CSTR - Coinstar

[yadayada]

ok interesting, didnt see it that way.

[siddharth18]

ok interesting, didnt see it that way.

 

Yeah. I may be wrong and heavily biased (opinionated?) but that's who I think about it. At what price would you buy/increase your position?

[yadayada]

already bought a 4% position and I got stocks that are better then this one.

 

One thing I am now not sure about is how sustainable their FCF is. What will capex be next year? In 5 years? Projected was 81 million$ in capex this year vs depreciation of like 192 million and 170 million last year I think . This is for core business of coinstar and redbox. Can you honestly say that the core business does 300 million$ in FCF and put a 10x multiple on that (if you think that revenue wont grow or shrink in that period)?

 

I really think tho that DVD and bluray will not die at least in the next 5 years.

another good article (and added numbers in attachment with dvd sales in US):

http://www.nytimes.com/2014/03/27/technology/personaltech/why-movie-streaming-services-are-unsatisfying-and-will-stay-so.html?_r=2

 

If you t hink capex will be more like 150 million for coinstar and redbox going forward on average, it is not so cheap. If you assume 250 million in a base case with this year's capex, if normalized capex is higher (more like 140-150m$), then FCF is already only 180-190 million$ in the base case. Putting a 8x multiple on that, and you really need the ecoatm to succeed.

 

Like how long do these atm's last? If they all have to be replaced at some point, then depreciation is a real charge. I did read that a lot of Coinstar machines do last past their depreciation accounting period tho.

 

Also this company gets a lot of hate from the market for a long time now, so catalysts are important.

 

i think Ill add if it dips to like 50$.

 

[siddharth18]

already bought a 4% position and I got stocks that are better then this one.

 

One thing I am now not sure about is how sustainable their FCF is. What will capex be next year? In 5 years? Projected was 81 million$ in capex this year vs depreciation of like 192 million and 170 million last year I think . This is for core business of coinstar and redbox. Can you honestly say that the core business does 300 million$ in FCF and put a 10x multiple on that (if you think that revenue wont grow or shrink in that period)?

 

If you t hink capex will be more like 150 million for coinstar and redbox going forward on average, it is not so cheap. If you assume 250 million in a base case with this year's capex, if normalized capex is higher (more like 140-150m$), then FCF is already only 180-190 million$ in the base case. Putting a 8x multiple on that, and you really need the ecoatm to succeed.

 

Like how long do these atm's last? If they all have to be replaced at some point, then depreciation is a real charge. I did read that a lot of Coinstar machines do last past their depreciation accounting period tho.

 

Ok regarding the capex, there are two sources:

 

1. Look at company's depreciation/amortization schedule [from 2013 10K]:

 

http://i.imgur.com/5nvMZVD.png

 

3-5 years seems like a really short time for kiosks to last.

 

 

2. The company presentation:

 

http://i.imgur.com/Kjun2xu.png

 

 

Of the total Capex, almost half is for "new ventures" and the maintenance capex isn't even $25M. So I really don't think Capex would anywhere near be $150M if this thing was run for milking the cash and returning it to shareholders.

 

Some comments from VIC writeups regarding depreciation:

 

"The company depreciates machines over a five year period but in the history of the company they have not retired any machines. The average machine in the field is between 5-7 years old. They still have machines in the field that were installed 13 years ago, at the beginning of company history. Once installed the machines have a long life and are cash cows."

http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/3073

 

"However, EPS is misleading as it does not include the benefits of the NOLs, much CapEx is expensed (R&D), and depreciation is much higher than necessary (i.e. No coinstar machine has ever been retired yet they are depreciated over 5 years)."

 

Source: http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/1763

 

 

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

 

 

Still I've emailed company IR about how long the machines should realistically last - will update when I hear back.

 

 

To the extent that it's being blown on "new ventures" - yes that's money leaving the shareholder's pocket and most likely isn't coming back. But the thesis is that the activist will put the pressure to cut the waste and return it all to shareholders.

[siddharth18]

Sorry for the long post. Their latest presentation has some more color on the current situation of the business. Some notes:

 

Value proposition:

 

A typical movie is on Redbox 9-12 months before pay-tv or streaming <-- content advantage

Pretty big DVD/Blu-Ray price advantage against VOD $5-$6-$7

Studio make more money on per-transaction basis with Redbox rentals than alternatives.Redbox captures price sensitive customers.Redbox enables discovery of content.

 

 

 

41M cards in Q1, 35M-36M unique customers using our service

Kiosks at 36500 stores

 

Expecting 500-700 deinstallation of kiosks this year in the USA as part of optimization. This will reduce content + operating costs. While a few hundred kiosks will be added in Canada.

 

Cash flow -

  CapEx was ~$138M two years ago. Around $22-$27M this year. Maintenance is really low - just $15M-$20M going forward.

 

5 studio agreements are set to expire this year. 3 of those are "extensions," and other two are to be negotiated. They've hired a studio exec who specifically aims to get better leverage in negotiating. Plus they're the only meaningful DVD buyer left so studios don't have many options.

 

Lumpy movie releases causes lumpy operating results.

[yadayada]

yeah I def think that streaming on demand won't become cheap anytime soon. Netflix will not offer new movie's, and dvd and bluray sales still make the studio's billions each year on the top 100 and top 20 releases (they got 50% profit margins on the numbers i posted in my last post). Netflix total cost in a year is like 1.5 billion$ for a huge library. So paying up a billion for like 20 more movies will not happen. so in that case they should lose revenue from people downloading movies illegally. But I heard internet is very crappy in the US.

 

Anyway, if they optimize a bit more and the new venture will not suck up  a lot of cash 1-2 years from now, they could possibly do more then 300 million$ then? I guess the major catalyst is buybacks then. If we assume the price won't go above 80$, they buy back 90 million$ this year at 70$ = 1.3 million shares. Next year they buy back 150 million$ worth at 80$ (if they only do 200 million$ in FCF). ANd in year 3 they buy back 200 million$ at 80$. That is 5.5 million shares. If the new ventures gives of a bit cash then, your return could be in a reasonable base case 250 million$ x 8 / 14.8 =135$ a share = 107%.

 

But I think if the new venture is a succes and they grow revenue, the market could price it at like 12x because it grows revenue again. in that case  221%.

 

If the machines really do last longer, then higher earnings should also be a catalyst here once they are no longer depreciated in the income statement?. If the market still doesnt realize it, and it takes 3.5 years, they could buy back more shares, and if FCF is still v high and Ecoatm is growing, this could be a homerun. with ~12 million sahres outstanding (if they buy back at 90$ in year 4) and a 12x multiple on 300 million$ you get a 370% return.

 

I do have problems killing this though. I get the impression that stores cannot take coinstar machines inhouse because they dont have the expertise and the scale (not even walmart). Another argument is that banks will do it. But people don't come in banks daily, they do come in stores like walmart daily. And it is extremely difficult for a competitor to break into this.

 

With Redbox, the only way this could get killed is by illegal downloading or people no longer caring much about new releases. But both don't seem very likely. That should have happened already then by now? It is 2014, I was downloading movies in 2008. And new releases have been getting worse in the last decade, but these guys have not been hurt by it.

[siddharth18]

yeah I def think that streaming on demand won't become cheap anytime soon. Netflix will not offer new movie's, and dvd and bluray sales still make the studio's billions each year on the top 100 and top 20 releases (they got 50% profit margins on the numbers i posted in my last post). Netflix total cost in a year is like 1.5 billion$ for a huge library. So paying up a billion for like 20 more movies will not happen. so in that case they should lose revenue from people downloading movies illegally. But I heard internet is very crappy in the US.

 

Anyway, if they optimize a bit more and the new venture will not suck up  a lot of cash 1-2 years from now, they could possibly do more then 300 million$ then? I guess the major catalyst is buybacks then. If we assume the price won't go above 80$, they buy back 90 million$ this year at 70$ = 1.3 million shares. Next year they buy back 150 million$ worth at 80$ (if they only do 200 million$ in FCF). ANd in year 3 they buy back 200 million$ at 80$. That is 5.5 million shares. If the new ventures gives of a bit cash then, your return could be in a reasonable base case 250 million$ x 8 / 14.8 =135$ a share = 107%.

 

But I think if the new venture is a succes and they grow revenue, the market could price it at like 12x because it grows revenue again. in that case  221%.

 

If the machines really do last longer, then higher earnings should also be a catalyst here once they are no longer depreciated in the income statement?. If the market still doesnt realize it, and it takes 3.5 years, they could buy back more shares, and if FCF is still v high and Ecoatm is growing, this could be a homerun. with ~12 million sahres outstanding (if they buy back at 90$ in year 4) and a 12x multiple on 300 million$ you get a 370% return.

 

I do have problems killing this though. I get the impression that stores cannot take coinstar machines inhouse because they dont have the expertise and the scale (not even walmart). Another argument is that banks will do it. But people don't come in banks daily, they do come in stores like walmart daily. And it is extremely difficult for a competitor to break into this.

 

With Redbox, the only way this could get killed is by illegal downloading or people no longer caring much about new releases. But both don't seem very likely. That should have happened already then by now? It is 2014, I was downloading movies in 2008. And new releases have been getting worse in the last decade, but these guys have not been hurt by it.

 

Exactly! As said in the NYT article, even if they charged a lot higher per month, Netflix wouldn't be able to afford the new/latest content unless studios suddenly agree to take a huge margin hit (and why would they?)

 

What I like the most is that management has stated to return most cash to shareholders. So this is being run for owners and providing a generous FCF yield.

 

As for coinstar business ...I don't think they have to worry about a "disruption." All the new and upcoming payment solutions are about wireless/electronic/mobile. Not a single solution in the last decade that makes it easier to redeem your coins.

 

As for illegal downloading - the cat is out of the bag already. The people that do that won't pay for any content which can be pirated...so it's not like a few years from now a massive percentage of redbox will start torrenting. Plus torrent requires some sophistication - ability to find torrents and ability to use the downloaded file to stream it on TV. Not everyone has TVs connected to their PCs, not everyone has fast broadband, not everyone frequents torrent sites.

 

We know studios are greedy and the last thing they want is to lower their margins on their content. There's a segment that refuses to pay $4-$5-$6 per movie when it's available for ~$1.2 per night...so it's pretty clear Outerwall isn't going away in the next year. We shall see.

[yadayada]

i guess if you think about it logically, 3-5 years for a redbox is pretty ridicilous. maybe some high friction parts inside the machines need to be replaced from time to time, but to replace the whole thing every few years? I wonder why they marked the usefull life at 3-5 years?

[siddharth18]

So Outerwall can borrow money at 5.875% from the bond markets: http://www.sec.gov/Archives/edgar/data/941604/000119312514225711/d737173dex991.htm

 

Yet the equity markets shun its equity yield over 15% FCF yield. If the company goes under, aren't bondholders and shareholders wiped out? Or are kiosks really worth equal to or more than outstanding debt?

[siddharth18]

i guess if you think about it logically, 3-5 years for a redbox is pretty ridicilous. maybe some high friction parts inside the machines need to be replaced from time to time, but to replace the whole thing every few years? I wonder why they marked the usefull life at 3-5 years?

 

I emailed IR and received a pretty detailed answer about the Capex.

 

 

IR's response below:

 

The useful life of a Redbox kiosk as determined by accounting rules is 5 years, and that is the basis we use for depreciating a kiosk. Certain components are depreciated over 3 years.

The majority of the Redbox kiosks were installed over the past few years. They were manufactured by Flextronics and we believe have a much longer lifespan than 5 years. Redbox has been in business for just over 11 years, so the early kiosks have been replaced over time as newer and advanced models were introduced.

Coinstar has been in business for over 23 years. There have been several models of kiosks and over time the newest models replaced older models.

We are close to a steady state in those areas and would expect to reduce CAPEX across the business except for ecoATM, as we are planning to invest in scaling that business.

In terms of maintenance CAPEX, in the next few years, we would consider a steady state for

·        Coinstar to be in the same range, $4-$5 million, it is today or slightly higher;

·        Redbox will likely grow to $15-$20 million over time, given the size of the network;

·        Corporate will likely be in the range of $25–$30 million, which is primarily for maintaining the infrastructure necessary to support for our businesses (data centers, customer service centers, etc.)

 

 

Meanwhile stock dropped some today too. It's strange because the bond holders don't perceive OUTR's business as perilous while the equity holders are skittish. I can't tell if it's just the bears rattling their sabre or the devout fleeing.

 

At least $200M FCF annually on $1200M equity value.

[enoch01]

Thanks for posting that, siddharth18!

[no_free_lunch]

One thing that concerns me with the company is the increase in debt.  It looks like they have gone from about $170M LT debt a couple years ago to $900M most recent quarter.  From what I can gather it has been returned to shareholders in the form of share buybacks so I won't say it was wasted.  However, $900M is a lot of debt for a business that looks to be flat-lining and in danger of going into decline.  If you add the debt to equity you get $2.1B, add back about $60M interest expense (just a guess) to FCF of $200M and you're at $260M pre-interest earnings.  So on that basis it is about 8x EV / CF.  Still reasonably cheap if it's flat-lining but if the business deteriorates maybe not so cheap.

 

I have to think about this one some more. 

[siddharth18]

One thing that concerns me with the company is the increase in debt.  It looks like they have gone from about $170M LT debt a couple years ago to $900M most recent quarter.  From what I can gather it has been returned to shareholders in the form of share buybacks so I won't say it was wasted.  However, $900M is a lot of debt for a business that looks to be flat-lining and in danger of going into decline.  If you add the debt to equity you get $2.1B, add back about $60M interest expense (just a guess) to FCF of $200M and you're at $260M pre-interest earnings.  So on that basis it is about 8x EV / CF.  Still reasonably cheap if it's flat-lining but if the business deteriorates maybe not so cheap.

 

I have to think about this one some more. 

 

Thanks for viewpoint! The $200M of FCF is the lower range of the estimated FCF this year, and it INCLUDES "growth" capex (called "new ventures") as shown here:

 

 

http://i.imgur.com/Kjun2xu.png

 

My point is that they do ~$400M EBIT with Redbox alone and  ~$100M EBIT with Coin counting business (which has been incredibly stable) for a total of ~$500M EBITDA. You have depreciation & amortization exceeding maintenance capex hence your effective tax rate on cash earnings is kinda lower until depreciation starts equaling maintenance capex.

So take $500M EBITDA, subtract interest and taxes and maintenance capex and we have the better idea of the underlying FCF this business can generate.

 

They do over 700M rentals a year and they have a lot of room to bump their price. Pricing here inelastic because

 

 

(i) there are no competitors anywhere near redbox's price,

 

 

(ii) there is a segment of population that can't stream movies because they don't know how to, or can't due to lack of broadband and

 

 

(iii) the entire price represents just a tiny portion of the consumer's entertainment budget. Just a 15 cent bump shouldn't drastically depress the demand but will provide 10%+ revenue increase, with absolutely no increase in cost.

 

With blockbuster & netflix gone out of DVD business, they have quite the leverage to demand better pricing from studios (who will milk the DVDs as long as they last and redbox is their biggest buyer) and retailers (who like Redbox because it drives traffic to their store and provides great rent per square feet).

 

The bottom line is that there are many levers management can pull and imminent death of DVDs is far from certain. This may not be a bad price if all cash is returned to shareholders.

 

Would welcome your thoughts & the price at which you think it'd be interesting!

[yadayada]

oh I didnt see that. I thought it was 700 million, which was already somewhat high. Now it is close to a billion last quarter. Why do they take on so much debt? Is it to buy back stock or something? They can easily fund their ecoatm with cash from operations. ANd then they still have enough to buy back some stock. 900 million seems to be on the high side. Allthough they don't pay a lot of interest. So their creditors must not see much risk.

 

FWIW they said that Eco atm could do 100-120k$ per machine. They would install like 10k machines. that would be 1 billion$ in revenue. With expected 20-30% ebitda margins. If you assume 200 million, maintenance capex of 60 million$, and then taxes of like 40 million (assuming actual depreciation is double like with other 2 ventures), that gives another 100 million $ in FCF in a not super optimistic scenario. 120k$ per machine, 25% ebitda margins gives 300 million$ in ebitda and probably like 150-200 million $ in extra FCF.

 

Last quarter with 940 machines, they did 68k$ annually. Given that these things are probably somewhat unknown still, and new, that looks somewhat promising?

[siddharth18]

oh I didnt see that. I thought it was 700 million, which was already somewhat high. Now it is close to a billion last quarter. Why do they take on so much debt? Is it to buy back stock or something? They can easily fund their ecoatm with cash from operations. ANd then they still have enough to buy back some stock. 900 million seems to be on the high side. Allthough they don't pay a lot of interest. So their creditors must not see much risk.

 

FWIW they said that Eco atm could do 100-120k$ per machine. They would install like 10k machines. that would be 1 billion$ in revenue. With expected 20-30% ebitda margins. If you assume 200 million, maintenance capex of 60 million$, and then taxes of like 40 million (assuming actual depreciation is double like with other 2 ventures), that gives another 100 million $ in FCF in a not super optimistic scenario. 120k$ per machine, 25% ebitda margins gives 300 million$ in ebitda and probably like 150-200 million $ in extra FCF.

 

Last quarter with 940 machines, they did 68k$ annually. Given that these things are probably somewhat unknown still, and new, that looks somewhat promising?

 

They had about 800M in LT debt before the latest 5.875%, 300M notes offering. So now if you're going to count it as $1.1B in gross debt, you gotta either account to the cash due to the $300M note offering or reduce the share count (if you think it'll be ultimately used for buyback). At $60/share they can buy like 5 million shares, eliminating one fourth of the float.

 

I think they mentioned they want LT debt to be around 2x EBITDA. I don't know if that's the "right" amount of leverage to take on, but if they're going to do it, now's not a bad time to be selling debt.

[yadayada]

Am I missing something here? Current valuation makes so little sense. If Ecoatm takes off this thing could do over 400 million$ in FCF. That would mean less then 3x multiple. Red box is not even declining, it is still growing! WTF Gopro at 160x earnings, and this thing trades like it goes out of business 2 years from now. Wired some cash into broker, and will buy some more now.

[siddharth18]

I've been thinking the same thing since past two days. Maybe we are missing something...maybe coinstar isn't a stable business or redbox really will succumb to online streaming in next year or two

 

I think in the near-term, traders are expecting a weak Q2 (worse than guidance) due to world-cup, weak movie lineup.

 

http://www.homemediamagazine.com/rental/analyst-redbox-growth-facing-increased-headwinds-33457

 

http://www.homemediamagazine.com/rental/analyst-transactional-vod-not-replacing-disc-rental-any-time-soon-33545

 

http://wallstcheatsheet.com/business/analyst-entertainment-industry-continues-to-hold-steady.html/?a=viewall

 

 

http://www.benzinga.com/analyst-ratings/analyst-color/14/06/4643852/outerwall-shares-fall-following-b-riley-downgrade

[TwoCitiesCapital]

Am I missing something here? Current valuation makes so little sense. If Ecoatm takes off this thing could do over 400 million$ in FCF. That would mean less then 3x multiple. Red box is not even declining, it is still growing! WTF Gopro at 160x earnings, and this thing trades like it goes out of business 2 years from now. Wired some cash into broker, and will buy some more now.

 

I'm hoping it keeps dropping. I haven't done my homework on it enough to make it more than a starter position, but would love to see them have the opportunity to buy back in the 40s. Would also push me to get to doing my research a little faster instead of playing x box with my free time after work :)

[gfp]

My thought has been that we will see a really disappointing quarter for redbox because the new release content for the last few months has been horrible.  You can't sustain their level of business without compelling new release content.  And "jack ryan:shadow recruit" isn't gonna cut it.  I used to sell puts on this name every month but turned very negative on it until the next earnings release.

 

One bad quarterly number out of redbox will restart all the chatter that redbox is declining - even if it is primarily due to the timing of content releases.  Coinstar is almost surely stable and might even surprise a tiny bit on the upside since you can get Amazon gift cards for no fee and to an increasing number of people, amazon credit is the same as money.  EcoATM is not material and has a lot to prove before I would include it in any valuation.

 

Time to check on the timing of their earnings announcement I guess

[yadayada]

yeah but that is really short term thinking. I guess all the people in this are traders? Because that doesn't affect the business long term.

 

One note on coinstar is that they have patents. When do they run out?

[gfp]

No doubt about it - it is extremely short term.  But this company gets massively reappraised depending on whether redbox is perceived to be a sustainable income stream or the sky is falling and the dvd is dead...  When you are selling monthly puts on a value name that is prone to sudden freak-outs, you have to mind the short term outlook.  I wouldn't have been selling puts on it if I wasn't long term intrigued by the cannibalistic share retirement story.  But there have been long term changes to their access to top content in a timely manner - and that was a key competitive advantage previously.  I'll be on the earnings call on July 31st for sure, though.

[siddharth18]

No doubt about it - it is extremely short term.  But this company gets massively reappraised depending on whether redbox is perceived to be a sustainable income stream or the sky is falling and the dvd is dead...  When you are selling monthly puts on a value name that is prone to sudden freak-outs, you have to mind the short term outlook.  I wouldn't have been selling puts on it if I wasn't long term intrigued by the cannibalistic share retirement story.  But there have been long term changes to their access to top content in a timely manner - and that was a key competitive advantage previously.  I'll be on the earnings call on July 31st for sure, though.

My thought has been that we will see a really disappointing quarter for redbox because the new release content for the last few months has been horrible.  You can't sustain their level of business without compelling new release content.  And "jack ryan:shadow recruit" isn't gonna cut it.  I used to sell puts on this name every month but turned very negative on it until the next earnings release.

 

One bad quarterly number out of redbox will restart all the chatter that redbox is declining - even if it is primarily due to the timing of content releases.  Coinstar is almost surely stable and might even surprise a tiny bit on the upside since you can get Amazon gift cards for no fee and to an increasing number of people, amazon credit is the same as money.  EcoATM is not material and has a lot to prove before I would include it in any valuation.

 

Time to check on the timing of their earnings announcement I guess

 

Pretty much what I've been saying all along...We are just one bad quarter away from a bloody selloff and bears claiming the death of DVDs.

 

There have been massive (short-term) put purchases with traders hoping for an early announcement of a bad quarter.

[yadayada]

isnt this thing going to pop then on the day of the results.

[jeremykgold]

But there have been long term changes to their access to top content in a timely manner - and that was a key competitive advantage previously.

 

What has changed?

[gfp]

But there have been long term changes to their access to top content in a timely manner - and that was a key competitive advantage previously.

 

What has changed?

 

Redbox used to get the DVDs on the day they came out at retail - before the rental and streaming competition.  Redbox could just buy the DVDs at Walmart, etc, to have them right away if they needed to.  Over time - starting a few years ago - they made deals with the studios like everyone else that delay the release of new titles.  My understanding is that now when redbox gets a dvd, it has already been available for sale at retail, watched on airplanes, cable/satellite on-demand, and possibly streaming.  That isn't a huge deal, as the usual redbox customer is not very affluent - but access to new releases does matter.  There is still a good value proposition for the average walmart shopper in getting their movie from the redbox kiosk as long as they return it promptly.