OUTR - Outerwall

[FCharlie]

I'm modeling a 15% a year fcf decline for redbox 16-18' and 25%/yr thereafter. For coinstar 10% yr decline 16-18 then 20%/yr thereafter.

 

Using 64% fcf to buybacks, 6% divi, 5% misc, 25% debt.

 

This gets me to around a 10%/yr return, next 6 yrs, including divi, w an exit multiple of 5x fcf.

 

That being said, if the declines I'm using in the model for 16-18 happen to be true, its likely at some point others will stop discounting such a fast drop off and you may get out with a much better price.

 

Anyways, having a hard time getting psyched here. I suppose its a decent margin of safety if my numbers prove to conservative.

 

Why are you projecting 10-20% declines in Coinstar??  Coinstar has had increasing sales and increasing operating income for years. What's your thinking on this?

 

Revenue:

 

2012: $290,761,000

2013: $300,218,000

2014: $315,628,000

2015 YTD is also higher than last year.

 

Operating Income:

 

2012: $63,153,000

2013: $68,585,000

2014: $85,054,000

2015 YTD is also higher than last year.

 

 

[FCharlie]

Redbox questions:

 

What is the presumed negative operating leverage going to come from? Credit card interchange should decline along with sales, don't retailers collect a portion of revenue? If so that should decline along with sales also. Outside of this you have expense associated with workers maintaining these machines, so I see the opportunity for negative leverage there.  Someone help me with more ways.

 

Also, what choice do customers have other than Redbox for new releases. Outright purchase of a movie is one. What else? Netflix never has new releases.

 

 

[Jurgis]

Netflix never has new releases.

 

Netflix streaming doesn't. Netflix DVD/Blu-ray does. I'm not new release chaser though, so I don't know the timing vs Redbox.

[Guest roark33]

One thing I believe bulls miss is that the product isn't "new releases."  The product is entertainment.  As netflix (amazon prime, youtube, etc) becomes more dominant in households, people may decide to watch an older movie, an indie film, a documentary or for their kids, some random disney movie that never even made in to theaters.  As a parent, I can tell you that kids don't have any clue when Inside Out is coming to DVD, they are more than happy to watch Ice Age 15 or whatever else is on. 

 

As a comparison, movie theaters are the only place to watch "new" releases, however, attendance hasn't increased (and has declined) since 2003.  This isn't due to direct competition for netflix or amazon, but due to competition for the public's entertainment hours. 

 

This doesn't mean Outerwall is dead tomorrow, but it does mean that it will be a managed decline and you have to really trust mgmt to manage that decline.  Also, you have to trust yourself to sell next time the share price pops, assuming it does. 

[frommi]

One thing I believe bulls miss is that the product isn't "new releases."  The product is entertainment.  As netflix (amazon prime, youtube, etc) becomes more dominant in households, people may decide to watch an older movie, an indie film, a documentary or for their kids, some random disney movie that never even made in to theaters.  As a parent, I can tell you that kids don't have any clue when Inside Out is coming to DVD, they are more than happy to watch Ice Age 15 or whatever else is on. 

 

As a comparison, movie theaters are the only place to watch "new" releases, however, attendance hasn't increased (and has declined) since 2003.  This isn't due to direct competition for netflix or amazon, but due to competition for the public's entertainment hours. 

 

This doesn't mean Outerwall is dead tomorrow, but it does mean that it will be a managed decline and you have to really trust mgmt to manage that decline.  Also, you have to trust yourself to sell next time the share price pops, assuming it does.

 

And based on "$/entertainment hour" there is nothing that beats Netflix at the moment. Especially the new Marvel and DC Comic series are really good. Maybe i should buy Netflix.  :)

[SnarkyPuppy]

I'm finding it difficult to come up with a value less than $31 unless I use severely negative assumptions in my DCF.  This assumes $220 FCF is a correct starting point and not an outlier

[actuary]

8.25 million shares short at 12/31 on what now may be down to something like 15 million outstanding. They were low on net leverage going into 4Q, so the pre-announcement may have been pre-meditated as one poster mentioned. The new CEO certainly has incentives to pull that type of move.

 

With this much short, I wish we could find a better articulated short thesis. Past the content agreements disclosed, is there a reason these commitments will be unavoidable for Redbox? If not, where is the negative operating leverage? Is the main thesis that they will blow the cash flow and fail to pay/refi the 2019 debt?

 

Really struggling with this one, because it's hard to see how such a massive volume of low dollar transactions falls off a cliff. Can anyone point to a fair precedent for that?

 

This looks like a very low hurdle to me. Can the market be so inefficient?

 

Management should take more pricing on Redbox and raise the dividend.

 

 

 

 

[SnarkyPuppy]

8.25 million shares short at 12/31 on what now may be down to something like 15 million outstanding. They were low on net leverage going into 4Q, so the pre-announcement may have been pre-meditated as one poster mentioned. The new CEO certainly has incentives to pull that type of move.

 

With this much short, I wish we could find a better articulated short thesis. Past the content agreements disclosed, is there a reason these commitments will be unavoidable for Redbox? If not, where is the negative operating leverage? Is the main thesis that they will blow the cash flow and fail to pay/refi the 2019 debt?

 

Really struggling with this one, because it's hard to see how such a massive volume of low dollar transactions falls off a cliff. Can anyone point to a fair precedent for that?

 

This looks like a very low hurdle to me. Can the market be so inefficient?

 

Management should take more pricing on Redbox and raise the dividend.

 

Imagine being any sort of fund/money manager/even an analyst trying to explain to your clients a purchase of Redbox, the "DVD" company.  The short thesis is very much the simplistic short runway of Redbox.  I am growing more and more confident that herd bias is at play here - the short float is begging for a squeeze on virtually any good news.

 

The Redbox segment alone has $1.3 trillion dollars in revenue for the trailing 9 months, equating to $327mm EBITDA (excluding one off restructuring costs of $15mm).  Coinstar another $89mm in EBITDA (a growing segment).    That's not including any 4Q figures.  Enterprise value is roughly $1.3bn. 

 

The only substantial risks are related to efficiently allocating capital.  Efficiently buying back shares, paying down the 2019 and remaining debt, and not throwing FCF away on venture capex (ecoATM etc).  This is a real risk given managements history. 

 

I'm pretty sure it's priced for a catastrophe right now - would love to hear any opposing arguments in quantitative terms.

[BTShine]

The fact that Coinstar's Operating Income is $120 million per year and stable/growing makes me worried for anyone short this company. 

 

Redbox will eventually die, but it may not be for a while.  The CD industry took a while to die (10 yrs?). 

http://www.businessinsider.com/these-charts-explain-the-real-death-of-the-music-industry-2011-2

 

Coinstar could probably produce $50 million in FCF for a very long time. 

 

[Guest roark33]

Here is another odd example of how technology will continue to disrupt Redbox.  This will probably be considered illegal in 1-2 years, but there is a "new" service called Vidangel.  It is from Utah and very popular there.  They basically edit the movies to cut out all the bad scenes for the mormons.  However, their business model works like this.  You technically buy the video for $20, and can stream it instantly and then sell it back for $18 or $19, i.e. $1 SD or $2 HD per night. So, it is instant streaming of almost any movie immediately after it comes out on DVD for $1 or $2.  They even have an apple tv app, which makes me think it may be more legal than I think (but I am skeptical).  Anyway, my point with "bad businesses" is there is always something around the corner eating away at their business and therefore the runway may even be shorter than you think. 

 

This is anecdotal, but this service is really popular in Utah and is making its way outside Utah.  You can watch the movies without any edits, so non-Utah people can also use it without actually watching the edited versions. 

 

[BTShine]

Yes, the Redbox business will die at some point, but not tomorrow, not next month and probably not in two years.  But it will almost certainly be smaller. 

 

I was thinking about what this company would look like if you split off Coinstar and gave it $400 million of the company's debt.  Coinstar would probably have an equity value of $500 million on about $40 million after-tax and after-interest earnings.

 

Then you'd be left with Redbox and the ~$450 million remaining debt. 

 

All this said I wouldn't go long the stock.  Might go long some out of the money call options since I think the odds are about 50/50 the stock goes back up to, or past, $60 a share.

[smartone]

Someone should break up the company to save it or Redbox may bring down the whole thing.  I think coinstar will be around for a very long time.  Additional upside....have they ever considered the international coin business? 

[TwoCitiesCapital]

Someone should break up the company to save it or Redbox may bring down the whole thing.  I think coinstar will be around for a very long time.  Additional upside....have they ever considered the international coin business?

 

They are considering it now. Also, how does a massively FCF positive, profitable business "bring down the whole thing"?

[JayGatsby]

Someone should break up the company to save it or Redbox may bring down the whole thing.  I think coinstar will be around for a very long time.  Additional upside....have they ever considered the international coin business?

 

They are considering it now. Also, how does a massively FCF positive, profitable business "bring down the whole thing"?

Where did you see that? I haven't read the indentures but would the bonds let them split the company?

 

I was noodling on a DCF last night and Coinstar is really the margin of safety. Seems like they have limited pricing power left and people will likely generate less coins but it seems to have staying power.

 

Was reading some comments on the Redbox facebook yesterday (they finally did a sponsored post that actually reaches their 5.6M followers). Tons of comments about how people used to get free codes via email and text but they haven't gotten them in months. If you know which customers are renting and which aren't (easy via loyalty program, email address or credit card), how do you not send something to the ones who aren't to try to get them back? Few comments that people didn't even realize Redbox still existed until they saw the post. I realize they have a very challenging macro but it really feels like they've been asleep at the wheel as well. I'm still trying to understand the terrible Q4. The numbers would say the decline is rapidly accelerating, which is why coinstar becomes so important. The decline rate really dictates how aggressive they should be with buying back stock or paying down debt. Either way the valuation is fine unless they misjudge the runway and have refi issues.

 

[flesh]

I have a small long position at 41.

 

Coinstar is declining already on a volume basis. I believe coinstar will die as credit/debit continues to be more pervasive and the venmo's and venmo like outfits accelerate the death of cash. How quickly? I don't know. I modeled 10%/yr fcf declines going forward.

 

Redbox, like the other poster mentioned, all sorts of things can disrupt an old inconvenient (relatively) tech. You don't have to know what it is, maybe it's vidangel like. I don't know. I modeled 15% fcf declines next three yrs and 25% after that. Other than the noted secular decline and small operating deleverage, I'm more concerned with the death spiral of reverse network effects.

 

I don't know at what point but it's reasonable to assume that at some point, the decline in redbox kiosks causes less impulse buying. If you can't return your dvd anywhere, how many less people will rent randomly?

 

Streaming as indirect competition. Clearly more and more people are signing up for streaming services. Isn't it true that some portion of those people who previously didn't have a library of older movies that can be viewed at any time for free (I know streaming isn't free but 0 incremental cost) will stop renting discs and/or rent fewer discs as a result? Along the same lines, increasingly, more are getting access to video library's through satellite and cable etc.

 

In short, I have a difficult time seeing the long term value and clearly anything can happen in the next couple years before I anticipate we'll see an accelerated decline. We'll have better short term info as we lap the price increases in the next two ec's.

[Guest roark33]

A funny ad from Vidangel noting the issues with Redbox.  This company originally started to edit movies for Mormons, but has effectively created a better mousetrap to "rent/stream" movies.  I am not sure if it will continue to be legal, but on a cost basis ($1 SD, $2 HD) and selection basis, it kills redbox.

 

[JayGatsby]

A funny ad from Vidangel noting the issues with Redbox.  This company originally started to edit movies for Mormons, but has effectively created a better mousetrap to "rent/stream" movies.  I am not sure if it will continue to be legal, but on a cost basis ($1 SD, $2 HD) and selection basis, it kills redbox.

 

This doesn't sound like something that will stick around. There was a similar service a few years back that tried to exploit a loophole by playing physical DVDs in a warehouse and streaming them to individuals. The judge ruled in favor or the content owners: http://www.wired.com/2011/08/zediva-preliminary-injunction/

 

U..S. District Court Judge John Walter issued a preliminary injunction against Zediva on Monday, writing that “As the copyright holders, Plaintiffs have the exclusive right to decide when, where, to whom, and for how much they will authorize transmission of their Copyrighted Works to the public.”

 

VidAngels says their editing is legal, but I don't think anyone takes fault with their editing. It's the distribution/sell-back that's a gray area at best. Redbox has some challenges ahead for sure, but I feel pretty good that they'll have a competitive price advantage, whatever that may or may not be worth. The laws are pretty strong that i) the owner of physical media can do whatever they want with it (same laws that allow libraries to operate), and ii) digital distribution requires a license from the content owner.

[TwoCitiesCapital]

One thing I believe bulls miss is that the product isn't "new releases."  The product is entertainment.  As netflix (amazon prime, youtube, etc) becomes more dominant in households, people may decide to watch an older movie, an indie film, a documentary or for their kids, some random disney movie that never even made in to theaters.  As a parent, I can tell you that kids don't have any clue when Inside Out is coming to DVD, they are more than happy to watch Ice Age 15 or whatever else is on. 

 

As a comparison, movie theaters are the only place to watch "new" releases, however, attendance hasn't increased (and has declined) since 2003.  This isn't due to direct competition for netflix or amazon, but due to competition for the public's entertainment hours. 

 

This doesn't mean Outerwall is dead tomorrow, but it does mean that it will be a managed decline and you have to really trust mgmt to manage that decline.  Also, you have to trust yourself to sell next time the share price pops, assuming it does.

 

Thanks for sharing this. I've been thinking about this a lot over the last week and I think this has been the best bear-case that I've seen. I never considered Netflix a direct competitor, but I myself am proof of the entertainment hours as well. While I may not think that individually Netflix, Amazon Prime, Chromecast, movie theatres, etc. are direct competitors, they are competitors for people's time/entertainment and people will only allocate so much time to entertainment.

 

The expectation would be for the lower cost entertainment to win, but that's not necessarily the case when convenience is considered AND Redbox has declining convenience.

 

I am still long after having switched from shares to LEAPS to remove the capital at risk, but I will not be adding to my exposure at these prices even though they are really attractive if the thesis is intact. I need to see how the company is really doing for another quarter or two to determine if my longer-than-expected runway plays out.

 

[Guest Grey512]

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.

[TwoCitiesCapital]

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.

[Guest roark33]

I talked with the CEO of Vidangel.  Obviously he believes he is on firm legal ground, but a few things that were of interest. 

 

They have been operating since August (beta for 6 months before that).  In July of last year before the public launch, they sent letters to all the studios and corresponded with a few back and forth about their strategy (notably Fox, which still has the distribution rights to Star Wars).  He mentioned that not one of them had complained or sent any cease and desist orders. 

 

He was well aware of zediva and aereo, and was convinced their legal strategy would hold. 

 

I am not sure I think he is right, but thought I would post it.  I think the studios allow these companies to operate under the radar because it is bad press for them to sue each and every start up, but if they get big enough it might be worth their while.  In the meantime, it is only bad for Redbox.  If it does end up being legal, it will be a good example of the Innovator's Dilemma and how Redbox didn't take advantage of the shift in strategy because it would have killed their mature cash cow. 

[JayGatsby]

I talked with the CEO of Vidangel.  Obviously he believes he is on firm legal ground, but a few things that were of interest. 

 

They have been operating since August (beta for 6 months before that).  In July of last year before the public launch, they sent letters to all the studios and corresponded with a few back and forth about their strategy (notably Fox, which still has the distribution rights to Star Wars).  He mentioned that not one of them had complained or sent any cease and desist orders. 

 

He was well aware of zediva and aereo, and was convinced their legal strategy would hold. 

 

I am not sure I think he is right, but thought I would post it.  I think the studios allow these companies to operate under the radar because it is bad press for them to sue each and every start up, but if they get big enough it might be worth their while.  In the meantime, it is only bad for Redbox.  If it does end up being legal, it will be a good example of the Innovator's Dilemma and how Redbox didn't take advantage of the shift in strategy because it would have killed their mature cash cow.

Where are they getting their content? It sounds like they don't have actual distribution deals with the studios. It's not illegal if the studios are signed off on it. I just don't see them allowing people to "return" digital content that they just spend hundreds of millions of dollars to create and sharing the $1 of revenue with the provider of this "service". I agree with you that the studios may allow this to continue as long as it's not too big of a drain. As long as it's limited to a small Mormon community they don't really care but when it starts gaining market share they react.

 

[Guest roark33]

He wouldn't share the exact details, but from using the system it is probably something like this.

 

They buy enough copies that they are selling them one for one, until they are sold back, i.e. they can't stream more copies at any one time than they have bought. 

 

When you buy your copy, you set your personal filters and their software edits "your copy", then when you sell it back, the software erases those edits and allows it to be sold again with a new set of filters. 

[JayGatsby]

I didn't think you could resell digital content. I'm not denying that redbox has risks, I just don't think this is one of them.

[Picasso]

I think streaming ultimately kills off RedBox more than anything else. 

 

Streaming has changed consumer behaviors in a dramatic way.  It's not as simple as saying some people will still rent DVD's to get early access or save a buck or whatever.  There is so much content available from the comfort of ones home that you don't need to see some flick the second it gets released to RedBox.  There's plenty of other content to enjoy; if you really want to see it you'd probably go see it in theaters.  And even theaters are having a hard time driving a ton of traffic (it's like the last public setting where a bunch of people stuffed in a room don't get screened for weapons). It's not the end of the world to wait a little bit until it comes out on Vudu or Amazon or whoever.  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. 

 

Data caps on residential broadband might impact this is a bit, but RedBox is probably close to dead by then or it'll be in a form you won't recognize as similar to todays model. 

 

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.  You probably get much better returns in those bonds than owning the stock, even if you end up not making any money assuming some kind of restructuring.  Better than being wiped out on the equity at some point.