OUTR - Outerwall

[AzCactus]

Even with a suckass movie slate gross profit for Outerwall was up y/o/y. I'm still undecided about the CEO, but the longer the stock stays around 60 dollar the bigger the margin of safety. I hope they give the new guy a shitload of stock and forces him to read The Outsiders.

 

Amen.  Read The Outsiders and remember who he works for.  I want them to buy back another 5-6% of the company sub $65. 

[JayGatsby]

What holds me back to invest again here is that declines normally accelerate if they have started, so don`t expect the decline rates to be stable going forward.

You raise a good concern that I've thought about a lot. In this instance I don't expect the rate of decline to accelerate, and actually expect it to decelerate from the rate this year. I think the price increase coupled with a bigger push from Amazon Prime / Apple / etc has caused the least price sensitive customers to jump toward streaming. As time goes on Redbox will be left with a more and more price conscious customer base (excluding video games and Blu-Ray). I don't see any competition on price for new releases, so expect a good runway there. Obviously that's just looking into the tea leaves so it's anyone's guess what will happen.

 

I wasn't too concerned that the CEO didn't use the term "capital allocation." Actions speak louder than words, and at least for now he's made the right decisions. The have a "capital allocation" section of their quarterly earnings news release.

 

Interesting points on keeping stock low. I don't think that's what they're trying to do, but who knows. It's definitely helpful for us long-term that the price has remained low, although it's sometimes difficult to remember that.

 

I thought about it a bit more and I'm warming up to the Gazelle acquisition. Eco is currently run-rating 2M value devices a year at an ASP of $59. My guess is part of the challenge on the ASP is they don't have a direct method to sell the devices and are basically selling them wholesale. If they can another 10% ($6) per device Eco becomes breakeven and if they can get another 20% ($12) per device it actually becomes profitable. Will be interesting to see what they can do.

 

Wonder what would happen if we ordered the The Outsiders via Amazon delivery to the corporate office...

[AzCactus]

What holds me back to invest again here is that declines normally accelerate if they have started, so don`t expect the decline rates to be stable going forward.

You raise a good concern that I've thought about a lot. In this instance I don't expect the rate of decline to accelerate, and actually expect it to decelerate from the rate this year. I think the price increase coupled with a bigger push from Amazon Prime / Apple / etc has caused the least price sensitive customers to jump toward streaming. As time goes on Redbox will be left with a more and more price conscious customer base (excluding video games and Blu-Ray). I don't see any competition on price for new releases, so expect a good runway there. Obviously that's just looking into the tea leaves so it's anyone's guess what will happen.

 

I wasn't too concerned that the CEO didn't use the term "capital allocation." Actions speak louder than words, and at least for now he's made the right decisions. The have a "capital allocation" section of their quarterly earnings news release.

 

Interesting points on keeping stock low. I don't think that's what they're trying to do, but who knows. It's definitely helpful for us long-term that the price has remained low, although it's sometimes difficult to remember that.

 

I thought about it a bit more and I'm warming up to the Gazelle acquisition. Eco is currently run-rating 2M value devices a year at an ASP of $59. My guess is part of the challenge on the ASP is they don't have a direct method to sell the devices and are basically selling them wholesale. If they can another 10% ($6) per device Eco becomes breakeven and if they can get another 20% ($12) per device it actually becomes profitable. Will be interesting to see what they can do.

 

Wonder what would happen if we ordered the The Outsiders via Amazon delivery to the corporate office...

 

I would be willing to chip in for that lol

[JayGatsby]

So shame on me for being too lazy to ever go try out an ecoATM, but I have an old iphone 4s and an old moto x sitting in a drawer and decided to see what Gazelle would buy/sell for. Also tried out a few others. They call them "certified pre-owned", similar to what you'd get at a car dealership. Also have a 30 day return policy.

 

iPhone 4s 16GB Verizon:

Buy: $20

Sell: $159.

 

Moto X Gen 1 Verizon

Buy: $5

Sell: They only sell iPhones and Galaxys

 

iPhone 5 16GB Verizon:

Buy: $70

Sell: $239

 

iPhone 5s 16GB Verizon:

Buy: $125

Sell: $319

 

Galaxy S3 Verizon:

Buy: $25

Sell: $149

 

I never thought I'd say this, but I actually like this investment for ecoATM. I think most of us value ecoATM at $0, so any incremental upside is good. It looks like the margin is in selling direct to the consumer. If the ASP for an ecoATM "value" device is $60 I see a lot of margin upside here. Unless Gazelle has some crazy amount of marketing or overhead I can't see how they aren't cash flow positive with those kind of margins. Eco should be able to leverage a lot of their existing overhead. We'll see I guess. Considering we're getting the business for free, it seems like a worthwhile experiment.

[Guest roark33]

Gazelle is almost certainly not profitable.  They have raised 56m and sold for 18m.  Just fyi...

 

https://www.crunchbase.com/organization/gazelle#/entity

[kab60]

I'm somewhat okay with 18m for Gazelle to try and increase the spread om devices bought/sold while slashing ecoATM capex. Hopefully it's not enough to get the CEO too attached. I never understood why Coinstar didn't expand more internationally, but I'd think there was a good reason?

[JayGatsby]

Gazelle is almost certainly not profitable.  They have raised 56m and sold for 18m.  Just fyi...

 

https://www.crunchbase.com/organization/gazelle#/entity

Good find. I'll never understand how VC companies operate I guess. How do you burn through $56M buying and selling iPhones on the internet? I feel like I could start that out of my apartment and be profitable. I still feel a better about eco than I did $18m ago though.

[frommi]

Gazelle is almost certainly not profitable.  They have raised 56m and sold for 18m.  Just fyi...

 

https://www.crunchbase.com/organization/gazelle#/entity

Good find. I'll never understand how VC companies operate I guess. How do you burn through $56M buying and selling iPhones on the internet? I feel like I could start that out of my apartment and be profitable. I still feel a better about eco than I did $18m ago though.

 

Its because ecoATM has negative scale, the more phones you want to sell the lower the price you will get. Thats probably the reason they didn`t have the problems they have now while testing. But that could have been avoided with 10 minutes of logical thinking. ecoATM is dead money and with the iPhone leasing model this will get even harder in the future. more used devices=more competition=lower prices.

[AzCactus]

Gazelle is almost certainly not profitable.  They have raised 56m and sold for 18m.  Just fyi...

 

https://www.crunchbase.com/organization/gazelle#/entity

Good find. I'll never understand how VC companies operate I guess. How do you burn through $56M buying and selling iPhones on the internet? I feel like I could start that out of my apartment and be profitable. I still feel a better about eco than I did $18m ago though.

 

Its because ecoATM has negative scale, the more phones you want to sell the lower the price you will get. Thats probably the reason they didn`t have the problems they have now while testing. But that could have been avoided with 10 minutes of logical thinking. ecoATM is dead money and with the iPhone leasing model this will get even harder in the future. more used devices=more competition=lower prices.

 

It's a good thing than that EcoATM should continue to be a small part of their business.  I think there are two key takeaways:

1. This is the first acquisition under the present CEO.  Thus, we shouldn't just assume it won't work just because previous management made poor acquisitions.

2. This investment working out is not predicated on perfect asset allocation but solid asset allocation.  The company bought back a ton of shares and will probably continue to do so sub $65 would be my guess.  Between you and I it would appease me more if they paid $0 dividend and bought back more shares. 

 

 

[mcliu]

Is it game over for RedBox if the streaming services like Netflix sign a deal with the studios to provide films on the same day as DVD releases? What are the chances of that?

[AzCactus]

Is it game over for RedBox if the streaming services like Netflix sign a deal with the studios to provide films on the same day as DVD releases? What are the chances of that?

 

Obviously your question is relevant, but I'm not sure how you go about handicapping that.  All I know is that Netflix and outerwall have coexisted for years.  I also think the value proposition of Outerwall is there cost of $1.50 I believe vs. $5 for vod.  That's a big difference.

[JayGatsby]

Is it game over for RedBox if the streaming services like Netflix sign a deal with the studios to provide films on the same day as DVD releases? What are the chances of that?

It probably would be, but I see the chances of that as pretty slim. Between Redbox, VOD and DVD sales the studios make a lot of money on the new release rental market. Then the last leg is to put them on streaming services like Netflix, similar to how they used to put them on HBO or even on regular TV. This would be a huge strategy change for the studios and I think it would cost them a ton of money if they did so. 

 

Frommi, I don't understand why eco has negative scale? Doesn't more scale in phone resale allow you to be more vertically integrated, do all the repairs inhouse, and have the infrastructure (that eco is buying) to sell direct to consumer for a higher price than you get wholesale? I still put far less value on eco than they've put into it, but those are sunk costs and if the new CEO thinks there are ways for him to earn a couple dollars from it I support that. I agree resale volumes will shrink with the lease model, but having a box sit in a mall doesn't cost much. They may even have a mall employee take the devices out of the box and mail them to a central location so the direct overhead required is almost none.

[kab60]

Is it game over for RedBox if the streaming services like Netflix sign a deal with the studios to provide films on the same day as DVD releases? What are the chances of that?

I'd say slim ~ atleast for it to be a signifikant risk at these levels. Lets do a small thought experiment; Redbox is gone in 2018. As in zero more rentals. Next year and the year after stock stays around these levels and company does ~ 500m FCF (they expect around 280m this year). That could take the enterprise value down to ~ 1100m I believe (off the top of my head) either through buybacks or paying down debt. I think Coinstar is worth around that but it doesn't really matter at these levels cause Redbox isn't gone in two years. The biggest risk is management, not Netflix (for this to be a succesful investment), but we might give them too little credit recently. These share buybacks create tremendous value and they have also bought back debt aggressively. I don't think the hard thing is to know when to buy Outerwall but when to sell.

[frommi]

Frommi, I don't understand why eco has negative scale? Doesn't more scale in phone resale allow you to be more vertically integrated, do all the repairs inhouse, and have the infrastructure (that eco is buying) to sell direct to consumer for a higher price than you get wholesale? I still put far less value on eco than they've put into it, but those are sunk costs and if the new CEO thinks there are ways for him to earn a couple dollars from it I support that. I agree resale volumes will shrink with the lease model, but having a box sit in a mall doesn't cost much. They may even have a mall employee take the devices out of the box and mail them to a central location so the direct overhead required is almost none.

 

Maybe i just don`t understand the market/business, but for me this comes down to supply and demand. I can`t imagine that demand for used devices goes up, but at the same time supply is exploding. And then there is a time lag between buying and selling and since prices of used devices deteriorate rapidly they lose money every time they can`t sell the device "in" time. (Negative working capital is something you want to see in a good business, this is the opposite.)

There is zero scale on repairs because a person can only do n repairs per hour.

[kab60]

I think those are valid points and personally I hate the business due to lack of scale effects etc. but I was surprised they'll collect ~2m devices this year. If they can get higher selling prices it might become profitable. Obviously the challenge, and why I don't think it will work, is because costs will rise when selling directly to consumers. Could ecoATM be worth anything to somebody else?

[thefatbaboon]

Ok. So I've spent my weekend trying to destroy this company. Here are my assumptions:

 

Rest of 2015

1m shares bought back for 60m. And 5m dividend.  this uses all q4 fcf.

Gazelle 20m added to debt. Bringing net debt to 850m.

Year end shares 16.2m

 

2016 - 2021

 

Red box

15% rental decline every year for 6 years. December 2016 price increase from 1.50 to 1.75. December 2018 price increase from 1.75 to 2.00. December 2020 price increase to 2.25. That these increases only have pass through of ~60% because the rest was lost to shorter rents. This meant revenues decline 15% in non price taking years and decline5% in price taking years.

Further more I assume significant negative margin leverage. In down 15% revenue years direct costs only decline 10%. Meaning that ebitda declines circa 30% in each of these years.  In down 5% years costs decline 7.5%. Meaning slight ebitda benefits circa 5%.

 

Coinstar

120 ebitda

15 capex

No growth

 

Eco

Loses another 120 (via op and capex).

Then written off.

 

Corporate and other

Costs via op and capex around 200m

 

Debt

Remains at 850m throughout

 

Tax

Continues to benefit from the depreciation shield. Until it "catches up" to capex. (Essentially means that cash taxes run at around 28% of ebitda minus interest minus capex)

 

Result

Over the six years a cumulative after tax fcf of approx 1000m.

I assume redbox and everything other than coin is then worthless.

I assume coin is worth 850 same as the 850 of debt. (About 8 times ebit. PE could easily lever that to get +20% roe at 850)

Even under the direst circumstances of 6 years of 15% annual rental declines the equity investor gets the current market cap back by the end of the 6 years.  And trades coin for the debt.

 

Anyone think the declines can be worse than -15% cagr?

Can anyone make coin worth less than 850?

Does anyone know regarding the nol potential of an Eco atm write off? Last quarters goodwill write off was not tax deductible.

 

Obviously not a good investment under this scenario. But still a six year total return of capital. Not a bad downside for a worst case.

 

[JayGatsby]

Interesting analysis. Because Eco was a stock deal they don't really get any tax benefit from impairments as far as I can tell. They can use the losses to offset capital gains, but they don't have any. There's some tax depreciation left in the equipment, but not enough to move the needle on your analysis.

 

I used coinstar this weekend for the first time in a while. I don't really understand where the costs are in that business so they must have a fairly large revenue share / lease with Kroger. Seems like they collect coins and Kroger needs coins so Kroger would just buy the coins direct from the machine with no outside labor required. Having said that, I'm not totally sure what Coinstar's value-add is to the process other than the occasional broken machine. Kroger must make enough from the machines that it isn't worth getting their own. I guess the moat here is that the consumer Googles "coinstar" when they're trying to find a box? I could see margin there going up in the short-term, but in the long-term it will probably contract. Transaction size won't really increase over time so they have to raise prices to match cost increases. I'm not sure how much higher than 11% they'll be able to go. 

[kab60]

Just a minor thing - there's 200m cash Q3 end. Net debt is more like 625m.

[JayGatsby]

A lot of that cash is trapped overseas or in Coinstar machines (with offsetting vendor payables). In their press releases they calculate net debt based on cash in domestic banks. Current # is $819M.

[kab60]

You're right - sorry about the confusion

[thefatbaboon]

Playing around with the redbox numbers really highlighted something. We all are aware of the importance of the unit decline rate but we've had no good discussion regarding the flexibility (or inflexibility) of direct operating costs.

 

I was quite disappointed seeing the results for the first three months of this year.  Units are down 16%. Pricing has offset most of that so revenue is flattish. But direct op costs are only down 7.7%.  Some of these costs are going to flex proportionately to revenues, like revenue shares. But I would have much preferred the overall decline be closer to the unit decline. In years where one can't swamp the effect with price, this Risks being very damaging to margins.

 

Ive taken my concerns into account in my destroy outerwall analysis above by having op costs perform significantly worse than revenues. But id be very interested in any good details about the redbox cost structure.  And potential for redbox to perform better. For example, might the content agreements have some delayed effect before declines work their way through?

 

Red man chew has declined low double digit for years but Swedish match have managed to squeeze a static cash flow out of it because of great pricing married to a flexible cost structure.  We all agree redbox is in decline. We all agree that there is some pricing...what do we think of the flexibility of redbox operating costs?

 

A 10% unit decline rate, 10% price every other year, and a cost structure that is declining around 8%.  That turns redbox into a beautiful see-sawing, but essentially static profit machine.

 

Take the same assumptions but have the cost structure decline 3% instead. We have a very different animal.

 

FYI I've been using following estimates:

Redbox

Ebitda 440

Capex 20

Revenue 1800

 

 

 

 

 

 

[frommi]

When the operating costs are so flexible, then why did they have to shut down redbox canada?

At current prices the margin of safety is so slim, that for me its not a good investment. There are so much better and safer things out there with BRK, LMCA, IBKR, LVNTA, etc. that i won`t touch this.

 

[JayGatsby]

When the operating costs are so flexible, then why did they have to shut down redbox canada?

That's a fair criticism. I'd imagine there's route density benefits that make it impractical to have boxes around Manitoba, but I would have thought it would work in Toronto, Montreal, Vancouver, etc

[rsmehta]

    2013: FCF: 166 mm, shares outstanding as on 12/31/2013: 26.1mm, $6.36 / share of FCF

 

    2014: FCF: 240 mm, shares outstanding as on 12/31/2014: 19mm, $12.63 / share of FCF

 

    2015: FCF: EST 280mm(assuming $75mm of FCF in Q$), shares outstanding: 16mm(repurchase 1.25mm shares), $17.5 / share of FCF

 

 

 

    Everyone is looking at the doomsday scenario, but how about the way FCF/share has grown in the past 3 years.

 

    Q4 and Q1 are going to be monster slates. I actually believe we will be somewhere between $80-90mm of FCF for each of these quarters(Q4 and Q1).

-----------------------------------------------------------

 

    You can make arguments like "if operating costs are so flexible, then why did they have to shut down Redbox Canada". Against this, I would argue "Look at how much more FCF was generated by the price increase last December, despite huge decline in rentals."

 

  Management warned of a very weak slate in Q3(Box office was down 45.3% YoY, so on a relative basis, ~23% rental decline is actually outperforming the box-office). Despite this rental decline, they still managed 65mm of FCF.

 

 

    I think Q4 will be very telling as to whether which one of the following thesis is going to hold true:

 

1. DVD rentals are in a major decline, and this is a value trap

or

2. Redbox is 50% cheaper than VOD/Apple TV/Amazon prime/Google play. They are going to be the Lowest-cost producer in the Rentals for new content. The Q3 decline in rentals was due to a weak slate.

--------------------------------------------------------

 

    I am always a believer that you typically can't mess with the lowest cost producer of anything(esp. when you are 40-50% cheaper than the alternative). I do believe that 80% of America will go the extra effort to save a couple bucks and rent from Redbox.

 

---------------------------------------------------------

 

    What would be interesting is if someone can plot YoY changes in box office content and compare that to YoY changes in Redbox rentals.

 

    This would be fairly insightful to the board

 

 

 

 

 

[kab60]

When the operating costs are so flexible, then why did they have to shut down redbox canada?

At current prices the margin of safety is so slim, that for me its not a good investment. There are so much better and safer things out there with BRK, LMCA, IBKR, LVNTA, etc. that i won`t touch this.

I'm pretty sure I'll hold on to my Berkshire stock longer than I will my Outerwall, but I think it's all about price. In 3-4 years time the company can probably halve it's enterprise value if stock stays around 60$ (unfortunately it popped today - no idea why). That would theoretically leave you with Coinstar (which I'd argue is worth half of the enterprise value today) and Redbox. Everthing Redbox earns past year 3 is pure upside. If you put a 10xEBIT multiple on Coinstar Redbox is "free" in two years. I have no idea who rents DVD's, it's dead in my Country and I always stream myself, but I suppose a combination of price, convenience and lack of decent broadband might play a role. My point is, Redbox could be dead in 3 years, and I don't think I'd lose much (if any). But if people still rent DVD's in 3 years, I'm pretty sure I'll do good. Now I might not be around in 3 years, because a high stock prices erodes my margin of safety, but I think it's hard to lose unless management does something stupid and that, I'm afraid, probably is a real risk. That's what I grapple with - not how much DVD sales decline.