Coinstar CSTR
November 20, 2009 - 3:07pm EST by
bedrock346
2009 2010
Price: 26.36 EPS $1.04 $2.05
Shares Out. (in M): 31 P/E 25.0x 12.9x
Market Cap (in $M): 817 P/FCF 25.0x 8.1x
Net Debt (in $M): 356 EBIT 95 151
TEV ($): 1,173 TEV/EBIT 12.3x 7.7x

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Description

Every few years Coinstar sells off and presents a buying opportunity for value minded investors.  While the stock has doubled from when I first wrote it up years ago, today's price may represent one of the best buying opportunities in years.  For reasons discussed below, I believe that the coin business combined with some minor operations held for sale and the present value of NOLs supports the current price and that investors are getting a free option on the hyper growth DVD kiosk business.  In short, the Redbox brand could be worth as much as the current stock price.

 

The company has always been controversial. In the early days, when the company was just rolling out its machines, the stock was heavily shorted because shorts maintained that no one would pay the 9% transaction fee.  As the company grew and became extremely profitable the short thesis then became that the business was so good everyone would enter and do it themselves.  (In the end, only Safeway tried this tack to poor results)  Another short story was that Commerce bank, with its relatively few branches, would take away the business with free coin counting - never mind that there were always low and no fee options for the fee adverse.

 

Fast forward to today. The company's previous management team tried to turn the company into a supermarket services conglomerate and bought several tangentially related businesses - taking substantial coin cash flow to pay for these bad acquisitions.  This squandering of shareholder resources eventually drew a proxy fight from the Shamrock Activist Value Fund.  The fight was settled (but not before the company spent $6mm of shareholder money) with Shamrock gaining a board seat.  Shortly thereafter the CEO retired and Paul Davis, a Starbucks and Frito Lay consumer products veteran, was brought in to run the company.  Brian Turner,  CFO and chief architect of the failed acquisitions was fired and replaced by the Redbox CFO. 

 

Why is all this history important to making money in the stock? Because Redbox has gone from almost no machines to 30k plus machines in 4 years time and from burning cash to projections of making from $150m to $200m in EBITDA next year.  It has reached $1billion in revenue much faster than movie rental darling Netflix.   If Redbox were to trade at Netflix's 8x EBITDA multiple the stock would be worth 8x $200m or $1.6 billion - $53 a share. The coin business will do at least $100m in EBITDA next year - at the cost of just $5m of maintenance Capx.  I think that steady cash flow is worth about 10x EBITDA less Capx or about $950mm.  My cash flow estimate could be low as the business has been undermanaged for years and Davis is focused on growing it. I believe that EBITDA could end up being more like $120-130mm+ in the coming years.

 

I value the Money Transfer and Epay assets held for sale separately along with the net debt and cash value of NOLs.  Money transfer was bought through 2 deals for just over $100mm. If you add the approximately $40mm in losses the total invested is about $140mm for a business that does about $90mm in revenue and loses about $9mm in operating income. I value it at around $100mm - or 1x revenue; Western Union and MoneyGram both trade at about 2.9x revenue.  The company has not broken out the total dollars invested in Epay but the division does about $30mm in revenue and loses about $2m.  I think that unit could be worth about $30m or 1x revenue as well for total consideration of $130 for the two businesses held for sale. Obviously since the businesses lose money they could be worth less, but they are subscale businesses that could be profitable as part of larger entities like MoneyGram, Western Union and Safeway's Blackhawk unit. In any event, this is a tiny part of my valuation and you could value the held for sale companies at zero and still have 50% plus upside to the stock. There are approximately $250mm of gross NOLs - primarily generated from the disastrous entertainment acquisitions that have since been disposed.  Given the company's high level of profitability,  Coinstar should be able to use the NOLs over the next two years.  At a 40% tax rate that represents $100mm in value. Discount that number by 15% for time value and you get about $87mm in cash value.  Thus the total value of the NOLs and assets held for sale is $217mm.  Net debt is $356mm.  If you add up all the value $950mm of coin + $130m for the businesses held for sale + $87mm in NPV of NOLs and subtract out the $356mm of net debt you get $811mm in value or just over $26 a share which is almost exactly the current stock price. 

 

What you are not valuing is the Redbox business, which could be worth as much as $53 a share for a combined value of $79.  I am not predicting this level of valuation, but I don't think it is out of the realm of possibility.   Another way to look at the valuation is to take the $300m of 2010 EBITDA, and divide it into the current EV of $1.16 billion. You are creating the company for 3.9x rapidly growing EBITDA. Skeptics argue that the DVD business is going away and is not worth 8x EBITDA - never mind that Netflix is in the same dying yet growing business and has just that valuation today.  Let's say Redbox is worth 1x EBITDA or $6.5 a share.  Then the combined business is worth $32.5 ($26 for the legacy businesses and NOLs and $6.5 for Redbox), a measly 25% rate of return from here. Do I hear 2x EBITDA for Redbox? Then you get $39 or a more exciting 50% ROR.  I believe that Redbox is worth at least 4x EBITDA or $26 a share and that sometime in the next 12 months investors will double their money in Coinstar.

 

Why is the stock so cheap? The stock sold off from the high 30s following second quarter's earnings when Fox and Time Warner joined Universal as studios that refused to ship to Redbox due to the $1 a night rental fee which they view as too low and cannibalizing to studio margins.  Coinstar sued and the studios have countersued, but the fight against 40% of DVD suppliers combined with the new CFO quitting due to an unwillingness to  move to Seattle from Redbox's headquarters in Chicago and the selling of a convertible bond - have all had a negative impact on the stock.

 

In the most recent quarter,  the company beat on EBITDA and guided up but was slightly off on revenue as the DVD business went from comping positive 35% to positive 28% q/q  due to Q3 seasonality. (I wish all my 4x EBITDA companies comped this way).  Addressing supply concerns, the company has announced a work around whereby they buy the embargoed DVDs directly from retailers.  They are also suing to get supply. 

 

In the end, this will probably be settled by the facts on the ground and by business people doing the sensible thing, not by judges or lawyers.  Redbox, according to NPD data, now has 20% share of the rental market. In addition, Blockbuster is closing at least 1,000 boxes in what looks like the deathknell of the retail DVD standalone model. After all, a small kiosk effectively displaces a 4,000 sq box whose main purpose is to rent the top 20 new releases. Netflix has a back catalogue model and the rest of the DVD market will be sales through channels like Wal-mart and Best Buy.  In the short term, Redbox is actually expanding the market for DVD's at 30,000+ prime supermarket and other locations.  (The original Redbox locations were McDonald's restaurants as they founded the business to drive dinner traffic; i.e., dinner and a movie). Redbox kiosks are welcomed by retailers, especially Wal-mart because it drives traffic.   $1 a night is the best deal for movie rentals - compared even to the cost of $5 a night for vod.  It also guarantees two trips (take and return) to the market. From Wal-mart's perspective, they get to shrink thousands of square feet out of loss leading DVD footage and replace much of it with one box from which they get a rental fee.

 

Catalyst

Unlike many other value stocks presented on this site, Coinstar is actually executing very well against its business model and has experienced multiple contraction due to noise surrounding the studio litigation.  Based on Coinstar's early success in getting supply from Universal , it seems the workaround for other two litigious studios should be successful.  The stock traded up to $38 on strong second quarter results before the litigation - the results have only gotten stronger since then.  Thus strong operating results in the face of ligation should get the stock higher. The big catalyst is obviously some kind of win win settlement with one or all of the studios. Minor catalysts will be successful monetization of the assets held for sale.

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