Few companies can survive the transition to value from growth; just look at Apple Inc. (NASDAQ:AAPL)‘s valuation as its shareholder base shifted from one end to the other.
Another company faces the same transition from growth to value. Coinstar, Inc. (NASDAQ:CSTR) investors have crushed the company’s stock as it focuses on returning cash to shareholders rather than making new investments for growth.
Is Coinstar Dead?
The company that completely changed the game for video rental and coin cashing has seen its valuation decline precipitously as it changes from a growth to value story. Coinstar, Inc. (NASDAQ:CSTR) trades at an EV/FCF multiple of 7, half the valuation it earned in January 2011.
Why are investors unwilling to pay for Coinstar’s valuable cash flows today when they were so willing to pay much more in 2011?
A look at Coinstar’s businesses
Coinstar has three true segments. First it has Redbox, which rents DVDs, video games, and BluRay disks to consumers via an automated vending machine. Redbox contributed $386.7 million to Coinstar, Inc. (NASDAQ:CSTR)’s 2012 operating profits, or 84% of the company’s total haul.
The remainder came from Coinstar’s change cashing business, which turns customers’ change into cash and gift cards. This segment added $99.2 million in operating profits.
The final segment, which is made up of new ventures, generated an operating loss of $25.8 million in 2012. Its most promising product in the new ventures segment is a kiosk which will turn unused gift cards into cash. Seeing as Americans purchase more than $100 billion in gift cards each year, there is promising opportunity in a new kiosk to convert undesired gift cards into cash that can be spent anywhere.
Discounting the entire new ventures opportunity, Coinstar, Inc. (NASDAQ:CSTR)’s valuation is much too low, in part because of fears that its Redbox division is in a secular decline as companies like Netflix, Inc. (NASDAQ:NFLX) convert customers to online streaming.
Consumers may slow their use of Redbox kiosks to rent DVDs, BluRays and video games in favor of online streaming. The company’s valuation suggests that investors see Coinstar as a one trick pony incapable of recreating the same success it had in DVD rentals.
Here’s why Netflix won’t kill Redbox:
1. Netflix, Inc. (NASDAQ:NFLX) has little to no interest in its legacy DVDs by mail business, hoping to kill it for lower cost and lower capex streaming businesses.
2. Content creators want to keep the physical media business around as long as they can, seeing as it provides for higher revenue per transaction and increased profits.
3. Netflix, Inc. (NASDAQ:NFLX) does not and will not have new releases available for streaming or rental by DVD any time soon. Netflix knows the risks of changing its pricing model–the company lost more than a million members in a complicated split up of its streaming and DVDs-by-mail service. Netflix also balked at creating a premium price point for members who want access to Showtime or Starz content.
4. Redbox instant is seeking to offer pay-per-view offers for streaming access of new releases. Netflix, Inc. (NASDAQ:NFLX) has said that it will not offer single-purchase solutions for access to new release streaming.
For all that has been said about Netflix, Inc. (NASDAQ:NFLX) taking down Redbox, the streaming company doesn’t seem to be trying too hard to take a jab at the little red kiosks that practically mint money for shareholders.
In fact, the biggest risk for Coinstar, Inc. (NASDAQ:CSTR) – falling DVD use – could actually help boost profits.
Why a DVD decline could be good for Coinstar
A marginal decline in DVDs could actually be good news for Redbox as it will be more impactful to the competition – the few remaining brick and mortar competitors.
If and when the economics disfavor brick and mortar services, Redbox will pick up substantially all of the customers left with no other alternative. Most importantly, these converts will be acquired with no new financial investment.
Not to mention that a geographic monopoly will give Redbox pricing power as it will be the only provider of new releases in physical form in the most convenient delivery system possible – a low cost, widely-distributed vending machine.
Could it get better than that? Why yes – it can!
A capital allocation story
In the fourth quarter of 2012, Coinstar, Inc. (NASDAQ:CSTR) reported that it spent $53.3 million on capital expenditures for its Redbox segment. Of that $53.3 million, $52.2 million was growth-related. The remainder, $1.1 million, was maintenance capex – money spent to keep its already existing machines in working order.
Take notice: once placed, a Redbox kiosk requires very little to no additional investment.
Redbox will continue to spew earnings that can be paid out in cash for as long as the machines stay standing. Few companies offer that kind of profitability.
Coinstar deserves a high valuation. An enterprise value of only 7 times free cash flow greatly undervalues Coinstar’s continuing operations and plans to reinvest much of its anticipated $700 million in free cash flows over the next three years into share repurchases and dividends.
Smart capital allocation will be a boon to shareholders who can see through an empty short thesis. Stay long and strong – Coinstar, Inc. (NASDAQ:CSTR) is far from dead.
The article This Company’s Transition to a Value Play is Great for Investors originally appeared on Fool.com and is written by Jordan Wathen.
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