Outerwall (OUTR) is a stock I've seen pop up recently on our MagicDiligence screens. It is especially intriguing because, despite a very cheap valuation, Outerwall has a 5-year compound annual revenue growth rate of 17.7%. Growth-at-a-ridiculous-price is my kind of GARP, so let's dig a bit more into the stock and see if the cursory potential is realized under the microscope.
Redbox and Coinstar
Most of us have come across a Redbox kiosk at Walmart, Walgreens, Kroger, or even McDonald's. There are over 44,000 Redbox kiosks out there where customers can rent or purchase movies (DVDs and Blu-ray) and video games for a daily rental fee. Redbox accounts for about 86% of Outerwall's revenue, at a segment operating margin approaching 20%. It is by far the largest and most important part of the company.
Outerwall's other big business is Coinstar, machines which will count your change and give you cash or gift cards and take a fee for the trouble. There are nearly 21,000 Coinstar machines, mainly located in grocery stores and Walmarts. Coinstar generates 11.5% of Outerwall's revenues at a tidy 33% segment operating margin.
Finally, last year the company purchased ecoATM, which are kiosks where you can trade in your used smartphone or tablet for cash. The concept is much like that of Gazelle or NextWorth, only without the hassle of mailing devices in and waiting for the check. ecoATM is still in its early days, currently contributing about 3% of revenue but expected to double its kiosk base to about 2,000 this year.
Any quantitative analysis of Outerwall will reach the same conclusion: the stock is cheap. The P/E ratio is a dirt cheap 8.6. The EBIT/EV earnings yield is in double digits at 10.2%. Even free cash flow yield, as pure a valuation metric as any, is well above market at 9.2%.
The company is also creating shareholder value through robust share buybacks. Combined with a tender offer earlier this year, Outerwall will likely reduce its share count by a whopping 24% this year, which will help drive earnings per share growth of 11%.
Is There Any Growth Left?
A key question to Outerwall's value is: is there any growth left?
Redbox has grown rapidly over the past 5 years, but with the kiosks essentially at saturation, squeezing more dollars per location is the last resort. As you would expect, this is a difficult track - Redbox revenues increased just 1.5% in the most recent quarter. While Coinstar is doing a little better (+5.2%), this was on the back of fee increases, which now exceed 10% and probably don't have a lot of room to move higher.
ecoATM is an interesting concept, and certainly there is plenty of room to expand from the current 900 kiosk install base. But Outerwall has had trouble with new concepts in the past (e.g., shuttering self-serve coffee machine Rubi), and ecoATM is such a small contributor that it is difficult seeing it as a major growth engine. To reinvigorate double digit growth, Outerwall is going to have to find a more scalable concept.
Another risk in Outerwall is its balance sheet. A massive $1 billion dollar debt burden is offset by just $250 million in cash, and the company generates about $220-250 million in free cash flow annually. That debt-to-equity ratio is rather absurd at 848%! Much of the debt was drawn to finance those large share buybacks, which is a questionable practice at best.
To be sure, I see this as a longer-term concern. Interest coverage is still ok at this point at 6 times, and the bulk of it is not due until 2016 and 2019. However, leverage like this acts as a magnifier. If Outerwall's results turn south, solvency concerns could lead to huge stock price declines. It also limits the company's ability to buy back shares, pay a dividend, or pursue attractive growth opportunities.
What Is The Stock Worth?
Over all, I think the market is too pessimistic on Outerwall. It reminds me somewhat of GameStop (GME), a company that many were sure would be buried by digital downloads... back in 2007! It hasn't happened. Redbox offers several advantages: it is cheaper ($1.20/day for DVDs) than video on demand, HBO, or iTunes rentals, and offers a far better selection than Netflix.
Driven by flattish revenue (given ecoATM and an increase in Redbox average fee driven by Blu-ray mix), stable margins (sustained by recent cost cuts), and a dramatically lower share count, I believe Outerwall isworth about $80 per share. That presents a very attractive 48% margin of safety to current share prices. Investors should be careful with this one, though, given the financial health concerns.