OUTR - Outerwall

[FCharlie]

Entertainment hours are limited. If you take the argument one step further, *everything* that distracts you - Instagram, Snapchat, Facebook, LinkedIn, the Apple Watch alerts from your wrist, the ever-increasing number of hours we are spending staring at our phone screens - is a competitor to RedBox.

 

And of course, the DVD drive as a hardware component is dying.

 

I was long OUTR briefly last year and thankfully sold out above $70. I don't know what in the world I was thinking.

 

WHATEVER way you look at it, ALL of OUTR (not just RedBox) should not be around in 20 years. Laugh at this if you want, but cash & coins will get gradually subsumed by electronic payments and then will get subsumed by bitcoin. Bitcoin is a superior form of currency, whatever way you look at it. It will be huge.

 

I don't have the balls to short Outerwall though.

 

Nobody is arguing for 20 years. The thesis is, at the current price, it only has to last a 3-4 years to make an astounding return on the remainder, coinstar, which is likely to be around for the next 10 years.

 

When I go back to big cities in the midwest, like St. Louis, I still see people using cash for a large number of their transactions and know plenty of people, including my little brother, who save their change from these cash transactions. My little brother rolls his own change, but I imagine a large number of people don't have the patience for that and are ok with taking it to Walmart and getting a gift card in return. Physical cash will likely disappear, but it's going to take longer than most think.

 

Change doesn't happen that quickly for things that are that big a piece of people's life and that the infrastructure is built out for - that's why QWERTY keyboards are still the standard despite being shown to be less efficient and accurate than other arrangements. Everybody already knows how to use QWERTY, learned to type with that arrangement, and there's a large infrastructure in place that has adopted it. Same thing exists with cash but it will eventually be eroded away just like QWERTY will eventually be eroded away by things like voice dictation.

 

Whenever I hear someone saying that cash is dead, I remind myself of being a kid and watching Back to the Future 2 when Marty McFly goes 30 years into the future ( to Oct 2015) and there are flying cars.  It's fun to imagine but really, I don't see cash going anywhere. It may even be a decade before the U.S eliminates the penny and rounds cash transactions to the nearest nickel so I'd be reluctant to project Coinstar's death.

[nafregnum]

Otherwise it's just a pain in the ass to go stand out in the cold outside some 7/11 and hope you don't get mugged. 

 

Ha!  I had that very feeling last night as I returned 3 DVDs outside a Food4Less in San Diego.  I wish I'd done that kind of informal due diligence before I went long back in the 60s...  :P

 

I'd probably stick with their bonds if I wanted to invest in this business at all.  Trading in the 70's with mid-teen yields. 

 

Crap!  Their bonds are in the 70s?  Is that a recent deterioration? 

 

[Picasso]

Yeah they were trading mid 90's for most of last year and then fell apart after that last earnings report.  Short maturity as well for that kind of bond pricing (2019).

[beerbaron]

Anybody could PM the prospectus for the bonds?

 

BeerBaron

[dabuff]

As a customer, I can say the only thing that keeps me going to Redbox is the price and the fact that much of what I stream does not come out in 4k (to compete with Redbox's Blu-Ray)

 

But as soon as someone offers streaming services of relatively new movies for <$1.50/day, won't that destroy my need to go to a physical kiosk, however close it may be?

 

And from a strategic perspective where are the barriers to entry?

 

The growth over the last several years has been phenomenal though; the question is what does the future look like?

 

If you look at their financials, they would have made 165m profit in the last year, with ~60k kiosks. That adds to only 2750 USD/kiosk per annum (7.50 profit/kiosk/day).

 

Don't mean to be a negative nancy just trying to figure the risk in this company's business.

[rishig]

Yeah they were trading mid 90's for most of last year and then fell apart after that last earnings report.  Short maturity as well for that kind of bond pricing (2019).

 

The 2019s are unsecured. Here are last few trades:

https://docs.google.com/document/d/1hrR_jyhoW-FGeR7YRIJsSsZgjhRl-Vd6W0OzH0AAobc/edit?usp=sharing

 

 

[JayGatsby]

As a customer, I can say the only thing that keeps me going to Redbox is the price and the fact that much of what I stream does not come out in 4k (to compete with Redbox's Blu-Ray)

 

But as soon as someone offers streaming services of relatively new movies for <$1.50/day, won't that destroy my need to go to a physical kiosk, however close it may be?

 

And from a strategic perspective where are the barriers to entry?

 

The growth over the last several years has been phenomenal though; the question is what does the future look like?

 

If you look at their financials, they would have made 165m profit in the last year, with ~60k kiosks. That adds to only 2750 USD/kiosk per annum (7.50 profit/kiosk/day).

 

Don't mean to be a negative nancy just trying to figure the risk in this company's business.

The long thesis for Redbox is basically:

1. Customers value the price advantage (as you do) and will continue to use Redbox as long as that price advantage is maintained

2. The studios have legal control over streamed content and have no reason to lower the rates. Right now a movie comes out in theaters for $10-$15, then is released to VOD for $6, then usually 28 days later is released to Redbox for $1.50, then at some point is licensed to Netflix. That process maximizes lifetime value to the studio of content so no changes are on the horizon that would be detrimental to Redbox.

 

Time will tell if that thesis is right or wrong, but at least that's how I see the long thesis. I feel pretty good about #2... if anything I'd expect studios to want to charge more for their content over time as their costs increase. #1 is more worrisome given Q4 trends.

[rishig]

Yeah they were trading mid 90's for most of last year and then fell apart after that last earnings report.  Short maturity as well for that kind of bond pricing (2019).

 

The 2019s are unsecured. Here are last few trades:

https://docs.google.com/document/d/1hrR_jyhoW-FGeR7YRIJsSsZgjhRl-Vd6W0OzH0AAobc/edit?usp=sharing

 

Sorry, bad link. Updated now and it should work.

[dabuff]

As a customer, I can say the only thing that keeps me going to Redbox is the price and the fact that much of what I stream does not come out in 4k (to compete with Redbox's Blu-Ray)

 

But as soon as someone offers streaming services of relatively new movies for <$1.50/day, won't that destroy my need to go to a physical kiosk, however close it may be?

 

And from a strategic perspective where are the barriers to entry?

 

The growth over the last several years has been phenomenal though; the question is what does the future look like?

 

If you look at their financials, they would have made 165m profit in the last year, with ~60k kiosks. That adds to only 2750 USD/kiosk per annum (7.50 profit/kiosk/day).

 

Don't mean to be a negative nancy just trying to figure the risk in this company's business.

The long thesis for Redbox is basically:

1. Customers value the price advantage (as you do) and will continue to use Redbox as long as that price advantage is maintained

2. The studios have legal control over streamed content and have no reason to lower the rates. Right now a movie comes out in theaters for $10-$15, then is released to VOD for $6, then usually 28 days later is released to Redbox for $1.50, then at some point is licensed to Netflix. That process maximizes lifetime value to the studio of content so no changes are on the horizon that would be detrimental to Redbox.

 

Time will tell if that thesis is right or wrong, but at least that's how I see the long thesis. I feel pretty good about #2... if anything I'd expect studios to want to charge more for their content over time as their costs increase. #1 is more worrisome given Q4 trends.

 

Thanks JayGatsby. I was thinking along those lines as well. So the question really is what probabilities assigned to either of those negative terminal events.

Like you point out it certainly is not in the studio's best interest to lower the price from there. What is stopping another company from replicating its business model?

White/black swans are ever lurking...

[Picasso]

Sorry meant the 2021's.

[rishig]

Sorry meant the 2021's.

 

2021's are in the low 80s, implying a 10% return in case they perform. If redbox starts to evaporate 5 years from now (quite likely) around 2020 - 2021, it's possible that the unsecured's may get impaired. Can Coinstar alone producing $90M in pre-tax income support $850M in debt? Also, the quality of assets in case of a bankruptcy seems weak to support the unsecured in case of a liquidation. All this for a 10% return?

 

(rounding off)

Current assets: $390M

Property and equipment: $350M

Tangible assets: $740M

***************************

Current liabilities: $400M

Total debt: $850M

***************************

 

[Picasso]

That's what makes the equity so risky in my view. If the debt is at 10% now before we've seen that deterioration in a major way, what do people think their cost of debt will be then?  If you can't get comfortable with the debt not sure why people are comfortable with the stock.

[rishig]

That's what makes the equity so risky in my view. If the debt is at 10% now before we've seen that deterioration in a major way, what do people think their cost of debt will be then?  If you can't get comfortable with the debt not sure why people are comfortable with the stock.

 

As an equity investor, it seems nice to see outerwall use its free cash flows to buyback stock. But if every single outstanding share is purchased back other than yours, you are still left with a company that produces pre-tax pre-interest income of $90m from coinstar with $850m in debt and redbox assets that are completely worthless at the end of 5-6 years (unless you think that DVDs will be relevant for a much longer period).

 

I would think hard about this before getting seduced by the buybacks.

 

[KCLarkin]

Total liabilities dropped $200M over the last 9 months. Why do we assume that they will still have $850M debt in 5 years?

 

I agree with your premise though. I stayed away becuase of the debt.

[rishig]

Total liabilities dropped $200M over the last 9 months. Why do we assume that they will still have $850M debt in 5 years?

 

I agree with your premise though. I stayed away becuase of the debt.

 

So, let me address this another way.

 

Current shares outstanding: 17.3M

Share price: 33.8

Market Cap: $585M

Net debt: $850M

Enterprise Value: $1435M

 

Say between now and 2020, free cash flow generated from the business is $750M ($150M average). (Maybe they use some of it to buyback and some of it for debt reduction, we don't know in what proportion).That gives you an ending Enterprise Value of $685. In the end you are left with Coinstar that generates EBIT of $90M. So, you have at that point, a business with EV/EBIT of 7.5x. A fair price in my opinon (provided average free cash flows are $750 in aggregate over next 5 years).

 

If free cash flows from redbox were to decline faster or if management gets some crazy new idea, you are out of luck. Also, the assets don't provide much protection on the downside. If the business is impaired, the balance sheet has negative book value.

 

In addition, management's capital allocation is not very inspiring. Throwing away money at buybacks has rarely been a good idea in a declining business in retail. See ARO as an example.

 

The *only* way to make money here is to have the confidence that free cash flows over the next 5 years are going to be significantly higher than $750M in aggregate. It's possible, but what are the odds? And why are the odds good?

 

I don't think even the longs think that RedBox will be around 5 years from now. So, this is a bet on decline rates and how much free cash flow is generated in the interim - an exercise that requires precision that is hard to calculate based on currently known data (or is difficult anyway).

[Txvestor]

A couple of points. I do not think their business declines homogeniously. I think there are regional variotions, urban v rural, etc. they have 40k+ kiosks, and i'm pretty sure some of them are insanely profitable, compared to others that are marginal. Tweaking that, their content, their pricing and many other variables can improve business performance. I also think they could and probably eventually would get used to a shrinking kiosk to the core model. I don't quite see that yet in their thinking but it eventually will enter.

Coinstar is a very stable business and one capable of servicing the debt by itself. I beleive that was in fact a large part of the reason why they were able to leverage up. The question therefore becomes ALL about capital allocation skills. If they piss it all away on ventures like ecoatm etc. then you are absolutely correct in that they will like Zinc, file BK even with good assets.

I think their approach will be evident when the buyback numbers for the current quarter become public. Many on this board believed that buybacks in the 60-80 tange were worthwhile but any higher and it was perhaps not great capital allocation. Well at half off, it should surely be good allocation. And if they bought back boatloads at 70 and hesitate with cash flows at 34, then it is a sign that they themselves have no confidence in their strategy.

Finally like it has been pointed out, I beleive apart from the secular decline, recent management of the business has been poor. They have got rid of the operations guy and this is one of those scenarios that with such pessimism baked in, and such a high short interest, any positive developments could rocket the price.

[shalab]

I looked at OUTR a while back and I didnt like that they were loading debt on to the balance sheet especially when the future cash flows are dwindling. I do think however that DVD sales will have a long tail and won't go to zero in five years. This is because the tv sets and dvd players last a very long time. I was in a bread and breakfast recently and they had movies on video tape.

 

Even though there are some gurus who are in this, to me there was no margin of safety in this investment.

[Sunrider]

I think that Coinstar may well be able to carry the debt, FCF can go to repurchases and some pay-down and they can optimise the location. But the big issue is - I've not seen anything in Prush' vita to indicate that he understands value or has done something like this before. What's needed is him to accept that he's not a superhuman CEO meant to find a Haleluja acquisition but one that should grind out the efficiency, shrinking the business to great returns through the continuation of the leveraged recap.  Most CEOs aren't made that way --- and even fewer Boards get it (imagine the conversation at the club - "oh yeah, that business that you're a director of? I hear it's shrunk by half!").

 

That's the problem (well clearly there are others, but this is the hardest I see to overcome ... Now that I convinced myself, I better sell before results - chances are there will be announcement on some other stupid way to spend shareholders' money and management will be entirely surprised that the market isn't applauding).

 

S.

 

[Guest Grey512]

• A quote from JRW, a fund manager, about their Outerwall position, from a recent Q4 letter:
   
  
  Generally in these letters, I like to highlight a new business we own, or an existing business I believe is exciting enough to share with clients and interested parties. In previous letters, I have outlined our thesis behind owning Interactive Brokers and World Wrestling Entertainment. I’ve also detailed the investment thesis in another business, which we ended up selling in the fourth quarter, and about which I made a sizeable mistake. I believe in fessing up for my mistakes, partly because my clients deserve such candor, and partly because I take every mistake I make as an opportunity to learn and become a better investor. This will certainly be the case when I look back on our ownership of Outerwall Inc (OUTR). I’ve done a lengthy post-game analysis on our ownership of Outerwall, in no small part because I pounded the drum pretty loudly on why I believed it to be a wonderful business that wasn’t given nearly enough credit by the market. I believe my biggest mistakes were being deceived by the attractive quantitative metrics (seriously, I salivated over a high teens free cash flow yield) and not recognizing the extent to which the melting ice cube was melting. I acknowledged that this was a business in secular decline, but I believed that the decline was going to be far slower and much less dramatic than what others believed, and than what the results have shown. I believed the extensive footprint in most major retail locations was going to make up for weak box office numbers and the nature of the decline in the physical DVD rental business. I believed that the weakness in recent box offices would be more than made up for by incremental price increases, and that ultimately the company would benefit from the string of upcoming blockbusters movie studios have in the pipeline. In reality, the DVD business is declining as quickly as one would expect from an outdated technology that is proving to be more obsolete by the day. There is a reason the free cash flow yield was and continues to be so high – it portends a dramatic fall off in the fundamental operations of the business. Redbox is still around, and may be around still for some time, but the ubiquity of streaming options and over-the-top applications are going to continue the DVD’s long march to the way of the VHS tape – and ultimately, walk Outerwall on the path of Blockbuster. The ice cube continues to melt and frankly it’s not likely to get any better. While the Coinstar business is a nice complementary business line, it’s never going to be a revenue driver. And the company made an ill-fated attempt to invest in the echoATM concept which never caught on and which is easily replicated.
   
  We took a haircut of more than 50% in our position across various accounts. This was a bad investment at a bad time by me, plain and simple. I apologize for what in retrospect was poorly placed support for this business. It might continue to be a viable entity, but it certainly should not have been a position in our Core Equity portfolio, and my inclusion of it as such was a bad error. Mistakes like this will happen again, but I promise to do my best to prevent them to the maximum extent possible, and to limit the harm to our portfolios when I do indeed make another mistake.
  

[AzCactus]

I dont know much about this manager.  From what little I see it appears that he doesn't have a great track record.  Although it also appears he has a newer fund.  Of much more relevance to me will be to see what arlington did over the past quarter.

[Txvestor]

I agree with the above. The last quarter numbers shook the confidence of a lot of people. The credibility of management in repeating the same BS about poor box office was very disappointing to say the least. That said heads did roll at the top, and they promised better execution and investment in reviving the business, whether that will happen or not is another question, but certainly it demonstrated to me that they feel atleast internally that execution was part of the problem.

The debt paydown and stock price collapse have decreased the enterprise value significantly, and

arguably raised the stakes significantly. If you estimate the FCF over the next year ar 225M, and they continue buybacks with most of it, they could potentially drop sharecount by a third. They probably also have one more price hike left, and if operations do turn, then it won't be long before mr. Market notices. Even if the secular decline in redbox was faster than anticipated, i think they could still manage it to positive cash flows by retreating to profitable kiosks for a few more years. So I think the question is how much will the FCF be, rater than if there will be atleast for the next 5 yrs.

Finally Coinstar provides a measure of comfort on the debt front. And as long as redbox pays down a good chunk of the debt and winnows down the shares before its death, that should leave the shareholders left behind with atleast coinstar which I believe is a very stable business which debt free shpuld probably easily be worth a 1B enterprise value. I mean credit cards have been around for well over 30 yrs and cash hasn't gone anywhere. So i don't think anything is goong to happen to that near term. In fact arguably recessions help them as people dig into their cupboards amd drawers  looking for extra cents whereever they can find them!

The issues have always surrounded managements capacity to allocate capital, and manage the decline efficiently. This past uear was disappointing, but the old management is out, so we will have to give the new guys a bit more time. However at these stock prices, I think the risks are more than adequately priced in here.

 

[Guest Grey512]

dsachory - why do you care what Arlington / Mecham did?

Did you just buy this because of Arlington?

 

No one is infallible.

 

In fact, right now it looks like the probability that Mecham made a mistake is higher than that he is right.

[feynmanresearch]

dsachory - why do you care what Arlington / Mecham did?

Did you just buy this because of Arlington?

 

No one is infallible.

 

In fact, right now it looks like the probability that Mecham made a mistake is higher than that he is right.

 

I agree with this.So many people thought Pabrai, Ackman, Einhorn etc were gods.Look where it got them

[AzCactus]

dsachory - why do you care what Arlington / Mecham did?

Did you just buy this because of Arlington?

 

No one is infallible.

 

In fact, right now it looks like the probability that Mecham made a mistake is higher than that he is right.

 

So let's look at it this way: you basically presented some information explaining why a manager bought and sold within a 6 month time frame.  All I said was arlington with a better, longer track record is more relevant to me personally.  I didn't buy primarily because of Mecham however given his long term batting average I  am interested to see hep he approached things during q4.

[AzCactus]

dsachory - why do you care what Arlington / Mecham did?

Did you just buy this because of Arlington?

 

No one is infallible.

 

In fact, right now it looks like the probability that Mecham made a mistake is higher than that he is right.

 

I agree with this.So many people thought Pabrai, Ackman, Einhorn etc were gods.Look where it got them

 

I could be wrong but I think Mecham's long term batting average is higher than those managers. I don't think he's a god but odds are his track record is better than yours and mine.  His behavior during q4 is of interest to me just like JRW's behavior was of interest to grey.