Outerwall Inc (OUTR), Netflix, Inc. (NFLX): Can Redbox Leverage Its Retail Network to Streaming Success?

Outerwall Inc (NASDAQ:OUTR)’s automated-dispensing machines average roughly 12 square feet in size. These machines are probably the world’s smallest retailers, primarily offering the company a way to market DVDs and coin-counting services to its millions of customers.  These machines also make Outerwall Inc (NASDAQ:OUTR) a valuable partner for grocery and mass-merchandiser landlords, which get to share in a revenue stream that would otherwise be lost.  While Outerwall Inc (NASDAQ:OUTR)’s Redbox unit has heavy competition from video-streaming companies, the business is the top dog in the DVD rental and coin-counting kiosk businesses.  So, should investors change their tune?

What’s the value?
Outerwall Inc (NASDAQ:OUTR)’s origins are in the automated coin-counting segment, which is still a highly profitable business. The company  generates the vast majority of its current revenue from its Redbox DVD rental segment, which it acquired in stages from restaurant giant McDonald’s starting in 2005.  The company’s market share in the DVD-kiosk business is pegged at around 50%, aided by its 2012 acquisition of NCR’s DVD-kiosk unit, which had approximately 6,200 machines.  The move was designed to eliminate a major competitor, which was validated by Outerwall Inc (NASDAQ:OUTR)’s removal of most of the machines from active service over the past year.

Outerwall Inc (NASDAQ:OUTR)’s top line has held steady in FY 2013 with total revenue up 2.6%. The company’s profitability has been hurt by losses from its push into new areas like beverages and electronics.  In addition, declining productivity in the Redbox segment negatively affected the company, with comparable-store sales down 9.9% for the period.  However, the unit’s operating margin remained above 20%, as its larger installed base of machines drove efficiencies in administrative and maintenance costs.

Protecting the moat
Video streaming continues to drain sales from the physical DVD market. Data provider IBIS World reported a 13.7% year-over-year decline for the physical-rental market as of August.  Outerwall has countered the threat by partnering with telecommunications giant Verizon in its Redbox Instant by Verizon service, which went into beta launch in March.  The service’s $8 monthly subscription fee, comparable to Netflix, Inc. (NASDAQ:NFLX)‘s monthly fee, includes unlimited streaming of movies from its library as well as four free monthly DVD rentals from its kiosk network.