A recent analyst report from a large investment house challenges the prospects for Coinstar and its highly successful redbox DVD-rental kiosk unit, and calls into question the business model for the devices.
Equity analysts from J.P. Morgan in late August trimmed their 2011 and 2012 earning-per-share estimates for the Bellevue, Wash.-based Coinstar, predicting that "DVD kiosk growth opportunity peaks in 2011 and that kiosk rental starts to decline in 2012."
The reason? Competitors of various stripes will increasingly offer streaming video or video on demand (VOD) through either the Internet or another device in the consumer's home, according to the analysts. This will be so convenient and inexpensive, goes the argument, consumers will stop visiting the neighborhood redbox.
"We believe adoption of online video streaming and downloading services will accelerate dramatically in 2011 … and be promoted by major retailers including Walmart, Best Buy, Sears and Blockbuster," write the Morgan analysts. As a result, "DVD kiosk revenue opportunity will peak in 2011 owing to loss of share of the home entertainment market to the online video services."
This finding isn't new. Bloggers and industry followers seem to believe the wide-scale launch and acceptance of VOD is inevitable. Coinstar itself acknowledges the inevitable with president and COO Gregg Kaplan declaring that his company is preparing its strategy to get in the streaming game. Kaplan has said that his firm may reveal details of that plan during its third quarter earnings call with analysts but until then it is keeping quiet. A Coinstar spokesperson declined to comment.
The question for investors is how long the DVD-rental model will churn out strong revenues and the competitive landscape Coinstar will face in the VOD world.
If consumer acceptance of streaming media were widespread today, Coinstar wouldn't stand a chance, says Dan Rayburn, principal analyst with Frost & Sullivan and executive vice president of streamingmedia.com.
"They have no digital offering now, and they've been talking about it for a year. They are in a hard spot," said Rayburn. A provider of streaming content has to be able to deliver its product directly to the consumer's television, and redbox simply isn't anywhere close to doing that, he says.
Competitors are, Rayburn says. He points to Netflix, the 15-million member DVD rental-through-the-mail firm that has prepared for digital streaming by cutting deals both with content providers and with manufacturers of hardware like TVs and video games.
Netflix recently agreed to pay $1 billion over 5 years for the content of a consortium of providers including Viacom, Lions Gate and MGM, adding newer selections to the Netflix library of 17,000 movies and television programs.
Rayburn says that Netflix also has struck deals with the manufacturers of 100-some devices, from Blu-ray players to game consoles to TVs, to install its software so that the devices are capable of accepting streamed content. Netflix reported that more than 60 percent of its members watched a streaming video in the second quarter.
It will take Coinstar "several years and a lot of work to get that penetration," says Rayburn. Further, it will take a whole lot of money, and it's not clear if Coinstar's got the change.
Still, redbox has been a tremendous money generator. The division accounted for $272 million, or nearly 80 percent, of Coinstar's total revenues of $342 million in the second quarter. Meanwhile Coinstar sold two businesses this year — a money transfer division and an electronic payments group — to bring in about $82 million that it said it plans to use to build a better redbox.
Coinstar also operates its green coin-counting machines and recently bought into ecoATM, a firm that operates kiosks where consumers can recycle their cell phones.
Despite Morgan's gloomy forecast, many investors are not jettisoning Coinstar. In the six trading days from Morgan's August 27 announcement to the Labor Day weekend the company's shares dropped a modest 3 percent to close at $44.37 on Friday, Sept. 3.
And other analysts that track Coinstar haven't jumped on Morgan's bandwagon.
Lawrence Berlin, who follows the stock for First Analysis Corp. in Chicago, notes that the consensus estimate of 10 analysts of Coinstar earnings-per-share (EPS) is $2.60 to $3.12 for 2011. In comparison, Morgan reduced its 2011 EPS estimates from $2.89 to $2.73, putting it on the low end of the consensus but not out of line with its colleagues. Morgan cut its 2012 EPS estimate from $3.13 to $2.65.
Berlin, who estimates 2011 EPS at $2.90, thinks consumers will continue to patronize redbox kiosks for several years because of its massive installed base, its $1-a-night fee for most DVDs, and because digital streaming will require an upgrade of a TV or monitor to get top-quality reception.
"(RedBox) has nearly 30,000 kiosks (installed). Within one mile of my place are a CVS, a Walgreens and a Jewel (grocery store) with a redbox. That's presence," said Berlin. "To get good looking picture with digital streaming you need a high resolution (TV). Right now DVD is a better choice."
Berlin also respects Coinstar's leadership. This week the firm announced the 1 billionth DVD rental from a redbox, just six years after installing the first device.
"This will take several years to play out. I suspect Coinstar has a smart management team that is working on this," Berlin said.
For now, redbox is on top in its sector, with a strong customer base and a popular product. It faces a tough challenge to use those strengths to make itself a leader in a new technology.
