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I like my coffee the way I like my -- well -- coffee: sugar, half and half, and dispensed by a little machine that lives in the drugstore around the corner from my house. At least that last part is the new dream of Starbucks (Nasdaq: SBUX ) and Coinstar (Nasdaq: CSTR ) . The coffee behemoth and the DVD distributor have teamed up to bring coffee to even more of the masses. Coinstar has also signed on with Verizon (NYSE: VZ ) to stream movies to people who want them yesterday. What does Coinstar stand to gain, and who are these dynamic duos even fighting against?
Form of … a working partnership!
People like to do a lot of things at once, and they don't like to spend too much time on the boring things. Coinstar has been riding that truth all the way to the bank. People want to watch movies, but they don't want to go to a movie-rental store. They want to spend the coins they have in that little plastic bag by the door, but they don't want to count them. They want to drink a cup of coffee, but they're not going anywhere else besides this one grocery store -- I'm serious, I'm not going next door, and yes, I can see it's right there.
This strategy has been working out well for Coinstar. Its DVD business, Redbox, grew revenue 39% in the first quarter of 2012 compared with the same period last year. Because of tight ship-running, operating expenses rose only 25%. As a result, net income for the segment grew 222% over the same period, to $76 million. The coin-counting business, meanwhile, had a $2.3 million fall in net income, mainly because of a disproportionate increase in operating expenses that were largely due to renegotiated contracts, with higher payments going to Coinstar host locations.
In total, net income was overwhelmingly influenced by the success of Redbox, and Coinstar grew its bottom line 532%. But relying on the continued astronomical success of Redbox is a bad idea. To help diversify away from DVD rentals, Coinstar has entered into these two joint ventures.
Streaming and steaming
Instead of going all the way to the store, why not just stream the movies you want? The Verizon deal is putting Redbox in even more direct competition with Netflix (Nasdaq: NFLX ) and Amazon.com. Both of the established streamers have the benefit of a huge catalog of content. While Verizon has claimed that its proprietary delivery system is more efficient, it won't matter if all it has is the first three seasons of Blossom.
The coffee venture is subject to much less competition. Oddly, it's this lack of direct competition that should make the prospect so chilling to other brewers. Starbucks has been trying to tap the lower end of the market for a while now, having made its first move with the introduction of surprisingly decent instant coffee.
The new machines will distribute coffee from Starbucks' Seattle's Best branded coffee line and will sell cups starting at $1. Coinstar is expecting to launch 500 of the machines by the end of this summer, with a long-term plan of operating thousands out of grocery stores and drugstores. This foray will help diversify the Coinstar business model and give Starbucks a low-cost way to compete with cheap coffee providers.
What to watch out for
I like what Coinstar is doing. I like its revenue growth and $226 million in free cash flow over the past 12 months. It's working with great product owners and reaping the reward of not having to develop its own content or coffee. In general, Coinstar is doing a wonderful job of becoming a conduit for other businesses. That's a lucrative, low-risk place to play.
It's also a relatively easy, albeit capital-intensive, model to replicate. Assuming a new challenger fails to appear, there are two things that investors should watch as the year unfolds. First, pay close attention to how quickly the coffee kiosks roll out. I want to see a solid 500 in the Q3 filing. Second, keep an eye on the Verizon announcement, since content is going to make or break the service. If the content list doesn't have anything interesting in it, failure is going to come quickly and brutally.
Right now, Coinstar is doing an excellent job of finding new and better ways to take advantage of our innate need to consolidate tasks. To learn about some other companies making it easier to spend money, check out the Fool's free report on the changing face of retail. It covers two companies that are redefining the way we buy stuff -- except for the money-taking part. Get your copy today.