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Coinstar (CSTR) is a leading provider of automated retail solutions offering self-service coin counting machines and DVD rentals through its Redbox kiosks at number of retail locations. At present, Coinstar has 30,000 self service Redbox kiosks at 26000 locations. Coinstar's kiosks are located mostly at leading grocery stores, mass retailers, drug stores, restaurants and convenience stores like Wal-Mart (WMT), Kroger (KR), Walgreens (WAG) and McDonalds (MCD). Customers use a touch screen to select movies at DVD kiosks and pay with either credit or debit card.

Redbox gets it DVD movie titles through licensing arrangements with various studios like Paramount, Universal Studios, 20th Century Fox, Warner, Lionsgate, Sony and other studios.

The coin business is another operation of Coinstar's business where consumers can convert their coins to cash at coin-counting kiosks. Coinstar installed its self-service coin machines at various retailer locations across the U.S., Canada, Puerto Rico, Ireland and the United Kingdom. Coinstar owns and operates coin-counting machines at approximately 18,900 locations. Coin-counting revenue is generated through transaction fees from their consumers and retailers.

Coinstar generates nearly 20% of its revenue from Wal-Mart, 14% from Walgreens and 11% from Kroger stores. These three companies represent nearly 45% of its total revenue.

In the year 2010, operating income from Coinstar's DVD segment increased approximately 89% from previous year. Operating income from the Coin Services segment decreased approximately 7.8% due to patent settlement with "ScanCoin" and the disposal of coffee kiosks.

Growth Spurts:

As end of the year 2010 Coinstar's revenue reached $1.436 billion from 2007 revenue of $307 million which is an outstanding cumulative growth of 67%, where as gross margin experienced a cumulative growth of 42% to $435 million in the year 2010 from $154 million 2007.


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Coinstar's outstanding performance is due to significant growth in its Redbox DVD rental business and its ever growing popularity, and its strategic locations like grocery stores and local pharmacies. Redbox rapidly filling the vacuum created by the failed national brick and mortal DVD rental businesses like Blockbuster and Hollywood video stores.


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As end of the first quarter 2011, Redbox increased its movie rental market share to 33 % from 24%in 2010 first quarter outpacing online retailers like Netflix (NFLX); while brick and mortar businesses lost their market share significantly from 33% to 20%.

As national chains like Blockbuster (OTC:BLOAQ) and Hollywood (OTCPK:HOLL) went through store closures, the DVD rental business is evolving from brick and mortar rentals to a self-service rental model.

Coinstar captured this opportunity by installing self-service at every retail store. Irrespective of broadband penetration, there is a need for physical DVD rentals and Redbox is fulfilling that consumer need.

Competitors like Netflix gained market share for its easy to view online movies and physical move delivery by mail. Whereas at Redbox customers can pick latest movies at Kiosks and can return the DVDs at nearest convenient location.

With Redbox rentals, customers do not need to sign monthly contracts and can rent whenever they need to for a price of one dollar. This is the big competitive advantage for Redbox since customers are price sensitive to DVD rentals.

Business Strategy:

Part of the Coinstar's growth strategy is its approach towards social media and information technology to take advantage of latest customer trends. As end of the first quarter 2011, Redbox has accumulated 27 million email accounts, 2 million text message accounts and attracted nine million unique visitors to its Redbox website.

Redbox has 2.6 million Facebook fan accounts and is adding 50,000 fans every month. So far 3 million Redbox apps were downloaded in iPhones and more than one million apps in other Android phones. Also Redbox is promoting its brand through various channels like McDonald's Monopoly game and Groupon (GRPN) ad campaign. It is evident, the growth in Coinstar's revenue and margins are reflecting these smart and innovative marketing strategies.

As Broadband is still emerging, there is room for physical DVD rentals. There are still many households that are not equipped for online movie entertainment, and they all prefer physical DVD rentals. Coinstar is aware of the future changes in technology and broadband market penetration.

In the future Redbox is planning to deliver its content both on the Internet and physical delivery format via its Kiosks. This presents couple of opportunities for Redbox. One, it can compete with other online movie rental firms like Netflix and other future content providers like Apple (AAPL) iTV, Google's (GOOG) YouTube, Amazon's (AMZN) next version Kindle. Second, it will be the major player at physical DVD rental outlets. Number of physical locations and its low-cost of operating Kiosks are going to be the biggest strengths of Coinstar business as compared to mail order DVD rental service. At present the customer satisfaction for Redbox is at its zenith and new internet presence going to add more value to the future growth in its DVD business.

Historically, Redbox used to acquire its DVD inventory through third-party distributors, direct purchases from retailers through its field team and through direct supply agreements with studios. Due to this inventory acquisition process initial procurement costs and salvage values were higher.

In 2010, Coinstar entered into direct DVD supply agreements with Warner studio, Universal Studios and Fox studio that reduced initial procurement costs of new inventory but eliminated salvage value of used DVDs. This helped Coinstar to eliminate field teams.

Coinstar recently announced installation of 1400 new kiosks at Safeway's (SWY) stores that include popular stores like Dominick's, Vons, Randalls and Tom Thumb. From June 17th 2011 onward, Coinstar introduced video game rentals at 21,000 locations, which cost $2 per game rentals compared to $1 for DVD and $1.50 for Blue ray DVD. This is a new stream of rental revenue for Coinstar and should be able to compete with game disk outlets like GameStop.

As Coinstar continuous to add new services like game rentals it does not add any fixed expenses. In this case the only expense is going to be the game disk purchase which is simple a variable expense. This in turn increases Coinstar business operating leverage and there increases its earnings per share.

In the coin business margins are high, Last year Coinstar processed $3 billion worth of coins. Coinstar typically charges 9.8% commission fees. Coinstar never used to track its customers before. Now it has came up with new innovative marketing strategy. One, the customers can anonymously collect cash and pay the full fees, or customers can register themselves with Coinstar and get full 100 percent credit to purchase store gift cards or other gift cards like star bucks, Amazon or iTunes gift cards. With the second option Coinstar collects commission directly from the vendors.

Store owners prefer their customers spend their money at their stores which is a win-win for store owners and Coinstar. On other hand, customers register for full pay e-payment for store credit, Coinstar collects customer data for future marketing purposes including DVD promotions. Coinstar has been in the retail business for the past twenty years. It has consistently explored new ideas and leveraged its experience with kiosk businesses.

Challenges:

With 28-day delay in DVD release, seasonality in demand has been extended from fourth quarter to first quarter of the next year. Thanksgiving movies are now available for Christmas holidays, where as Christmas movie releases are available in January. This is a drastic adjustment in seasonality. Also, Blue-ray business has not been caught up the speed of DVD rental business. Part of it is consumer price sensitivity for higher prices and also slower adoption of technology.

Projections and Future growth:

Coinstar is projecting next year Redbox sales to $1420 - $1555 million from $1160 million this year, as compared to its coin revenue anywhere between $280 - 290 million from last year revenue of $276 million.

Coinstar also projecting its overall business growth between 18 to 29% for the year 2011 and projecting earnings growth from lower end at 29% to 53% at higher end.

While expanding its DVD Kiosks, Redbox is also focusing on delivering its content online which is going to be direct competition with existing players like Netflix.

Conclusions and Recommendations:

As Coinstar continuous to exhibit growth, it is strategically well positioned to reach out to its customer base. Continuous compounded growth in sales for past four years is outpacing the growth in general economy and online competitors, and Coinstar is filling the big vacuum created by bankrupted national video rental businesses. Coinstar leveraging its twenty years of Kiosk business and well aware of cost conscious consumer sentiment. New additions like game rentals will add value to its core DVD rental business. As growth in revenue is evident, the operating income and cash flow from operations are increasing; this is one measure of quality earnings.

In the video rental businesses like Redbox, account receivables are virtually zero; as Redbox becomes ubiquitous any marginal increase in price of DVD rental directly improves earnings per share in the future. As you see in financial ratios Coinstar solvency ratios are manageable and healthy, the cash conversion cycle is 4.69 days which is very impressive. With estimated earnings growth of 30 to 50 percent next year and consistent 15 percent return on equity, Coinstar is undervalued.

Financials:

Year

2010-12-31

2009-12-31

2008-12-31

2007-12-31

12/31/2010

12/31/2009

12/31/2008

12/31/2007

Revenue

1,436.42

1,032.62

650.08

307.38

Cost of Goods

1,000.94

716.04

408.21

153.69

Gross Profit

435.48

316.58

241.87

153.69

Operating Income

143.21

104.71

86.14

57.77

Interest Expense

34.86

34.25

21.52

Net Income (Continued Operations)

65.89

43.69

45.73

22.8

Net Income

51.01

53.64

14.11

-22.25

EPS (Diluted &Continued)

2.03

1.31

1.10

EPS (diluted)

1.57

1.76

0.50

Current

Quarter

Cash & Investments:

23.02

71.29

19.39

66.41

21.40

Account Receivables:

21.10

25.96

19.27

51.91

49.81

Inventory:

93.99

140.32

95.53

92.25

33.36

Current Assets:

379.71

488.39

440.08

367.79

301.97

Account Payables:

124.23

161.55

80.08

132.19

49.83

Current Liabilities:

403.83

633.30

374.77

384.10

197.24

Long term debt

354.12

167.26

409.39

295.94

266.15

Total debt:

372.15

377.32

468.75

351.37

272.65

Total Assets:

1178.33

1282.71

1222.80

1066.71

768.57

Total Liabilities:

757.97

839.59

810.41

746.69

463.44

Equity:

420.36

443.12

412.39

320.02

305.13

Goodwill:

267.75

267.75

267.75

290.39

221.46

Operating Cash Flow:

315.62

123.89

169.67

58.06

Investing cash Flow

-143.09

148.11

-168.88

-99.27

Financing cash Flow:

-122.05

41.94

4.65

58.28

Accruals (Cash Flow)

-106.64

-228.31

44.94

64.01

Net Operating Assets:

749.15

861.75

604.98

556.38

Accrual Ratio:

0.15

-0.37

-0.03

Tax rate:

39.50%

37.05%

29.40%

Shares Outstanding

32.397

30.514

28.464

Margins & Ratios:

12/31/2008

12/31/2009

12/31/2010

Change in Sales %

111.49%

58.85%

39.10%

Change in Gross Margin

57.38%

30.89%

37.56%

Changes in EBIT

49.11%

21.56%

36.77%

Interest Coverage

4.00

3.06

4.11

Change in Operating Cash flow

192.23%

-26.98%

154.76%

Gross Margin

37.21%

30.66%

30.32%

Operating Margin

13.25%

10.14%

9.97%

Profit margin

7.03%

4.23%

4.59%

Current Ratio:

0.94

Quick ratio:

0.71

Cash Ratio:

0.06

LTD / Equity:

0.84

Receivable Turnover

12.78

29.01

63.52

Inventory Turnover

6.50

7.63

8.49

Payable Turnover

4.49

6.75

8.28

Average Collection Period:

28.56

12.58

5.75

Days on Hand Inventory:

56.16

47.86

43.00

Days of payables:

81.38

54.10

44.06

Cash Conversion days:

3.34

6.34

4.69

Free Cash Flow to Firm:

4.76

-15.95

181.50

Return on Assets:

4.98%

3.82%

5.26%

Return on Equity:

14.29%

10.59%

14.87%

Return on Capital:

9.06%

7.48%

10.56%

Disclosure: Long on CSTR, AAPL. Own Coinstar and Apple stocks in both personal and Covestor portfolios.

Source: Start Collecting Coinstar