Coinstar: The big short that isn’t Herbalife
By Matt
Andrejczak, MarketWatch
SAN FRANCISCO (MarketWatch) — While Bill Ackman’s big bet
against Herbalife Ltd. grabbed headlines, Wall Street quietly amassed a giant
short trade on Coinstar Inc., making the Netflix Inc. rival the most heavily
shorted stock on the S&P 1500.
Coinstar (NASDAQ:CSTR) owns those Redbox DVD rental kiosks
found near the front doors of supermarkets like Kroger Co. (NYSE:KR)
, Safeway Inc. (NYSE:SWY) or a retailer like Wal-Mart
Stores Inc. (NYSE:WMT) .
Investor bets against Coinstar’s stock going higher have been piling up as Netflix (NASDAQ:NFLX) shares have soared. Just over 50% of Coinstar’s 28 million outstanding common shares are sold short — an astronomical figure that’s up from 27% a year ago. (By comparison, short interest in Herbalife (NYSE:HLF) is 31%. Herbalife is the nutritional products-maker fund manager Ackman has made a controversial $1 billion bet against.)
Coinstar shareholders might benefit from a massive short squeeze if the company delivers better-than-expected earnings in the months ahead and Netflix disappoints. A short squeeze happens when a stock rises sharply, forcing a short seller to return borrowed shares at higher prices.
Recently trading at $58.44, Coinstar’s stock has advanced 14% since late February. But the stock is down 19% from its July 2012 high of $71.82.
At issue is the future health of its Redbox business, which accounts for 91% of Coinstar’s total operating income and 87% of its revenue.
Shorts bet streaming will win
Coinstar bet
With the Redbox business stumbling the past six months, short sellers are
doubting that demand for physical DVD rentals can keep pace with video-streaming
options over TV.
They also don’t think Coinstar’s soon-to-be launched Redbox Instant joint venture with Verizon Communications Inc. (NYSE:VZ) will entice Netflix or Amazon.com (NASDAQ:AMZN) subscribers. Redbox Instant, which is still in beta testing, is a streaming service that will cost $8 a month. It will include credits for four free DVDs at a Redbox kiosk.
Coinstar owns 43,700 Redbox kiosks in 35,800 locations. But revenue per kiosk has slipped two consecutive quarters.
The company has been hurt by a lack of new movies to stock its machines, underperforming Blockbuster machines it acquired last year, and the summer Olympics that the company claims slowed movie rentals.
To shore up the business, Coinstar is slowing the pace of Redbox installations in the U.S., shifting unproductive kiosks to new locations and expanding the amount of DVDs a single Redbox can hold.
S&P 500 breaks closing high
Simon Constable and Stephen Wood of Russell Investments discuss the S&P 500 reaching an all-time closing high, and Jerry Seib looks at President Obama's comments on Newtown and gun control. Photo: AP.In a March 21 report, Pacific Crest suggested Coinstar won’t make its internal 2013 revenue target of $2.375 billion to $2.55 billion. Pacific Crest said its first-quarter survey of 1,004 people showed 36% of respondents rent DVDs, a sharp decline from 43% in the same 2012 period.
“The relatively stable kiosk rentership is unsustainable, in our view, as it, too, will inevitably succumb to the rapid deterioration and secular decline of DVD rental demand,” analysts at Pacific Crest wrote.
Coinstar declined to comment for this article. Its first quarter earnings report is April 25.
Coffee kiosks
Coinstar aims to widen its automated kiosk business beyond movies and video games. New ventures include kiosks being rolled out that sell coffee, fresh food, gift cards, and tickets to live events. Overall, Coinstar estimates it can profitably double its revenue to $4 billion by 2017.These new pursuits are a question mark, said Wedbush Securities analyst Michael Pachter, who rates Coinstar’s stock a buy with a long-term price target of $66 a share.
“People aren’t so sure and this causes people to doubt if the company will have sustainable cash flow,” Pachter said in a phone interview. He thinks the core Redbox movie business will do just fine as the year unfolds.
At the same time, Coinstar’s net margin, or profit on each dollar of sales, has climbed in each of the past three years.
By comparison, Netflix’s net margin has been hammered and is at its lowest level since 2002, FactSet data shows.
Value investors, such as Artisan Partners and Weitz Funds, have taken notice. Both mutual fund companies own Coinstar shares based on their most recent regulatory filings.
In its 2012 year end shareholder letter, Weitz said that it bought Coinstar when the stock slid into the low $40s.
“The company is poised to generate substantial discretionary cash flow from its network of Redbox DVD kiosks, and our view is that management will re-invest that capital wisely,” the fund’s managers wrote.
B. Riley & Co. analyst Eric Wold believes Coinstar is worth more. He estimates Coinstar’s shares are worth $80, or 5 times his calculation for the company to earn $499 million in earnings before interest, taxes, depreciation, and amortization.
He argues that physical DVD rentals (those by mail, video stores and kiosks) will generate 2013 sales of $5.3 billion and remain stable through 2017.
Priced at $1.20 a rental, Redbox is a value proposition that appeals to price-conscious consumers, especially those who don’t get high-seed Internet broadband connections that stream video content, Wold contends.
“DVD rentals won’t fall off a cliff anytime soon,” Wold said in a phone interview.
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