Coinstar Investors Counting Pennies That Don’t Exist

Coinstar (CSTR) primarily operates self-service coin counting and self-service DVD rental kiosks at retail locations. You drop in a piggy bank full of coins in one of their machines, and you get cash in notes (discounted value) or a gift card. Coinstar’s trucks go around collecting the coins, so the recent increase in fuel costs is a negative for the company.

Market cap: $1 billion; EV: $1.3 billion

Coinstar is a company that has been a perpetual turnaround, with almost every year (including 2008) being described as a transition year. The company has been acquiring other companies, and recently increased its ownership stake in a subsidiary resulting in consolidation of the subsidiary’s accounts, so the numbers and growth rate it is reporting are not comparable to the previous year.

The company is estimated to earn $0.60 per share (pro-forma) this year and $1.05 next year. The earnings estimate for next year looks overly aggressive, and to me it seems almost impossible to achieve. At $36, the stock is trading at 60x ’08 EPS! And even if it were to meet next year’s earnings estimate, that’s still a rich 34x multiple for something that’s very uncertain. Earnings quality is poor, with the company pro-forma’ing out stock compensation, intangible amortization and occasionally asset write-downs. Over the last 12 months, the company has generated no cash, and in fact free cash flow has been negative. D&A is running above capex, and working capital has been consuming cash.

The risks to the business are many. Some regional banks are installing coin counting machines that their customers can use for free. Self-service DVD kiosks are a novelty whose days are numbered under the onslaught of Netflix and online movie distribution. One long term risk is that with a penny costing more than a penny to manufacture, it is possible that the US Mint will phase out the coin. This would result in less need for Coinstar’s services.

The company was in an ongoing battle with an activist shareholder (Shamrock), and is currently in some kind of truce, having appointed one of Shamrock’s nominees to its Board. Some investors piggyback on activist fund investments, thinking that the outcome is bound to be positive. This is a dangerous strategy. An activist shareholder can ensure a company deploys its cash flow productively, or goad the company to sell itself if there is a willing buyer, but there is little it can do to improve the company’s operations or increase its cash flow. Note Carl Icahn’s failures at Blockbuster (BBI) and Motorola (MOT). Or even Shamrock’s investment in iPass (IPAS), which is down 60% in the last year.

Fair value for CSTR stock: $15 (a generous 25x multiple on ‘08 EPS of $0.60)

Disclosure: Author has a short position in CSTR

Comments

[CSTRshareholder]

Your comments are funny. CSTR has won huge new coin counting business from Walmart and regional banks. They are installing 1,000's of machines this year and next. Their share of this business is increasing since banks don't have the technology to properly count and service these type of machines.

Second, CSTR is now majority shareholder of Redbox. This startup has captured the #1 share of the movie rental vending machine market and is due to go public this year. The start up loses over the last few years are now going to be monetized in the IPO.

Good luck on your short. I will sell when the stock hits 50 later this yr.

[howling wolf]

CSTR seems well managed. They used a marginally profitable business to gain a foothold inside WMT. Redbox will IPO and seems to be receiving a good reception. Will appeal to the impulse movie renter drawn by the $1 daily rental price, but will end up paying far more as that seeming $1 day multiplies each day the movie is retained.

Counting coins seems mundane, but they have used it to build recognition as an entree into the money transfer business. And while a penny may be worth less and less with each passing year, it will most certainly be around for years to come.

[alex s gabor]

Coinstar obviously has never heard of "The Penny King!"

[alex s gabor]

Advice to George Soros Funds, short several million shares of Coinstar using options. It will be 15 or less before the year is out!

[cm001]

The biggest challenge for the company is long-term decline in use of coins.

[borisb]

one of the CNBC Fast Money traders - KFine says the Coinstar is wasting shareholder money. That said the stock has been able to maintain its valuation in the 20s & 30s for a long time through thick and thin so i dont know whats going to break it now, espically if they beat earnings estimates in the March 2008 quarter.

[Stephjen]

PNC counts my coins for free.... (if I used coins and not just a debit card.)

Maybe people will start taking their coin jars to turn it into "real money" now that they are feeling so un-confident

but as a value minded investor, the valuation is too rich.

[ac5000]

Coin counting is high margin and CSTR has pricing power with the issuers of gift cards. Redbox may eventually sell dvd and be able to produce virtually any movie by dowloading it, writing it and printing the cover. Chanos has been recommending to short this stock since 2003 and is down 400%. so he will basically say anything to move the thing down

[luckychucky]

In tough economic times, logic says people will likely have less spare change lying about. They'd also be less flippiant about letting 8 percent of it go just for the convenience of having a machine count it out for them. That kind of cavalier consumer attitude about fees is usually a sign of flush times, not lean times. My gut feeling is that their business model is just too flimsy a gimmick to represent solid strength.

To respond to 'CSTR Shareholder's comment above - <i>of course<i> Redbox has captured the #1 share of the movie rental vending machine market...nobody else is in that market because it's utterly pointless, and they can have it all to themselves in the face of Netflix, cable tv and downloading, both of the pirated and legallly sanctioned kind. Even if a CD-based rental business fantasy can currently manage to eke out some toehold, its days are guaranteed to be critically numbered in the face of the absolutely inevitable trend toward completely virtual media disribution over ever-faster Intenet transmission speeds. Any business model which can't see that one coming is blind a a bat. Look to Netfilx, if nowhere else - they're moving everything, sometimes slowly, sometimes quickly, toward streaming and downloading. RedBox will go the way of the 8TrackTape. So yes, Redbox dominates that market, and I'll breathe a great big sigh of relief that I don't.

As the above article states, where you ever do see 34x-60x PE multiples and there is any attempt to actaully justify them in the light of reason, it's usually for spculative growth companies with phenomenal potential if the bet pays off: say, if they discover the cure for cancer or develop photovoltaic power via a special porces which will make it half as cehap as coal... look at this dog of a stock (a dog with fleas) and honestly tell us it's anywhere within meteor-strike range of that kind of breakthrough profitability. This star seems highly likely to implode.

[thecommonman]

I believe luckychucky is out of touch with the common man. I believe the coinstar machines will be in greater use during down times as people cash in their change jars to help buy gas. Otherwise those coin jars just sit around the house for years. My credit union offers free coin counting -- with a coinstar machine. Also, I think many consumers will enjoy impulse renting $1 DVDs from Redbox units at MacDonalds & 7-11. The customers who regularly visit these locations are probably less likely to use Netflix and VODs, and may spend more of their free time watching DVDs than the person who spends considerable free time online. I think there is a strong market providing these vending type services to the average joe.