Coinstar fits one of my favorite Short themes: companies with a limited lifespan business, that the market values for long term growth.
Finite Business Opportunity Extrapolated as Long Term Potential
I have applied this thesis to many stocks in the past, including Movie Gallery (RIP), United Online (UNTD), and Handleman (RIP). All these companies had extended periods of growth, but new technologies emerged that not only ended the growth but potentially the businesses’ ultimate existence. Analysts and investors dismissed these threats well past reasonable risk assumptions. Spotting shorting opportunities presented by technology threats can be used very successfully as pair trades as well. These companies’ misfortune is usually the direct result of a new technology that is another company’s path to prosperity.
The stock of this video rental store continued to climb after it became clear that Netflix (NFLX) and other forms of media distribution, digital or otherwise, were a huge threat to the traditional video rental store business model. Movie Gallery eventually filed for bankruptcy.
Originally a provider of free dial up internet service, UNTD still exists in some strange business combination with FTD flowers now somewhere in the mix. This stock was still climbing in 2003 when the likelihood of dialup remaining a viable internet platform was already more than in question, with the onset of rich media. The stock is 1/3 of the levels it achieved as recently as 2007, just before the introduction of fiber cable.
This one is my favorite. The CEO of this rack jobber of CDs at big box retail actually questioned whether a viable music download service would ever be possible. This was in 2003 after the ITunes Store was already introduced. HDL shares traded higher into 2004, from $18 to over $23/share and currently fetch less than .05 cents/share.
These companies were all threatened by the emergence of new media distribution models digital and otherwise. All interesting pair trades at the time with beneficiaries of this same shift such as Apple (AAPL) and Netflix.
Interestingly enough, Coinstar benefited from this same shift away from traditional video rental stores, also recently further cemented by the bankruptcy of once high flyer Blockbuster Video. The performance at CSTR’s acquired subsidiary Redbox network of DVD rental kiosks has sent the stock rocketing to all-time highs. This upward move in stock price was certainly assisted by a significant short position in the stock. Do investors really believe this is a long term growth story? That consumers who are able to acquire an unlimited selection of media digitally in the comfort of their home are also going to run out to a kiosk to grab a DVD? CSTR doesn’t even believe this is a long term growth story. The company has already announced a digital service offering to be introduced at some future date.
BulwaTechReport.com offered this opinion on Coinstar recently and established a short position in the name:
In the future all media will be distributed and collected over the internet. CSTR will be left with a massive inventory of unused DVD kiosks to maintain or dispose of. The company claims they have a digital strategy in development. That is a crowded space that I doubt will be successful even for the leaders like NFLX. If you don’t own the pipes or the content the cost structure is not favorable. Throw piracy into the mix and good luck. As this realization comes into focus in the coming months and years CSTR stock should work back to pre Redbox levels in the $20/share area. With significant debt on the balance sheet and the obligation of dealing with 30,000 useless kiosks, the ultimate price of the stock may fall even lower.
According to Yahoo Finance, not one of 12 analysts offering coverage, rate this stock a sell or even an ‘underperform’ with the majority considering it a ‘buy’ or a ‘strong buy’.
Jim Cramer endorses CSTR November 17, 2010 in his Lightening Round saying “Coinstar : “I like Netflix more, but that quarter was pretty good; I like it.”
In spite of Netflix being the poster child for the shift away from traditional video rental I believe that digital delivery may not be so fantastic for this company either. Netflix doesn’t own any content or distribution networks either. The long term success of this business model remains in doubt in my opinion.
Zacks also rates CSTR a buy, saying in a recent report:
Following the earnings release, the stock quickly jumped to an all-time high after the news. CSTR is taking a breather right now, but as investors get used to the higher price, it should continue higher. Following the earnings release, the stock quickly jumped to an all-time high after the news.
With great new growth companies to invest in, I truly don’t know why anyone would own CSTR - for its leveraged balance sheet? For its reliance on technology with a dubious future? With Apple and NFLX and HULU and many others already in the field, why should I bet that Redbox will succeed with their digital strategy? As a pair trade, maybe I should buy some Schnitzer Steel (SCHN) - this company is bound to make money recycling all those scrap DVD kiosks in the near future.
Disclosure: Short CSTR