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Coinstar Costs A Pretty Penny

  • November 22, 2006

If you have ever had to convert your jar of change into crisp dollar notes, you are probably familiar with Coinstar (CSTR) kiosks found in grocery stores like Albertsons. The fee Coinstar charges to count your change is 8.9 cents per dollar or in other words 8.9%, a steep fee that translates into high profits for the company and shareholders. In fact recent investors in Coinstar are probably a happy lot, watching their investment appreciate a whopping 54% over the last four months and a little over 35% over the last year. The reason behind this sudden euphoria for a business as mundane as counting coins?

A number of new initiatives at Coinstar have been adding some excitement to their traditional coin counting business as well as opening up new sources of revenue. After counting a customer’s coins, instead of just issuing a slip that can be exchanged for cash, Coinstar is now offering gift cards from various retailers such as Amazon.com, Starbucks and iTunes. Customers are not charged the 8.9% counting fee if they choose one of these gift cards and Coinstar probably makes more money from the retailers. A win-win situation for all parties concerned.

In addition to grocery stores, the company is now targeting financial institutions with a new line of smaller and quieter coin-counting kiosks that allow banks and credit unions decide the fee they would like to charge their customers for counting coins. Coinstar is also diversifying its revenue stream by bringing “Disney Kiddie Rides” to store fronts and has a stake in the DVD rental kiosk company redbox.

With so many new developments at Coinstar, I started looking into the company as a potential candidate for the December edition of InsideArbitrage. However a closer look under the hood left me with the feeling that I would not even want to mention Coinstar in my Stocks That Almost Made the Cut blog entry for December. The company appears to be grossly overvalued at these levels.

When the company released second quarter results in July, earnings of 18 cents a share handily beat analyst estimates and revenue came in at $130 million, an increase of 18.67% year-over-year. This sparked off the recent four-month rally in Coinstar leaving the company sporting a lofty current P/E of 49.06 and a forward P/E of 36.68. The interesting part about second quarter results is that earnings were actually down 14% year-over-year even before including one-time charges. The story was similar when Coinstar reported third quarter results on November 2nd. While revenue increased 18% to $140 million, income fell 22% to $5.29 million.

The balance sheet also failed to inspire me with over $200 million in Goodwill for a company with a market cap of just $933 million. Coinstar does have a sizeable cash position of $181 million (including investments) but also happens to hold over $200 million in debt.

Is it possible that I am overlooking the potential from the new lines of business and the DVD rental kiosks by redbox? The prepaid phone card business that Coinstar has diversified into is highly competitive and sports very low margins. As for redbox, other DVD kiosk companies like DVDPlay already have a strong presence in grocery stores like Safeway (SWY) and even Microsoft has entered the highly fragmented movie rental industry by offering movie downloads on its XBOX 360 gaming console. Moreover the collection at these kiosks is highly limited and if I want to watch the British television series Foyle’s War or the movie The Motorcycle Diaries, I am out of luck.

While I would not go so far as to short this cash flow positive company, I certainly would not want to start a long position and may even consider the $30 Jan 2008 naked LEAP puts (LUDMF.X) for my personal portfolio and the InsideArbitrage Model Portfolio.

As an interesting side note, given the rise in commodity prices in recent years and the drop in the value of the dollar, certain coins such as pennies and nickels are worth more for their metal content than their face value. According to Wikipedia, “copper one-cent pieces (those dated prior to 1982 and some 1982-dated coins) now contain about two cents’ worth of copper”. How is that for a 100% return on investment?