Coinstar: A Deeper Analysis of the Starbucks Deal

After the market close on Tuesday, Coinstar (NASDAQ: CSTR) announced an exclusive agreement with Seattle’s Best Coffee, part of Starbucks Corporation (NASDAQL SBUX), to install new Rubi coffee kiosks in grocery, drug, and mass merchant retail channels, featuring Seattle’s Best Coffee beverages. The kiosk rollout will begin this summer, with ≈ 500 kiosks expected by the end of the year, and thousands of machines expected in the next several years. The kiosks occupy roughly nine square feet, and grind and brew fresh whole beans in a single cup on demand at any point in time. Price points begin at $1.00 per cup for coffee, with more specialty drinks costing up to $1.50 per cup. Seattle’s Best Coffee has over 20,000 locations where groceries are sold and over 50,000 points of distribution. Initially, the kiosks will be installed in the Northeast and West Coast regions of the US.

Tuesday’s announcement appears to be in line with the coffee kiosk installation guidance provided by Coinstar at its Analyst Day on May 17. At that time, the company disclosed that it planned to launch and expand to up to 500 locations in 2012, with ≈ 15,000+ potential nationwide locations, compared to an installed base of ≈ 20,000 coin machines and ≈ 37,000 DVD kiosks.

Coinstar also discussed the total coffee kiosk opportunity at its Analyst Day. The company has targeted a run-rate of $11,000 – 12,000 in annual revenue per kiosk at the 15,000 locations. Redbox DVD kiosks generate over 20,000 transactions per year, on average, suggesting that the potential for coffee per kiosk 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.

We are maintaining our FY:12 and FY:13 estimates. For FY:12, we expect revenue of $2.31 billion and EPS of $5.20, compared to guidance for revenue of $2.155 – 2.280 billion and EPS of $4.40 – 4.80. For FY:13, we expect revenue of $2.64 billion and EPS of $5.50.

We continue to believe that earnings power is much greater than FY:12 guidance. Coinstar factored in continued-high interchange fees, higher spending on new venture development, and an uncertain DVD release schedule. We expect a superb box office in Q1 to drive solid DVD rentals in the back half of the year, providing EPS upside.

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 the 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 (NASDAQ: NFLX) and other forms of entertainment), variability in consumer demand for video rentals, changing macroeconomic factors, and debt repayment and refinance risk.

After the market close on Tuesday, Coinstar announced an exclusive agreement with Seattle’s Best Coffee, part of Starbucks Corporation, to install new Rubi coffee kiosks in grocery, drug, and mass merchant retail channels, featuring Seattle’s Best Coffee beverages. The kiosk rollout will begin this summer, with ≈ 500 kiosks expected by the end of the year, and thousands of machines expected in the next several years. The kiosks occupy roughly nine square feet, and grind and brew fresh whole beans in a single cup on demand at any point in time. Price points begin at $1.00 per cup for coffee, with more specialty drinks costing up to $1.50 per cup. Seattle’s Best Coffee has over 20,000 locations where groceries are sold and over 50,000 points of distribution. Initially, the kiosks will be installed in the Northeast and West Coast regions of the US.

Tuesday’s announcement appears to be in line with the coffee kiosk installation guidance provided by Coinstar at its Analyst Day on May 17. At that time, the company disclosed that it planned to launch and expand to up to 500 locations in 2012, with ≈ 15,000+ potential nationwide locations, compared to an installed base of ≈ 20,000 coin machines and ≈ 37,000 DVD kiosks.

Coinstar also discussed the total coffee kiosk opportunity at its Analyst Day. The company has targeted a run-rate of $11,000 – 12,000 in annual revenue per kiosk at the 15,000 locations. Redbox DVD kiosks generate over 20,000 transactions per year, on average, suggesting that the potential for coffee per kiosk 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.

We are maintaining our FY:12 and FY:13 estimates. For FY:12, we expect revenue of $2.31 billion and EPS of $5.20, compared to guidance for revenue of $2.155 – 2.280 billion and EPS of $4.40 – 4.80. For FY:13, we expect revenue of $2.64 billion and EPS of $5.50.

We continue to believe that earnings power is much greater than FY:12 guidance. Coinstar factored in continued-high interchange fees, higher spending on new venture development, and an uncertain DVD release schedule. We expect a superb box office in Q1 to drive solid DVD rentals in the back half of the year, providing EPS upside.

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 the 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.