Outerwall's Secret Profit Trigger

| About: Outerwall Inc. (OUTR)

There has been a lot of buzz surrounding Outerwall Inc (NASDAQ:OUTR) this past week. On August 5th, an activist letter penned by ADW Capital Partners LP was sent to OUTR's Board of Directors outlining a number of initiatives the company should take to increase shareholder value. Just this weekend, Barron's published a piece entitled "Outerwall's Box Full of Money", which cites a possible 20% increase in OUTR's share price. Even the Motley Fool is claiming that Outerwall could be the next Tesla (NASDAQ:TSLA) given that 40+% of its shares are sold short, most at levels below the current price.

Secret Profit Trigger

But perhaps the most compelling and least understood, positive catalyst for Outerwall is the Court Opinion reported in the Washington Post on July 31st by District Court Judge Richard Leon that calls for significantly reduced debit card fees for low-ticket merchants. In his opinion, Leon wrote that the Fed disregarded the statutory intent of Congress by "inappropriately inflating all debit card transaction fees by billions of dollars." The opinion effectively calls for the reduction of the fixed fee portion of debit card transactions which disproportionately affects small ticket merchants.

Those retailers with the smallest average debit ticket stand to benefit the most from any reduction in the fixed component of debit interchange. Outerwall has one of the lowest average tickets of any publicly traded retailer and its largest line of business accepts only plastic as payment, not cash. Specifically, the Redbox line of business has $2B+ in annual credit/debit card revenue which accounts for approximately 86% of parent Outerwall's total gross revenue. Nearly all of Redbox's transactions are small ticket given the low price point of their offering ($1.20/night DVD rental, $1.50/night Blu-ray rental, $2/night game rental).

The District Court ruling sets the wheels in motion for an imminent reduction in debit card transaction fees that will have a direct and quantifiable positive impact on OUTR's financial performance.

Impact to OUTR - Substantial Upside

The extent of the positive impact depends on just how far debit fees are cut. If we assume that debit rates for small ticket transactions are cut to the levels prevailing prior to the passing of the Durbin Amendment in 2011, as many expect, Outerwall stands to reap an additional $70 million per year in EBIT, assuming an average basket size of $3. A simplification of the math is $2.1 billion Redbox revenue divided by $3 average ticket = 700 million transactions x $.10 savings per transaction = $70 million EBIT benefit.

Not only would this boost annual EPS by $1.48, it would also increase the attractiveness of Outerwall as an acquisition target to private equity firms. At the current trailing twelve month P/E of 14, the implied stock price move would be an increase of $20 per share resulting in a stock price of around $82.

With this highly positive catalyst not yet priced into the price of OUTR shares, the risk-reward appears compelling for a long position at current levels.

Disclosure: I am long OUTR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long call options on OUTR.