The short thesis on Outerwall(NASDAQ:OUTR) is certainly easy to grasp at first glance (DVDs are going away and Outerwall's Redbox division is in the DVD rental business). In fact, it's pretty obvious which would explain why Outerwall has one of the highest short interests of any stock at nearly 50% of the float. The purpose of this article is to explain why, upon closer inspection, it's a lazy (and dangerous) short and one that's based on a misunderstood premise.
Traditional retailers get into trouble when their sales decline and they are stuck with high fixed costs. Unlike traditional retail, OUTR has very few fixed costs. Importantly, it is not locked into any long-term real estate leases at the kiosk level. That's a critical distinction that short sellers in this name haven't figured out yet. When costs are predominantly variable, operating companies can adjust their cost structure to remain profitable even in the face of declining revenue. In the case of Outerwall's Redbox division, they simply buy less movie inventory for their kiosks. If a kiosk is no longer profitable, they remove it with no penalty. The market has mistaken OUTR as a traditional brick-and-mortar retailer but its business model is far more flexible and robust.
This is worth repeating: OUTR will remain highly profitable even in the face of declining revenues.
In the absence of any imminent decline in profitability, the short thesis becomes less attractive. Additionally, there are a number of potential upside catalysts that could result in a substantial short covering rally. A misunderstood stock with nearly 50% of its shares sold short is a powder keg with explosive upside potential should any of the following occur:
- Buyout from a strategic acquirer - Gamestop(NYSE:GME), Cardtronics(NASDAQ:CATM), DISH(NASDAQ:DISH), and Blackhawk(NASDAQ:HAWK) are all logical suitors) - or a private equity financial buyer. Historically, the biggest impediment to a buyout was an uncooperative board which rebuffed offers above $90/share in years past. Thanks to Engaged Capital, their 14.6% ownership stake, and their 3 seats on the Board of Directors, the Board is now committed to entertaining all bona fide buyout offers.
- Increased margins from lower retail host revenue share deals drive increased EBITDA. Channel checks indicate that new contract renewals are being signed at commission rates of up to 5% lower than prior terms. This margin drops right to the bottom line.
- Netflix's de facto rolling price increase (ungrandfathering) makes the Redbox relative value proposition stronger which results in kiosk sales declines slower than currently modeled, further extending the profitable lifespan of this segment which the market has given up for dead.
- Redbox Digital launches and is well received by the market
Outerwall is a fundamentally misunderstood story that has the potential to catch unsuspecting short sellers offsides. The obvious melting ice cube story is one that everyone is familiar with and which is priced into the stock. The subtleties of the comany's cost structure are less well understood as are the numerous catalysts that have the potential to move shares sharply higher.
Disclosure: I am/we are 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.