It’s painful to see a company that looked so promising slow down so quickly. What’s even more painful is watching management try to explain how they are going to grow in the future, when everyone knows the numbers don’t add up. This is the situation at Coinstar, Inc. (NASDAQ:CSTR). The company has a few choices to try and get their stock moving again, but at present they aren’t making either choice.
Would Peter Lynch like this company?
Peter Lynch used to say that he looked for companies that operated in slow growing businesses, where they could take more market share. He tried to avoid exciting businesses, because there is no excitement in watching your stock go down due to competitive pressures.
It seems like Coinstar, Inc. (NASDAQ:CSTR) is tailor made for Mr. Lynch. The company’s Redbox kiosks compete in an area that seemingly no one wants. Netflix, Inc. (NASDAQ:NFLX) essentially killed off Coinstar’s main competitors with their original disc by mail business. Amazon.com, Inc. (NASDAQ:AMZN) is trying to spoil Netflix, Inc. (NASDAQ:NFLX)’s fun by adding thousands of streaming videos to Amazon.com, Inc. (NASDAQ:AMZN) Prime. Not to be outdone, Coinstar teamed up with Verizon Communications Inc. (NYSE:VZ) to offer Redbox Instant. However, the core of Coinstar’s business is the Redbox kiosk and their green Coinstar, Inc. (NASDAQ:CSTR) counting machines.
There is the problem
The Redbox concept seemed poised to grow its kiosk count for years, but the company put the brakes on that theory last year. With over 40,000 kiosks, the company believes it is approaching saturation. In the past, it wasn’t unusual to see several hundred new kiosks being opened, in the last three months, the company opened a net of just 30 locations.
Last year, Redbox benefited from a decline in Netflix, Inc. (NASDAQ:NFLX)’s DVD customer base. Netflix went from over 10 million DVD subscribers last year, to under 8 million in the current quarter. Redbox also managed to push through a 20% rate increase without anyone noticing, and same-store sales were up. However, those trends are going away, and Redbox’s same-store sales were down a jaw dropping 11.8% in the current quarter.
While fans of the company would point to the company’s New Ventures as the division that will drive future growth, the numbers simply don’t support this theory. At current, Redbox represents 88.38% of Coinstar’s revenues at over $500 million. By contrast, New Ventures only has revenues of $1.3 million.
To put this in perspective, Netflix, Inc. (NASDAQ:NFLX)’s growth is supposed to come from streaming subscribers. The company has about 30 million streaming subscribers to just less than 8 million DVD subscribers. Amazon.com, Inc. (NASDAQ:AMZN)’s growth is supposed to come from general merchandise growth, which makes up about 66% of sales. When investors think of Verizon Communications Inc. (NYSE:VZ), they think Verizon Wireless, which is driving both profits and cash flow.
The point is, each of these businesses is targeting growth based on a large part of their existing business. With Coinstar, Inc. (NASDAQ:CSTR)’s New Ventures business representing just 0.24% of revenue, this division is barely worth mentioning, much less pinning the hopes for future growth upon.
So what can the company do?
Coinstar has two choices, and either is better than the current plan. The company seems content to tell investors that Redbox growth will commence again, and that new initiatives will spur better results. The problem is, Redbox already holds 47.8% of the physical rental market. Even if they continue to take market share, they are too reliant on big Hollywood releases to drive demand.
One option, would be for Coinstar, Inc. (NASDAQ:CSTR) to get serious about the Redbox Instant business. At current count, there are only about 3,200 titles available to stream. Compared to the 38,000 that Amazon.com, Inc. (NASDAQ:AMZN) Prime offers, and thousands more and original shows from Netflix, Inc. (NASDAQ:NFLX), this number is a joke. Netflix, Inc. (NASDAQ:NFLX) and Amazon.com, Inc. (NASDAQ:AMZN) have a real value proposition, Redbox Instant does not.
For $8 a month, the offering has to be valuable enough to entice customers. You get four free Redbox rentals, but to get 114 titles for the other $4 a month is simply not enough. Verizon Communications Inc. (NYSE:VZ) is the joint partner in this business and generated over $3.9 billion in free cash flow last quarter. I would suggest Coinstar and Verizon set a target to add several thousand new movies to this service, or it may already be doomed.
The second option is, Coinstar, Inc. (NASDAQ:CSTR) can accept that it’s a mature company, and start handing out dividends. The company is targeting free cash flow of $185 million to $205 million this year, and has only 29.94 million shares outstanding. Even if Coinstar only used 25% of their free cash flow on dividends, this would represent a payout of $46.25 million. With under 30 million shares, this equates to a payout of about $1.55, or a current yield of 2.65%. This yield would reward investors, while the company would still have ample cash to continue slowly building its New Ventures unit, and increasing revenue from Redbox and Coinstar.
However, if Coinstar isn’t going to do either, investors should be very worried. Redbox Instant simply isn’t a competitive option at this time, and New Ventures is much too small to be meaningful. The company has to rely on Redbox to grow, and 30 new kiosks on an installed base of 40,000 isn’t going to work either. It’s decision time for Coinstar’s management, either pay to play with the big boys, or pay a dividend and just admit that this isn’t the fast growing company it used to be.
The article Either Pay to Play, or Pay Up! originally appeared on Fool.com is written by Chad Henage.
Chad Henage owns shares of Verizon Communications. The Motley Fool recommends Amazon.com and Netflix. The Motley Fool owns shares of Amazon.com and Netflix. Chad is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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