This is my first attempt at posting an article on Seeking Alpha. I am doing so for three reasons. The first is I have already benefited a great deal from this community and wanted to give back some effort. The second is Chris Katje's Seeking Alpha article (linked above and from which I took the initial quote for this piece) in March and how it really got my mind going on this company. Finally, I expect and want a discussion with the community to help me think better about Coinstar (CSTR) as a holistic situation over time not just as a month by month or quarter by quarter play.
Up front, I am a fairly recent direct long in Coinstar. I am also long Microsoft (NASDAQ:MSFT) ,Verizon (NYSE:VZ), Netflix (NASDAQ:NFLX), Wal-Mart (NYSE:WMT), Amazon (NASDAQ:AMZN) etc. as well through mutual funds and ETFs etc. I am not long any of those as a direct trade at this moment. As a general rule, I am not short much right now although I have played that side with success in the past. Right now, I do keep a decent percentage in dry powder in case the whole world melts down.
Having said the above, we all know the fundamental aspects pertaining to Coinstar and there are several extremely well written articles here on Seeking Alpha that explain those fundamentals in detail both from a positive and negative perspective. I will recap some highlights of that positive analysis as provided by my friend Gunnar Peterson (via an email exchange) and a few others but the more interesting part to me are the trends and futures beyond the current situation. Extending and having vision for the new paradigm in the current "Techno-Industrial Revolution" is something I do pretty well and I think, from what I have researched, Coinstar's management has that vision (see this article for an interesting take on Rubi and the various kiosks that they are testing from 2012) and is making the right moves to give them a great chance to rapidly succeed going forward.
Two quotes, again dug up by Gunnar, summarize my view on the market, the world in general, and all of the so-called experts in both:
Incompetence is the disease of the novice, overconfidence is the disease of the expert. Incompetence irritates me, overconfidence terrifies me. -- Malcolm Gladwell
I would much rather work with a guy with a 130 IQ who thinks he is a 120 than a guy with a 160 IQ who thinks he is a 170. That second guy will kill you. -- Warren Buffett
Coinstar's Basic Fundamentals by the Numbers:
From my friend Gunnar via email:
- On the metrics the stock is stupid cheap
- 44% of the DVD market* 13% operating margins
- the DVD market is projected to grow (albeit slowly) instead Coinstar is priced as if its dying
- partnership with Verizon so you can watch instantly
- 42,400 kiosks nationwide
- Gunnar's favorite stat: it costs Coinstar $15k to stand up a new Redbox kiosk which holds 600 discs. Each kiosk averages 19,000 rentals/year which generates $49k in revenue
For a slightly older set of numbers (although maybe just barely a bit too optimistic on the earnings side for 2012) and some interesting commentary on why the model was and I still think is being underestimated (see Bill Wolf's 2012 Seeking Alpha Article here).
OK, so we knew all of the above and on the technical side we know that there is an inordinate amount of the stock short and so that pressure coupled with a positive trend that can be explosive at times can make this company's stock extremely volatile either way. When I first read how much was short, I thought it was a misprint. After realizing it was not, I then begin to wonder if someone saw something I did not or if this was an ADR that had been pumped so far above valuation that it made it an almost automatic short. My research and the numbers above provided by Gunnar prove that was not and is not the case so I dug deeper.
On a personal and subjective experience level, I rent from Redbox religiously. I do so because it is easy. The number of kiosks has increased drastically over the last year and every time I go, I see people in line renting from Redbox or people walk up and stand in line behind me to rent. I also thought back to the first time I noticed the red kiosks and realized it was at a large mall. I think initially Redbox had not appealed to me because who wants to go to a mall to rent a movie. It's a mindset issue. I also remember back to the first time it appealed to me directly and I actually rented. It was the first time I saw it in a Wal-Mart. In fact, it stuck out to me that they had one at each entrance and that you could return DVDs to either box or to a box at a CVS or Kangaroo gas station or wherever and it did not matter.
So all of that is kind of boring but what is not boring is the ease of use of something that mixes the physical and virtual worlds going forward. For instance, Redbox instant does just that and gives me options to do either/or which appeals to mine and many others desire to sometimes hold something in our hand (especially when the movie gets to us much quicker that way or I happen to walk out of Wal-Mart and see a kiosk) and to sometimes order it online (if I am lazy and not leaving the house one day). A brick and mortar true hybrid is the nirvana for many companies and yet either way most companies go they seem to miss one to get the other because scalability kills you one way and the lack of touch kills you the other.
So enter kiosks. The coin counter thing interested me but I seldom used them while others evidently used them a great deal. I am stingy that way I guess and would have rather rolled my own money at that point than pay the fee. I blame my dad for that since I spent my formative years rolling pennies as my payment in labor for going on vacation. The interesting part is if I had done the math of cost versus time, it was a no-brainer to use their machines and I think that now carries over into the next-gen hybrid cloud/brick and mortar kiosk model they are pursuing. More importantly, I think, Coinstar cut their teeth in this model with a very low chance of loss associated with the machines they put out while at the same time becoming experts at what works and what does not work as far as kiosks go. They solidified and distilled this knowledge and expertise, put the right infrastructure in place to maintain their capabilities, and squared up some very interesting and underused space in places like Wal-Mart, Walgreen (WAG), Publix, Circle K (CLKFS), Kroger (NYSE:KR), Piggly Wiggly, SafeWay (NYSE:SWY), Dollar General (NYSE:DG), CVS (NYSE:CVS), Kangaroo (NASDAQ:PTRY), etc. (to name just a few) giving a double benefit of driving revenue and foot traffic to their alliance partners while also securing the resources they needed to troubleshoot on the ground aspects of their roll-out. Coinstar then slowly branched out to more complicated aspects melding online with the physical (holding a DVD/Blu-Ray at a kiosk, requesting a rental, direct marketing to their base for add-ons, etc.) and now they are diversifying in more ways than even people that are long the stock may realize.
But why does this mixed model appeal to so many people? It's a societal shift. For instance, I like people most of the time. Well, OK, I like some people most of the time... er ... o never mind!
All jokes aside, what I realized is that if I can get away with not talking to a sales person and still get my hands on what I need, I will do so. Period. Why is that? Take Books-A-Million for example, every time the people in my local store ring a book up they pitch me an add-on product. Do I get why they do that? Absolutely. Do I like it? No. Not in the least. At the same time, often both at Books-A-Million and many other retail stores, the expertise that set sales people apart in the past seems to be sorely lacking at times. It actually seems to me to complicate my transaction just like the older model of car sales does at this point. It's annoying and annoyed consumers simply do not buy nearly as much as content consumers.
Does that means the extra offers that Redbox throws at me when I go to check out annoy me? No, they actually do not. I simply click no if I am uninterested and don't have to interact with someone who clearly has no idea what my desires are anyway and is simply going down a checklist to "strive for five". At times I even click yes because maybe they made an offer that was truly worth my time or that somehow appealed to this generations compulsion to click anything and everything. Often though, I find the offers are on target and on point if fairly basic and rudimentary in current state.
Simply put, most of this again comes down to a question of the balance between usefulness and efficiency. Clearly many of the standard brick and mortar companies fail that very simple and yet very important test. Going forward, I think the "efficient/useful living test" will rapidly become more and more important as society progresses because it will be even more difficult to keep up than it is now. The interesting thing is that Netflix passes one aspect of the test but seems to lack, at times, in the other. For instance, since I am already paying for their service I would tend to bristle at ads that pop up when I go to stream the service. Coinstar would face the same issue but they have two avenues to pursue it in the entertainment section of their business, much less in the other segments. Netflix has to grow users pretty much period. Coinstar can raise the revenue captured from individual customers (actually scaling better with a smaller base) by making it attractive to add-on other things in a model with which we are all familiar.
Some will say "just do everything online". Stream, buy, interact, etc. and while we can try to do that, our society has simply not and may never be able to achieve that type of model. I am not even sure, even if we could, it is actually healthy for us to achieve it. In fact, we want to touch things and interact when we want to be extroverted and we want to not touch and not interact when the mood strikes us to be more introverted. We want choices. We seek a hybrid model in just about everything we do that lets us decide the path. Seldom do we enjoy being herded down one path or the other as Netflix can confirm based on their original mailer/streaming customer challenges. Let the customer choose within your product line or I guarantee you they will instead choose within someone else's.
Even Amazon, who I order a lot of stuff through, is lacking a scalable brick and mortar touch solution for what they do right now. Google is trying to pilot stuff like that again in San Francisco with their BufferBox acquisition but virtual at some point requires much more extensive physical presence and physical is not cheap to build and staff in the traditional way. Kiosks, on the other hand, solve a number of challenges all at once and do so in a way that gives the customer avenues to pick his/her own path. Again, in my opinion, sometimes consumers just want the instant gratification of touching the product or in the case of movies, maybe they do not want to wait the few weeks before it will be available to stream. Beyond that, consumers also may want to rent games at kiosks because they might like it or hate it and in this world (unless you buy used) once it's opened you own it. In all of these situations, the one thing that holds is consumers want that choice.
So beyond the coffee kiosks (which is a stellar idea because it works well and they are partnered extremely well), and besides the used electronics (which is an extremely high margin business), and besides the kiosks selling tickets at the cut-throat admin fee of $1 (while also capitalizing on the local add-on potential) versus Ticketmaster etc...what else is there?
In the end, everything is local and about choice and a strong business is made by creating moats either through technology, execution, brand, partnerships or some combination of those four. The coffee sales for Coinstar's Rubi is a prime example of one of those four situations because Starbucks (NASDAQ:SBUX) sees it as a way to do what they do best in a more scalable and less costly environment as a secondary avenue to sell more coffee (the goal is 10,000 cups per year per kiosk). At the same time, the traditional coin counter kiosks are now picking up more and more banking capabilities per a relationship with PayPal (NASDAQ:EBAY) and study after study continues to show that a significant segment of the population is unbanked/under-banked which means no-one can really estimate what value a company can produce by cracking that market segment over the next three to five years especially via a hybrid mobile/physical approach with a cloud/online back-end like Paypal and a physical presence that again allows a touch situation when the consumer chooses or "needs" to use it (ATM model). Also of relevance is the fact that the mix of unbanked and under-banked might very well be mobile friendly but technologically shy regarding their money and a easy ATM concept like the Coinstar/Paypal kiosks could help mitigate some of the more serious reservations they might harbor. Yet, in this scenario that banking capability comes as an almost "Oh by the way, we can do this" side benefit of the established coin kiosks. That does not even touch on EBay's marketplace itself as a potentially interesting avenue for the used goods as well as other more touch-oriented markets. The above also leaves out a number of other ventures that I think will matter including fresh healthy food kiosks, gift card exchange kiosks (which may be this generations coin counting), and traditional but far more advanced vending kiosks etc. Beyond all of that though, and probably the most exciting aspect to their model right now from a "the sky is the limit" perspective, is a significant but potentially overlooked aspect of the Redbox Instant service...
Streaming of Games, Apps, Your Life
Notice that one of the very first devices that the service is available on is the XBox console via a "launch exclusive" partner agreement. Microsoft clearly sees the XBox as a powerful enabler in the home and the next generation of these types of consoles are going to take streaming of games and apps and life in general to new levels. It is also interesting that Microsoft sees the exclusivity aspect with Coinstar as a significant enough positive that it emphasizes that fact over and over again. It has already been made abundantly clear by Sony (NYSE:SNE) as well as the various companies like Nvidia (NASDAQ:NVDA) and AMD (NASDAQ:AMD) that are offering competing visions for streaming gaming frameworks which will do anything a current generation console can do and beyond while rapidly expanding to things we have not even thought about yet. For additional confirmation of this trend, poll some of the younger generation, or better yet ask your children or your neighbors. They know this. Coinstar knows this. MSFT knows this. Verizon knows this. Sony knows this. Who can make it happen though? Who has the experience and the infrastructure to mix those two worlds to yet again give the consumer (young and old) efficient but useful choices?
As a positive aside, the remainder of the devices Redbox Instant is tailored for also initially include Samsung (OTC:SSNLF), Google's (NASDAQ:GOOG) Android, and all of Apple's (NASDAQ:AAPL) devices, not to mention Microsoft's Windows and the Mac OS X platforms. I think the limited number of devices the service was released on was purposeful. Taken in context, it makes a clear point while at the same time covering all of the most necessary bases and most importantly it gives Coinstar the teeth cutting period (supported by the physical kiosks as well) that it needs to work through the challenges and hone this next generation model (remember that you can start streaming on one device and move the stream to another one seamlessly which is required for gaming) within the coming months before things get intense with next generation gaming and digital life.
All of the above is clearly in my humble opinion and there are a lot of additional threads and concepts that I had to leave out because this article was already long. I will leave you with this, there will always be a mix of brick and mortar and virtual and the companies that execute on that hybrid will be the ones we remember in the next twenty years when the rest have come and gone or been commoditized. I believe that Coinstar has a valid chance of being one of those longer term "Digital Life" enablers because they understand that a balance between efficient and useful choices is the preferred method for consumers now and in the future and they have set themselves up as an expert in doing just that extremely well.
Disclosure: I am long CSTR. I am also long/short various other stocks in this article through mutual funds etc. I hold no direct long or short direct positions, and do not intend to establish any for 72 hours or more, if at all. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.