Seeking Alpha
Profile| Send Message| ()  

Coinstar, Inc.'s (CSTR) shares have fallen almost 30% to $51 per share, since flying high in July at $72 per share. In case you missed it, late in July, the shares nose-dived on revenue that trailed analyst estimates by $13.5M or 2.5%. But should investors really be ignoring net income growth of 38% and rental market share gains of 8% simply because three months of sales growth did not live up to the average of thirteen analysts' expectations?

Sellers of the stock will be quick to tell you that the revenue miss must mean that the rental DVD business is finally starting to slow as consumers turn to streaming movies online at home, but as Coinstar CFO Scott Di Valerio points out, during the third quarter, "consumers had fewer DVD releases to choose from." As CFO, he probably cannot come right out and say that the majority of these releases were pretty bad too, but I will say it, and personally I rented a lot less as a result.

I have been a Redbox consumer since the early days and even though I own an Apple TV unit and subscribe to Netflix streaming, I continue to use Redbox because it offers a distinct value compared to everything else on the market. Through iTunes on Apple TV, Apple Inc. (AAPL) sells its new releases for $4.99 and offers older releases for $3.99. Titles purchased through iTunes are available on-demand for up to 24 hours. The same new release titles can be found at Redbox for a $1.20 per night rental fee plus Redbox offers the flexibility to keep the title longer if necessary.

And then there is Netflix, Inc. (NFLX) streaming. Ask any user of Netflix streaming to describe their personal experience with the service and you are likely to get the following response: "Lots of movies, but not very many good ones". Occasionally, blockbusters like Iron Man become available on Netflix streaming, but by this time most people have either seen it at the movies or rented it through Redbox. Another challenge, not just for Netflix, but for all streaming services, is that not everyone has access to a high-speed internet connection. Even some customers that do have a high-speed connection pass on streaming services because the value is eroded by additional fees charged for data by their internet providers.

The argument that DVD rentals from kiosks will go away in the future is certainly a valid argument, it will happen one day, but there are many hurdles to get through before it happens. This will not be a Blackberry to iPhone like switch, or a CD to MP3 like switch either. It will take more time. Until someone comes up with a way to make streaming a better value offering to the mass market, Redbox DVD kiosks are here to stay.

Top Investors Disagree Over Value

Shrewd short seller Jim Chanos of Kynikos Associates went public with his Coinstar short back in April, however famed investors do not get it right all the time. Chanos lost his shirt not too long ago betting against Ford. According to Morningstar's website, on the other side of the Coinstar trade is the five-star rated Fidelity Contrafund which has been recently accumulating shares, and hedge fund Citadel Asset Management which has also been recently accumulating shares.

Relative to Netflix, Coinstar shares certainly seem to offer a much better value. Many value investors swear by picking stocks with a price to sales of below one. Coinstar's price to sales is a meager 0.8 - which means that you are paying only .80c for each dollar of sales.

CSTR

NFLX

Price/Cash Flow

3.8

24.1

Price/Sales

0.8

1.1

Enterprise Value/EBITDA

3.8

10.7

Data per Morningstar's Website August 22, 2012

From a cash flow standpoint the business is also cheap. That may be why it was recently rumored that Coinstar was in talks with a private equity firm to sell the company. Analysts are in disagreement on whether or not there is any truth to the rumor. While many of these private equity rumors from "unnamed sources" tend to be false, the idea is not improbable. The founder of Coinstar recently announced that he is leaving the organization in March of 2013. Major departures, such as the loss of the founder or CEO, often kick off private equity conversations. It is well known that the company has strong cash flows, over $10 per share of cash, healthy growth and only a small amount of debt. A search of employee reviews on Glassdoor may also lead one to believe that the company could be run more efficiently. So from a private equity standpoint there is no denying that it is probably on their radar; the question is at what price?

Modeling in the future switch from DVD rentals to streaming would be the biggest challenge for private equity analysts. At what point will streaming seriously begin to dent the DVD rental business? Will Coinstar's partnership with Verizon be enough to offset these future DVD rental declines? These are all tough questions that a buyer must scrutinize. Coinstar's core Redbox business is partially hedged by their recently announced streaming partnership with Verizon Communications (VZ) and future product innovations that are already in the pipeline. The exact details on Redbox's streaming service named Redbox Instant have not yet been released, but it now has the chance to compete directly with other streaming services by leveraging Verizon's fiber optic customer base.

It would be difficult to find another company that has shown net income growth of close to 40% in its most recent quarter with similar valuation metrics. The last time the company's P/E ratio was this low relative to the S&P 500 was 2002 and since then the stock has rallied significantly. What is on the horizon for the rest of the year? Well, in a show of confidence, Coinstar filed documents with the SEC this month stating that it had entered into a trading plan to purchase up to $270 million worth of shares over the next six months. In addition, the company is launching Redbox Instant through Verizon later this year. According to the CEO, the focus will be on "quality over quantity" so expect fresh new titles at great prices. It would be wise to keep an eye on next quarter's earnings, but at this point, it seems like the upside potential is greater than the downside risk.

Source: Redbox's Parent Coinstar Is In The Bargain Bin