On May 16 Coinstar (NASDAQ:CSTR) hosted an Analyst Day.
Company management discussed the current coin and DVD businesses, and discussed new ventures. Specifically, management provided some details about the impending coffee rollout and about the Verizon Joint Venture, and showed off other new ventures still in testing mode.
The coffee kiosk opportunity appears material. The company believes that there are 15,000 potential locations, and has targeted a run rate of $11,000 – 12,000 in annual revenue per kiosk. These figures sound conservative, given the installed base of 20,000 coin machines and 37,000 DVD kiosks. Redbox DVD kiosks generate over 20,000 transactions per year, on average, suggesting that the potential for coffee could be as great as $20,000 – 25,000 annually. At the high end of the company’s target range, coffee could generate as much as $0.65/share when fully penetrated, although we believe the potential could be twice as large.
Coinstar provided some details on its joint venture with Verizon. The JV will combine DVD and Blu-ray Disc rentals from Redbox with a new on-demand streaming and download service from Verizon. The JV’s product portfolio will include subscription services and more, be available to consumers across the US, and be introduced in 2H:12. The Verizon / Redbox JV will provide “over-the-top” video distribution services delivered via broadband networks to video-enabled viewing devices, in addition to rentals from kiosks. Although pricing was not specified, it appeared to us from the context of the discussion that the proposed offering will allow for unlimited streaming and limited DVD rentals at Redbox kiosks. We are encouraged that Coinstar limited its exposure by requiring the JV to pay it for DVDs rented, suggesting that the company will not lose money over the long run.
The company also mentioned a “new Redbox venture”, specifying only that the venture would be entertainmentoriented. We believe that Coinstar intends to sell movie tickets through its Redbox kiosks, helping its studio partners to drive higher-margin theatrical exhibition sales, while driving awareness of films that will ultimately come to DVD.
NCR acquisition likely to close by the end of Q2. The antitrust review now complete, Coinstar is set to close the deal with NCR by the end of Q2. Coinstar will purchase the assets of NCR’s DVD kiosk division, including approximately 10,000 kiosks, certain retail contracts, and DVD inventory. Redbox will pay up to $100 million for the assets (assuming no retail contracts are lost), with NCR guaranteed $25 million in total margin over five years. We think that the acquisition makes sense for both Redbox, which will absorb its closest competitor and increase its nationwide footprint meaningfully (including at many high traffic retailers such as Safeway and Publix), and for NCR as well, which has sought to shed the unprofitable segment in order to focus on its targeted industries. We note that Redbox will have to replace all of the Blockbuster kiosks with its own branded Redbox kiosks as Redbox and NCR DVD kiosks are not manufactured to the same specifications. Further, since the NCR business was unprofitable, likely due to many underperforming locations, Coinstar will only assume certain retail contracts. We think it is highly likely that Redbox will close approximately half of NCR kiosks, and will replace the remaining half with Redbox kiosks over an estimated ten-month period (500 kiosks per month for 10 months through mid 2013). We estimate that approximately 5,000 NCR kiosk locations will be retained in the U.S. and will generate an average of at least $40,000 in revenue per year per kiosk, providing incremental annual revenue of $200,000,000. At an operating margin of 25%, a tax rate of 40%, and a share count of over 30 million shares, incremental annual EPS of roughly $1 is expected.
Maintaining our OUTPERFORM rating and our 12-month price target of $88, which reflects a multiple of 16x our 2013 EPS estimate of $5.50. This is a slight discount to Coinstar’s historical valuation to reflect competition, an uneven visibility outlook, and long-term technology challenges.
Risks to attainment of our share price target include changes to movie release timing, the effects of competition, (both from other video rental companies including Blockbuster and Netflix and other forms of entertainment), variability in consumer demand for video rentals, changing macroeconomic factors, and debt repayment and refinance risk.
Michael Pachter is an analyst at Wedbush Morgan.