Motley Fool Hidden Gems guest pick Coinstar (Nasdaq: CSTR ) was making waves on Wall Street Friday. While earnings for the third quarter were strong, the stock gain of 29.5% was also fueled by news that Wal-Mart (NYSE: WMT ) was going to test the company's coin counters in 100 stores next year.
Wal-Mart has more than 3,800 stores nationwide. While Coinstar already has 44,000 retail locations at such grocers as Kroger (NYSE: KR ) and Alberston's (NYSE: ABS ) , adding the world's largest retailer would be a big feather in the company's proverbial hat.
But let's take a moment to get real. The Wal-Mart test -- yes, it is just a trial -- will run through the third quarter of 2006. That's a long way off, and there's no assurance that a long-term arrangement can be made.
What the company does have going for it for sure is a new program that allows U.S. customers to avoid the 8.9% fee charged for counting their coins. That fee is high enough to just discourage some customers from unloading a mound of change they've been collecting around the house.
But now, for free, customers can have their coins counted and the total value issued in the form of a gift card produced by (so far) 4,500 specially equipped counting machines. Those gift cards can be used at Amazon (Nasdaq: AMZN ) , Starbucks (Nasdaq: SBUX ) , Movie Gallery's (Nasdaq: MOVI ) Hollywood Video, Pier 1 (NYSE: PIR ) , and other major retailers. This has been going on for a while, but the cool part is that it has the obvious effect of drawing business while still getting paid by retailer "x."
Coinstar is selling for 21.0 times 2006 earnings and is expected to grow earnings by 15% a year for the next five years. The business itself is sound, and the coin-counting machine business provides a very scalable and veritable cash cow over the longer term. That premium valuation should be weighed against the risk of the company's acquisitions (since its 2003 recommendation) that are aimed at expanding and diversifying the company's retail offerings (think little amusement machines in varying stores). I'm compelled to wonder whether these acquisitions will result in the same returns as their coin machines and/or realize the expected synergies across the longer term from a cost standpoint (also remember the costs of investing in said machines). They provides a nice compliment to coin machines, but will they scale as well?
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