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Mikhail Broyan
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Analyst and Private Portfolio Manager. Main focus is on macro trends, value stocks, market over-reaction situations with a mid-long term exposure. My core objective is to share ideas on opening long/short positions in middle-large cap market and building a stable and balanced portfolios. ... More
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  • Outerwall (OUTR): A Misunderstood Value Stock Story

    Odd name, good business

    Ask anyone if he/she knows about Outerwall Inc. and get a negative response in most cases. But public recognizes Coinstar, Redbox brands, and I'm pretty sure that Ruby and EcoATM would have their place in minds. The reason I see behind the renaming of the company from Coinstar to Outerwall is a try to show the company has diversified businesses and coin-counting machines do not fully represent their stance.

    Currently Outerwall is represented by:

    1. Coinstar (US, Canada, UK and Ireland): 20 000+ coin-counting kiosks that convert your coin change to cash, gift cards, tickets etc.
    2. Redbox (US, Canada): approximately 44 000 self-service movie rental kiosks, where you may rent or purchase top films and video games as well as tickets to the cinema. A streaming video joint venture with Verizon (NYSE:VZ) under Redbox Instant brand was formed.
    3. Ruby (US): kiosk network, that prepares fresh ground coffee for $1 per serving.
    4. EcoATM (US): a very promising new venture, where Outerwall was first involved as a 23% stakeholder, and then acquired the entire stake for $ 350 million. EcoATM is a countrywide network of kiosks, that purchases used phones, tablets, mp3 players.

    Nearly 65% of revenue stream is represented by Redbox kiosks, but I strongly believe this is not a permanent case.

    Outerwall don't pay any dividends, but if you're holding the stock for a long time you can always simulate them by writing call options or hedge by setting up an option collar (selling covered calls and buying a protective puts simultaneously, that in most cases with OUTR is zero-cost collar combination).

    Why you should buy this stock?

    Outerwall Inc. is a technology company. Some analysts may argue this, telling Outerwall is DVD rental company and should be compared with any catalogue goods selling company, but no: they're doing everything via enhanced vending kiosks, and now have even a streaming video JV with Verizon . When talking about their rivals, you should take a look at Netflix (NASDAQ:NFLX), Time Warner Cable (NYSE:TWC) and Amazon (NASDAQ:AMZN). This list should also include Swiss Nestle S.A. (OTCPK:NSRGY) and Starbucks (NASDAQ:SBUX) and many others, as the company's new ventures such as Ruby are becoming quite popular and may be a serious market participants. By all means, nobody shall use Ruby machine at home, where Nespresso or Lavazza capsules are more convenient, but imagine office environment, malls, gyms where using capsule systems is a bit problematic and too costly, old machines such as Necta do not provide appropriate quality and freshness. Ruby is the golden player here. And yes, just $1 is quite expensive and delivers a decent profit margin, having not expensive ad campaigns and personnel costs.

    But what about the Redbox, the most important venture for Outerwall? Many Wall Street analytics like to talk about "declining DVD industry" and "they expect streaming video to be a game changer in the industry". There is some sense in what they say, but please remember just a thesis from me: DVD is a form of digital media storage, not media itself. Redbox already uses Blu-Ray discs and I'm pretty sure we will use more efficient data storage devices in nearest future.

    Redbox has some great advantages over its streaming rivals:

    1. You don't bother about your Internet connection while enjoying your movie. Remember the time we were first introduced Full HD video in 2000s? Now we are waiting for 4K and 8K resolution to conquer the market. I think streaming such high quality content shall become an issue for Netflix and peers. But I don't see anything, that will stop Redbox from renting 8K video
    2. Timing. You want to watch the top box office movies? Mostly they're not yet available on streaming networks.
    3. You can't get video games from Netflix or Time Warner Cable . You may buy them from Amazon , but I think you'll prefer lend it from nearby Redbox kiosk.
    4. Series war is going to start. Every streaming service is trying to make you watch exactly their series. And what if you enjoy both Boardwalk Empire and House of Cards? Buying all subscriptions is burning a lot of money indeed.

    Let's take a look on Outerwall's fundamentals:

    (click to enlarge)

    As you can see in the table above, OUTR is trading at a great discount when comparing it with peers.

    Also, when talking about fundamentals, it should be right to mention Outerwall is spoken to be a "most hated stock on Wall Street" and that means it has a short interest of 35% and Days-To-Cover value of 12.95. Being a deep value stock, and considering the company has quite decent balance sheet and stable revenue flows, we could assume this stock is a massive short squeeze candidate. Even if this doesn't happen in near term, this shorts are going to be a "pillow", establishing a strong bottom on current price levels.

    Outerwall Inc. operates mainly in four countries: US, Canada, UK and Ireland. I strongly believe it has plenty of room to develop into a worldwide vending network and expand to new markets as Latin America, BRIC countries and Europe. By all means this is an opportunity you should never ignore.

    Why I think this stock is cheap?

    As I've mentioned above, many analysts have some skeptic theses, as Redbox's business is going to decline and Redbox is the main cash generating unit, Outerwall will lose its positions and not be able to grow. That's why the stock is over shorted (but still is in the uprising long-term trend).

    The last guidance was disappointing, and OUTR plunged nearly 20%. Ok, bad guidance is a serious reason for a stock to decline, but was it worth 20%? I doubt this. This was a clear market panic and overreaction, driven by extreme bearish sentiment. Nobody accented that guidance was because of marketing costs and not declining market. Nobody remembered an additional 100 million stock repurchase plan was established. July 2013 was the best rental month in Redbox history. Unique credit card usage increased 11% YoY. The market ignored all of this. And this creates an opportunity to get a deep value stock with a decent discount. Also, with a market cap of $ 1.4 - 2 billion Outerwall is a great acquisition target if any company becomes interested in this business.

    My expectations and possible risks

    My current middle term valuation for Outerwall Inc. is $60 - 65 per share until year end, that means 20 - 25% growth potential. I don't see any significant risk factors that will drive the stock down and it fails to get to this target. Long term risks are tied with the management of Outerwall Inc. and their ability to make right decisions with a good timing. If the company fails to maintain the growth and development market expects, it may be quite a notable issue for its value.

    My stock recommendation: Buy at $48 - 50 per share with a target of $60 - 65 per share. Use options to hedge your positions or generate any additional income.

    Additional disclosure

    I own OUTR stocks and use options to hedge my position. I am going to hold and add to this position as this stock meets my conditions.

    My views are my own and based on research I've conducted. Please do your own research before making a decision.

    Disclosure: I am long OUTR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Oct 01 1:47 PM | Link | 2 Comments
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