After beating earnings estimates from analysts and proving to the wall street guru's that the 20% increase in prices wouldn't hurt the company's bottom line, anyone short the stock got hammered. Trading in the mid-40's, Coinstar (NASDAQ:CSTR), the owner and operator of Redbox movie and game rental kiosks, surged approximately 20% on a short squeeze. Prior to earnings 40% of the outstanding shares were held short.
After pre-announcing excellent earnings, the stock again soared, this time briefly surpassing the $70/share level. However on the scheduled earnings date the company gave guidance that didn't satisfy the street and the stock began a pull back. The stock has since traded as low as $57.
So with the overall market seeing returns fade, why is now the best time to jump into CSTR versus a competitor like Netflix (NASDAQ:NFLX)? Coinstar today announced a deal with Walmart Canada to place its DVD rental kiosks in stores, starting with the Vancouver and Toronto areas. The CEO of Redbox stated that within "a few years" the company would like to have a presence in the country of about 2,500 kiosks. Best Buy (NYSE:BBY) already has a few kiosks (65) in the country and wishes to expand to 130 kiosks however has no plans to establish a footprint comparative to that which Coinstar wishes to establish.
Many have felt that Redbox was operating in a soon to be extinct industry, the physical dvd rentals. This move to expand across the northern border will help the company solidify its existence, increase revenues and build its brand into a household name.
In case the physical distribution of rentals does begin to decline the company has begun taking steps to diversify its business model by partnering with Verizon (NYSE:VZ) in a joint venture. It is rumored that the JV will allow Verizon subscribers to pay-per-rental rather than be forced into a subscription service.
Finally, between the middle of April and the beginning of May, the number of shares held short has increased more than 17% to the point where now 30% of shares outstanding are held short. This equates to a short interest ratio of 6.5, up from 4.6 in the middle of April.
Short sellers are too bearish on the stock long term and it is only a matter of time until the shorts get squeezed...again.
Fair Value Analysis
To further support my claim of the under valuation of Coinstar, one only needs to consider a conservative cash flow analysis. Analyst expectations are for revenue growth over the next five years to be around 18%, for conservative purposes I'll use only 9% growth in revenues. The company has been able manage operating expenses more efficiently, however for the analysis 23.4% of revenues will be subtracted for operating expenses. This is 430 basis points higher than the operating expenses from 2011. The company's cost of goods have been raised to 71% of revenues, even though they have locked into contracts with several studios to prevent these costs from rising out of hand. Finally I've raised the company's tax rate to 35% from its 2011 tax rate of 33%. Assuming the company can grow cash flows over the long term at 3% while having a weighted average cost of capital of 7% (industry average), the stock price still commands a 33% premium to its current market valuation with fair value estimated to be approximately $79/share.
News of Coinstar's agreement with Walmart Canada obtained here.
Fundamental data obtained through FinViz.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CSTR over the next 72 hours.
Additional disclosure: I am considering going long CSTR once other assets are liquidated.