Spinning Off Redbox May Be Coinstar's Best Option

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Includes: BBI, NFLX, OUTR
by: Thomas Mcmillen

Heard on the Street has a column today about Redox and their parent company Coinstar (NASDAQ:CSTR). Essentially, the article called for investors to sell their Coinstar stock based on valuation.

Currently, Coinstar is trading at about 44 times 2009 earnings (which they are expected to beat), while Netflix (NASDAQ:NFLX) is trading at around 27 based on 2009 earnings. The argument could be made that 44 is clearly a reflection of investors' optimism for Coinstar to beat earnings and a more reasonable multiple of 35 is probably the correct valuation (based on future growth prospects).

This leads me to my point: What are Coinstar's options to sustain shareholder value? In the next year they will probably have to compete directly with both Netflix and Blockbuster (BBI). Blockbuster has already started testing kiosks and plans to start rolling them out in full force in the next couple of months, while Netflix has decided to stay out of the kiosk market for now.

With the increased competition from Blockbuster and the crowded rental market in general, what should Coinstar do to avoid a falloff in growth and revenue? For now and the foreseeable future, no matter what Blockbuster does there is going to be growth with Redbox. But, at some point they will hit a wall and Blockbuster will eat into their profits and maybe their margins (however it is more likely Blockbuster is going to get the margin damage).

The best option for Coinstar might be a spinoff of Redbox. The market would value the spinoff based on future earnings and the potential for Redbox would be inflated based off of positive results thus far.

The hopefulness surrounding any offering would help shareholders get a pure play on Redbox. Which is the reason many of them are looking into Coinstar in the first place. This could also pave the way for a takeover by Netflix or a move by another media company to acquire Redbox at a heightened valuation. This is something shareholders always enjoy.

The only problem at this point is the IPO market. Only a handful of deals have been done this year, and only the strong companies have succeeded.

If anyone could break through the frozen IPO market it would be Redbox. The $1 dollar service is clearly recession proof and recessionary forces are actually likely to increase Redbox rentals. Moreover, they have not even begun to penetrate a majority of the markets.

When the street values a company at 44 times this year’s earnings, it is a reflection of confidence in a company’s future. Therefore, a deal might be able to happen, despite the strong head wind.

To lock in gains now, they could sell a majority of the shares and keep the proceeds to invest somewhere else. They could also maintain an interest, in case this decision turns out to be regretful.

Will this likely happen? Probably not. But, even though it sounds crazy, and probably is, it could be the best move in a long term plan for Coinstar.

Disclosure: I am not currently long or short Coinstar, Netflix, or Blockbuster, nor have I been in the past.