In our go-go society, convenience is everything. This has extended to every part of our lives, including food and entertainment.
Formerly known as RedBox, Outerwall (Nasdaq: OUTR) is the epitome of this convenience. Its RedBox DVD rental kiosks are popping up like Starbucks' (Nasdaq: SBUX) back in the early 2000s, with several on a single street corner. Meanwhile, its legacy coin-counting kiosk division, Coinstar, continues to be the industry leader for turning loose change into dollars.
Beyond its coin and movie kiosks, Outerwall also has electronics recycling (EcoATM) and product-sampling (Sampleit) kiosks.
Outerwall fell off a cliff last year after releasing poor quarterly results. It's now back on track, but still only managed to perform in line with the S&P 500 Index for the year.
As a result, Outerwall has garnered the support of a couple of major hedge funds lately, including TPG-Axon Partners, which owns 5% of the company. Jana Partners has taken an activist stake and owns 13.5% of the company.
|Outerwall's legacy coin-counting kiosk division, Coinstar, continues to be the industry leader for turning loose change into dollars.|
Jana has raised the possibility of a sale of the company, noting that the company is flush with cash and that it hopes to prevent management from squandering it. The company has nearly $8 per share in cash, around 12% of its market cap.
That cash could be used to continue its share repurchase program or an eventual dividend payment. During the third quarter, Outerwall bought nearly 1.8 million shares for $95 million. It is expected to purchase another $100 million in the fourth quarter and has another $50 million set for the first quarter of this year.
The business model of Outerwall's Coinstar unit is tough to argue with. The company has strong margins and consistent cash flows that require minimal capital expenditures to maintain. In the U.S., roughly $3 billion in coins are converted annually through 76 million transactions.
Outerwall should continue being a leader in the retail industry by conveniently delivering innovative products and services. This comes as the company is dumping underperforming investments in favor of higher-growth opportunities. Most notably, Outerwall abandoned its photo and coffee kiosk businesses last quarter.
Outerwall and Verizon (NYSE: VZ) co-own RedBox Instant, which is available through mobile apps, video game consoles, laptops and smart televisions. For $8 a month, customers get streaming content and four DVDs per month from a kiosk. By comparison, $8 a month gets Netflix customers only streaming content.
Although it seems as though there's a RedBox on every corner, the company thinks there are still plenty of advantageous locations to be tapped. This strategy includes moving underperforming kiosks to higher-traffic areas. Outerwall expects that video games and Blu-ray will extend the life of its RedBox kiosks and that Coinstar will continue to be the stable cash flow generator for the company.
In terms of new kiosks, there's big potential with Outerwall's EcoATMs. There are over 175 million mobile devices sold annually and there's a big market opportunity to recycle the old devices. In addition to cellphones, EcoATM kiosks also take tablets and MP3 players. In the U.S. alone, Outerwall sees potential for 5,000 to 10,000 kiosks. Each kiosk takes about six to eight months to reach $100,000 to $120,000 in revenue. The payback period is roughly 18 to 22 months.
Risks to Consider: In addition to the perception of RedBox and Coinstar kiosks on every corner, there is also the concern that other companies could enter the market. As far as Outerwall's DVD rental business is concerned, consumers are gravitating towards streaming content available in their homes and on their smartphones or tablets at a touch of a button. Streaming could have a negative impact on earnings over the long term.
Action to take --> Buy Outerwall for upside to $75, which is nearly 15% upside. Analysts expect Outerwall's earnings per share (EPS) at an annualized rate of 20% over the next five years, putting the company's PEG (price/earnings-to-growth) ratio at an ultra-low 0.7. If Outerwall were to trade at $75 a share, it would still be trading at a forward price-to-earnings (P/E) multiple of only 13.