January 16, 2011Business case for Coinstar from investor viewpointReasons for being bearish long term on Coinstar. How Netflix, NCR and normal technology flow work against them. Why Coinstar Is a Better Short Than Netflix - Seeking Alpha There are plenty of articles detailing why Netflix (NFLX) is a good short. These articles make some great points, and Netflix may very well be a good short, but in our opinion it is primarily a valuation short. Coinstar (CSTR), on the other hand, faces many of the challenges that Netflix faces, but has no subsciber base and no streaming strategy. RedBox is a business that will ultimately be rendered obsolete. The traditional coin business is also in secular decline, which the company has offset with price increases (higher percentage take on the coin kiosk) for the time being, but the secular tailwinds that caused such bullishness around Visa (V) and MasterCard (MA) (the move to a cash/coinless society) create secular headwinds for the coin business. Investment Thesis Coinstar’s primary growth engine, the RedBox DVD rental business, dominates an industry that is fast becoming obsolete – physical content delivery. As movies-on-demand and internet streaming of media become more and more prevalent, the DVD industry will accelerate its secular decline. Coinstar is currently priced like a growth stock and garners the correspondingly high multiple because it has been a strong growth story by taking significant market share, albeit in a slowly dying medium. As the company saturates the market, its organic growth will slow, and as the industry’s secular trends accelerate, this will become overwhelming. Ultimately, the obsolescence of DVD will cause sales to plateau, then decline, resulting in a significant multiple contraction. Bear Case: DVD rental companies would like to believe. Bull Case: Risks to the Short:
The price target of $31.50 is based on a discounted cash flow analysis, giving the company full credit for growth that is expected to occur the remainder of this year into 2011 and 2012, from which I have modeled sales growth in 2012 of 10%, declining to 0% in 2014. After that I applied a terminal value of 8x to those earnings, comparable to GameStop (GME), another business retail content provider deemed by the market to be going obsolete. This, plus discounting interim cash flows, results in a price of $31.50, $20.00 of which is driven by the terminal value, which is arguably high given the very real risk of obsolescence.
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