Coinstar (CSTR) plunged yesterday after the press once again reported that famous short-seller Jim Chanos is short the stock. When a prominent short-seller is publicly shorting a stock that I am bullish on, I like to understand the reasons and make sure that I still believe in my story of the stock. Below I have listed some of the reasons Chanos is short Coinstar, and I outline some reasons why I view things differently.
Chanos previously laid out why he thinks Coinstar is a value trap in a presentation. The reasons he gives are the following:
- Redbox is reaching a saturation point in the U.S. as 68% of Americans live within a 5 minute drive of a Redbox kiosk and Coinstar's acquisition of NCR's DVD kiosks will push Redbox closer to full saturation of the U.S. market;
- Coinstar is resorting to "unconventional" ways to support Redbox growth (as examples Chanos cites a recent price increase, the acquisition of NCR's DVD Kiosk business, and a new coffee kiosk concept Coinstar is rolling out this year);
- Redbox is under pressure due to actions by movie studios changing their movie distribution windows and implementation of credit card implementation fees; and
- In a CNBC appearance in April, Chanos pointed to DVD sales falling as VHS tapes once did and asked what happens when DVDs are replaced by streaming.
I was happy to read that the concerns Chanos had did not involve an accounting irregularity, fraudulent behavior or overvaluation. His basic argument is that 1) Redbox is Coinstar's growth engine, 2) Redbox's growth is coming to an end, and 3) Redbox DVD kiosks will be as worthless as Blockbuster's stores once everyone streams their movies rather than renting DVDS. I have a different take on the longer term viability of Redbox and Coinstar.
- Attaining a monopoly on physical DVD/Blu-ray rentals is not a bad thing - Redbox is rapidly gaining market share in the DVD/Blu-ray rental market. From the latest quarterly conference call, Coinstar CEO Paul Davis said "With Redbox, we had nearly 180 million rentals and we now have 38,500 Redbox kiosks in over 31,100 locations. We're particularly excited about the growth that we experienced at the market share. We -- for the quarter, we are on a unit basis at 42.5%, which is up a full 8 percentage points year-over-year. We lead our online by mail competitor now by over 15 percentage points." That is a huge market share and it is rapidly growing. Coinstar is further expanding Redbox's market share by purchasing NCR's Blockbuster branded kiosks. After that transaction, Redbox is the only major player left when it comes to same-day DVD and Blu-ray rentals. If the U.S. and Canadian market become saturated with Redbox kiosks, Coinstar can continue to collect significant cash flow from operations without having to spend lots more money for growth. The fast-growing earnings will be replaced with significant free cash flow.
- Redbox is the low-cost provider of new-release movie rentals in the U.S (and has the best video quality) - Redbox's DVDs and Blu-ray discs offer compelling value compared to all other options for someone looking to rent a newly released movie and watch it on their TV. When I want to watch a new release movie on my TV, I have several options. I can order the movie on demand through Comcast (or any other cable/satellite provider). This costs about $6 and is probably the easiest, but most expensive option. I can order the movie on ITunes for $4-5 and stream the movie through Apple TV (if I had an Apple TV that is). I could rent the movie from Amazon for about $4-5 and try to figure out how to use my DVD player or other device to stream the movie on my TV. I could subscribe to a DVD by mail service such as Netflix or Blockbuster and pay a monthly contract fee (about $8 per month) to maintain an online cue and receive DVDs by mail. However, despite all these other options, I believe that the ability to rent a high-quality DVD or ZBlu-ray disc from a conveniently located Redbox kiosk for between $1.20-$1.50 a night is the superior option when I want to watch a new release movie on my television. The rental options from Apple and Amazon options have been around for some time and are great if you want to watch a movie on your tablet or phone, but they are not convenient for watching on your TV. The option to rent a movie on Comcast or pay-per-view has been around a long time (during VHS days even), and people have not switched en masse to the pay-per-view option over renting a physical movie. My unscientific view of why this migration has not taken place is that the quality of streaming is not as great as watching on a physical disc and people do not want to feel ripped off by paying more than they need to for a movie. The DVD by mail option does not have the immediate gratification of renting a DVD from a kiosk or through a streaming option and entails a recurring fee which many people get fed up with over time.
- Redbox has a structural advantage in pricing over streaming options - Redbox can offer rentals at a much cheaper rate than streaming options due to the "first sale doctrine" which is a concept in copyright law that allows someone to buy a copyrighted work (such as a movie) in a physical form and then rent it out or sell it to other parties without getting further permission from the original producer of the copyrighted work (such as a movie studio). Because DVD and Blu-ray sales to consumers are still extremely profitable for movie studios, Redbox can buy discs at a low price from retailers and wholesalers if studios do not want to deal with them directly. Streaming providers have not been able to convince studios to lower prices for streaming videos because they do not have the leverage of the first sale doctrine in their negotiations. Studios are frightened that lower streaming rates will cannibalize purchases of DVDs/Blu-ray discs, and so they maintain higher pricing when they can. Unfortunately for the studios, the first sale doctrine allows Redbox to continue to buy DVDs and Blu-ray discs cheaply and rent them out at attractive prices for consumers. This is a big win-win for consumers and Redbox, which as discussed above is the only significant physical DVD/Blu-ray player left standing.
- Coinstar's growth initiatives in automated retailing and streaming video are promising - Chanos suggests that Coinstar's entry into the coffee kiosk business is a negative. I disagree. Coinstar is aggressively rolling out its new Rubi coffee kiosk that will serve high quality "Seattle's Best" coffee. There is a huge opportunity to serve decent coffee at a reasonable price in locations where there are no good options or during times when coffee shops are not open. Think about how great one of these would be in an office environment replacing the usually sub-par coffee options. Also another great automated retail concept that Coinstar is pursuing is ecoATM, which is a machine that can take your old cell phone and pay you cash for it. Similar to the namesake Coinstar machine, this concept would take something people want to get rid of and turn it into money. I think the opportunities in automated retail are huge, and Coinstar is in prime position to take advantage. These kiosks don't take up much room, cost very little to operate and do not require employees (compare Redbox to Blockbuster or Rubi to Starbucks). These kiosks drive traffic and provide additional revenue to larger retailers such as Wal-Mart, and Coinstar forms a symbiotic rather than adversarial relationship with such retailer. This is a win-win-win. Coinstar gets to place its kiosks in highly trafficked locations, the retailer gets additional revenue from otherwise dead space, and customers can get more services provided in the convenient locations they regularly frequent. In addition to these opportunities in automated retail, Coinstar is aggressively pursuing a streaming video partnership with Verizon. This partnership seems to provide a nice low-risk way for Redbox to get involved with streaming video, and demonstrates that management is not blindly ignoring the potential for its business model to become extinct.
Disclosure: I am long CSTR.