Is Coinstar Destined to Become Pocket Change?

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Alan Brochstein , CFA submits:

I don't follow Coinstar ( CSTR ) very closely, but I have paid attention to the company for several years now. For those not familiar with it, it's the operator of those ubiquitous coin-counting machines, but, more importantly, it is the operator of those ubiquitous Redbox DVD rental kiosks.

Most recently, I was very impressed by their hiring of Scott Di Valerio as their CFO last year, adding significant legitimacy to a company whose business model has been changing over the years and is questioned over the longer term. Di Valerio, a Microsoft ( MSFT ) veteran, was a very senior member of their Finance Department who was thought to be a potential successor to John Connors when he left in 2005. It wasn't because of this that the stock did so well last year - that was a function of better expected earnings estimates:
Reuters 2010 Earnings Estimate Progression for Coinstar

As you can see, the estimates rose from about 1.60 for 2010 to about 2.20 over the past three quarters, rising substantially after each earnings report. The numbers for 2011 were similar, with the estimate rising from 2.26 three quarters ago to 3.34 at year end (roughly 50%).

The stock was shredded on Friday after a nasty pre-announcement, leaving the stock 37% below its all-time high set in late November. It's still sharply higher than when Di Valerio's appointment was announced in March:

CSTR 2-year Price Chart

Before I address the fundamental issues, let's talk about the chart. First, this was a big breakout earlier this year (right after Di Valerio joined). The 38 level had been resistance for quite some time - that was the prior all-time high in May 2008, and you can see the several attempts in 2009 to move higher. Second, after Friday's plunge, there is an "island" of trading left above. Interestingly, there was an island previously after the April breakout that was ultimately essentially filled at the lows in September (38.75). A final technical observation is that this guy is still in a longer-term uptrend for now and has beaten the market by 39% over the past year despite the recent carnage. From the lows of 2008 (15.71 in December) to the peak two years later, the stock has now corrected approximately 50%.

So, is this one worth taking a shot? I think it merits serious consideration, and I hope to spend the next few weeks giving it more thought. The preannouncement that they shared late Thursday was all about short-term issues from what I could tell, and investors should be aware that the real challenge on this stock is its long-term strategy. Many are betting (23% of the float is short) that it lacks a strategy to be viable in the future, as digital delivery of movies will make the company about as appealing as a dial-up internet provider. I tend to think that this view is overstated -- they used to say the same thing about Netflix ( NFLX ). Like the dollar stores, which maybe should have been wiped out by Wal-Mart ( WMT ), dollar DVD rentals will likely enjoy a long tail.

Looking specifically at the recent news, here are the key points:

  • Q4 Sales will be $391mm rather than in a range of $415-440mm (still 31% growth and redbox growth of 38%)
  • GAAP EPS will fall between .65 and .69 rather than in a range of .79-.85 (though .04 of the reduction is due to a higher share count and to share based expense due to the run-up in price at year-end). This is flat sequentially but up huge from a year ago.
  • Performance was weak from new title releases and slower uptake of Blu-ray titles - note that this was the first quarter with the new 28-day delay for new titles.
  • The company also admitted to having removed older inventory too early.
  • Finally, customers returned rentals to different kiosks from which they rented to a greater extent than expected.
  • For 2011, the company now expects sales of $1.7 to $1.85 billion and GAAP EPS of $2.60-3.10 - previous consensus was EPS of about $3.34.

What can we make of all of this? My first observation is that the growth is stunning, yet below expectations. Second, it seems like all of this is due to short-term factors. The economy is much stronger than a year ago, and I maintain that people weren't as shy about going out and spending money during the holiday season. Additionally, from what I have heard, the titles weren't very good. My family tends to be a consistent small user of Redbox, and we didn't rent any movies in December. We did go away for a few days, but the real issue was that nothing was that appealing. Is all of this worth a 33% drop in the value of the company?

The long-term story is not as clear to me. The bears would argue that there are too many kiosks out there and that the demand for physical DVD rentals will be in decline. I would suggest that the company has probably benefited from some high profile video chain store closings as well, exaggerating growth. That guidance was a bit too wide for my liking (a 15-20% spread in the EPS outlook), but the stock has moved to a defensible valuation level now. At the low-end, the stock trades at 16PE. The median over the past 5 years has been 32X. The balance sheet is fairly strong, with net debt to capital at Q3 roughly 27%. Total Net Debt is less than 1X trailing EBITDA.

Bottom-line: Gun to my head, I would buy. Since there isn't a gun to my head, I plan to investigate further over the next month. The company will be reporting on 2/3.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

See also Mead Johnson Nutrition CEO Discusses Q4 2010 Results - Earnings Call Transcript on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: CSTR , MSFT , NFLX , WMT

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