-out Q4, presents a significant risk of a short squeeze in CSTR going into the historically strong Q1 period.
Disclosure: I am long CSTR.
Additional disclosure: I am long options on CSTR