The Demise Of The DVD: Timing A Coinstar Play

Feb.13.12 | About: Outerwall Inc. (OUTR)

Investors looking to put their money in the home entertainment industry need to beware - there are changes brewing that could change the face of the industry. Coinstar (NASDAQ:CSTR), the owner of the RedBox DVD rental kiosks and favorite of Mark Kingdon's Kingdon Capital, announced on February 7 that it intends to partner with Verizon Communications (NYSE:VZ) to start offering a national subscription service later this year. The service would provide online access to movies and other content while providing access to the RedBox kiosks. In other words, it would be reminiscent of what John Thaler's JAT Capital Management favorite Netflix (NASDAQ:NFLX) does, only instead of receiving your videos in the mail, you would have to pick them up from the kiosk. Also like NFLX, the service would license older movies and some television shows for streaming. Coinstar Chief Executive Paul Davis told the Wall Street Journal, "We are confident we will have a very competitive offering at a great value," but added that the service would "not [be] at the Netflix level."

According to the securities filing regarding this upcoming partnership, Verizon would own 65% of the joint venture, to which Coinstar will make an initial contribution of $14 million. The deal will help Phill Gross and Robert Atchinson's Adage Capital Management favorite Verizon expand its video offerings. Right now, Verizon offers bundle services with DirecTv (DTV) and FIOS in limited areas. The addition of streaming video and RedBox services would allow Verizon to compete against DISH Network (NASDAQ:DISH), the cable provider which bought Blockbuster and now offers Blockbuster video on demand as well as DVD services. However, the move is not without its risks. A less expensive video offering like the venture planned with Coinstar could undercut Verizon's existing FIOS service.

For Coinstar, the deal could be golden. The company has been talking about getting into streaming video service, with another company, for the last 12 months, a move largely predicated by concerns that digital media and streaming services would eventually overtake DVDs, much in the same way that digital music caused the decline of the CD. That's not to say that Coinstar will be abandoning its DVD services anytime soon, or even discounting them. The company announced on February 6 that it would purchase NCR Corp (NYSE:NCR)'s DVD kiosk's and other assets for a price tag that could be as high as $100 million. NCR owns the license to brand its kiosks (it has almost 9,000 across the country) as Blockbuster, using the famous blue and gold logo. When Blockbuster's assets were acquired by DISH, NCR sued. The issue has not been resolved but the deal with RedBox would make it null anyway. The agreement would end once the sale to RedBox is complete and RedBox will be using its own branding.

So, what does this mean for investors?

On the one hand, Verizon and Coinstar could be clutching at straws. Coinstar announced in its Q3 2011 report that it was raising its prices. Whereas it once cost $1 to rent a movie for the night from RedBox, that amount is now $1.20. The price for Blu-ray disc rentals remained the same, at $1.50, as did the price for video games, which is $2 a day. The RedBox change may not be as dramatic as Netflix's whole debacle last summer, when the company hiked prices 60% and split its rental service from its streaming service - but still. Coinstar's share prices plunged 10% when the news was announced on October 27. On the other hand, the company was able to rebound from that - from October 26 to February 7, CSTR is up over 6% - and its most recent quarterly performance report (February 6) was encouraging. It reported $520.5 million in revenue, beating analyst estimates of $498.09 million, and earnings per share of $1.00, above analyst estimates of 64 cents a share. In fact, Coinstar beat analyst estimates regarding its revenue and EPS every quarter last year.

It all sounds good and the acquisition of the NCR kiosks will certainly help matters, but DVDs are still becoming less common. Positive performance now could turn into quickly plummeting numbers before long if the current trend towards digital media continues. Now that so many televisions offer apps that let users access services like Netflix and there are so many inexpensive peripherals for streaming movies, like Roku which allows users to watch Hulu and stream movies from Amazon (NASDAQ:AMZN), the demise of the DVD could come up quick - and that's not even counting the offerings and availability of services by Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG), each of which have their own system for streaming movies. We think that Coinstar is good for a short-term investment. Buying in now, there would be enough room for upside in the next year, but investors should only invest in Coinstar if they can keep a wary eye on what is happening in the market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.