Coinstar Investors Counting Pennies That Don’t Exist

Jun.20.08 | About: Outerwall Inc. (OUTR)

Coinstar (CSTR) primarily operates self-service coin counting and self-service DVD rental kiosks at retail locations. You drop in a piggy bank full of coins in one of their machines, and you get cash in notes (discounted value) or a gift card. Coinstar’s trucks go around collecting the coins, so the recent increase in fuel costs is a negative for the company.

Market cap: $1 billion; EV: $1.3 billion

Coinstar is a company that has been a perpetual turnaround, with almost every year (including 2008) being described as a transition year. The company has been acquiring other companies, and recently increased its ownership stake in a subsidiary resulting in consolidation of the subsidiary’s accounts, so the numbers and growth rate it is reporting are not comparable to the previous year.

The company is estimated to earn $0.60 per share (pro-forma) this year and $1.05 next year. The earnings estimate for next year looks overly aggressive, and to me it seems almost impossible to achieve. At $36, the stock is trading at 60x ’08 EPS! And even if it were to meet next year’s earnings estimate, that’s still a rich 34x multiple for something that’s very uncertain. Earnings quality is poor, with the company pro-forma’ing out stock compensation, intangible amortization and occasionally asset write-downs. Over the last 12 months, the company has generated no cash, and in fact free cash flow has been negative. D&A is running above capex, and working capital has been consuming cash.

The risks to the business are many. Some regional banks are installing coin counting machines that their customers can use for free. Self-service DVD kiosks are a novelty whose days are numbered under the onslaught of Netflix and online movie distribution. One long term risk is that with a penny costing more than a penny to manufacture, it is possible that the US Mint will phase out the coin. This would result in less need for Coinstar’s services.

The company was in an ongoing battle with an activist shareholder (Shamrock), and is currently in some kind of truce, having appointed one of Shamrock’s nominees to its Board. Some investors piggyback on activist fund investments, thinking that the outcome is bound to be positive. This is a dangerous strategy. An activist shareholder can ensure a company deploys its cash flow productively, or goad the company to sell itself if there is a willing buyer, but there is little it can do to improve the company’s operations or increase its cash flow. Note Carl Icahn’s failures at Blockbuster (BBI) and Motorola (MOT). Or even Shamrock’s investment in iPass (NASDAQ:IPAS), which is down 60% in the last year.

Fair value for CSTR stock: $15 (a generous 25x multiple on ‘08 EPS of $0.60)

Disclosure: Author has a short position in CSTR