Chatting With Coinstar -- Interview With Newly Minted CEO Scott Di Valerio

The Motley Fool is on the road in Seattle! Recently we visited Coinstar -- now officially renamed Outerwall (NASDAQ: OUTR  ) -- to speak with CFO-turned-CEO Scott Di Valerio about the 22-year-old company's well-known coin-cashing machines, as well as its more recent acquisition of Redbox, and future initiatives to expand into other aspects of the automated retail market.

The Fool's senior analyst Eric Bleeker speaks with Scott about Coinstar's history, culture, and values, the logistics and economics of automated retail, the recent joint venture with Verizon, and what Coinstar's "The best is yet to come" approach means in practice.

A full transcript follows the video.

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Eric Bleeker: Hey, I'm Eric Bleeker, joined here by Scott Di Valerio, CEO of Coinstar, or soon to be "Outerwall," hopefully?

Scott Di Valerio: Yes.

Eric: Just wanted to check in with the metamorphosis of the business, because it is a truly intriguing business. Can you talk about how the company got started and progressed to the point it's at right now?

Di Valerio: You bet. Coinstar started around 22 years ago. Our founder was in grad school and had a whole bunch of coins, and was ready to go out one night and went to the bank to give them the coins so he could go out, and the bank said, "No, you need to roll all your coins," all those kind of good things.

He came back and did his senior thesis on how to get coins back into the marketplace in a more efficient and effective way, and then came back to Seattle and started Coinstar. Again, the rest is kind of history, from that perspective. We started with that Coinstar line of business, and continue to grow off of that.

The company did a number of acquisitions for a period of time, and one of those began a strategic partner with McDonald's, with Redbox. That was about eight years ago. We continued to increase our investment in Redbox over time, and then acquired them outright about four-and-a-half, five years ago and brought them up underneath the Coinstar brand.

We've been very excited about that, the marriage of both the coin line of business as well as the Redbox line of business, and then our ability to go out and continue to innovate in new businesses with Rubi, our coffee business, and we have four or five other small businesses that we're testing out; some that will work, some that won't, but again it's our history to be innovative, inventive, and to continue to try and grow out the business in new ways.

Eric: Great. First generation of the company Coinstar, second Redbox, and really beginning a third one right now. You talked about making low bets across the business. How would you establish what you want to put manpower behind, versus when you're going to move on beyond an idea?

As we know, one thing that can concern shareholders a lot of the time is companies chasing some too far. How are you going to establish the discipline for the right moves to make?

Di Valerio: Right. Well, we are very structured in how we make investments in our new business innovations, and what the metrics are that are required for them to continue, for us to continue, to invest. We do kind of run them on a survivalist basis.

There are key metrics that each of the businesses that we decide to move forward with are on. They have to hit them on a monthly/quarterly basis. If they're not hitting those metrics, we make some tough decisions. We're looking for alternative solutions for our Orango business, which was our used/refurbished electronics business. We shut down Chirp about two years ago.

Again, it's around being very structured. Once a business isn't doing, consistently, what it needs to do we turn it off and move on to others. We have a team that really does focus on bringing new businesses to marketplace. We set up card tables and test them out, and then begin to figure out how that business might work if it's successful.

We have enough to keep churning those through so we don't need to hang on one that that might not be doing what it needs to.

Eric: Got you. I guess that would lead into, from a leadership perspective -- and I know you're new on the job here -- but how would you foster that kind of culture, where people are always looking for new ideas?

You're clearly looking to take advantage of some of these verticals, and what you see as a huge opportunity in automated retail. How do you build out a culture within a company, that people are trying new things and not afraid of failure, and being really innovative?

Di Valerio: We're lucky because it's in our DNA, because of how we started the company; both the coin and the Redbox businesses, as well as some of these newer businesses. What we try to do -- you mentioned it -- allowing people to fail, but to learn from those failures and then keep making the right investments going forward.

We really do try to foster a company where people feel like they have the power to make decisions. They're empowered to go after businesses, but they also are empowered to make mistakes and then to learn from those mistakes. I think we've been successful at that.

We've structured, in order to be able to do that, we have a team that's really focused on the new business innovation. We have teams within each of the lines of business that are focused on that, that continue to extend out our brands and not sit back on our haunches.

Again, it's a matter of just allowing that openness and really being -- as we talk about -- being inventive, being intuitive with our businesses, and then also being inclusive, both from our employee base but really also inclusive by understanding what our customers want.

Eric: Got you. Let's talk about one of the big bets you're making this year. Correct me if I'm wrong here, but when I read the analyst calls, it looks like you're actually going to roll out a lot more Rubi machines this year than net Redbox machines and Coinstar machines.

Obviously a big bet here; you guys are very confident. It's interesting, the Verizon [ (NYSE: VZ  ) ] partnership, it's in many ways them using your brand, and you guys have their expertise for getting content. With Rubi, it's you guys using Seattle's Best as the brand portion, and using your expertise with the automated retailing.

What was the thought process that, "This is the vertical we want to attack, and this is how we're getting started more in food and beverage"?

Di Valerio: We've been looking at this coffee business and working at it for a few years. One of the things that has been true since we started is the cups of coffee per day that are needed have always been very good.

A lot of times when you start businesses you have to teach customers, or have them discover and then use the machine, and go through. Sometimes it takes some time to build up that demand and that returning demand.

With the coffee business when we put the machines out, from day one they've been very successful. A great cup of coffee at $1 or $1.50 for 12 or 16 ounces, or it's $1.50 or $2.00 for a latte type drink, and espresso type drink -- that's a great value and a great taste. What happened is, people really like being able to do that and having that kind of value.

Why we think Rubi will be a big success is because it has always performed from a cups-per-day perspective. What we're focused on is getting the kiosks operating at a high level of uptime, like we have with our Redbox and coin machines, so that it's delivering a consistent cup of coffee at the right time points, and those types of things, as we move forward.

We feel very good about that, and that's what we're focused on. The business model works; it's getting the kiosks to be at the right uptimes. Once we do that -- we'll have about 2,000 in at the end of this year -- we'll go on to multiple thousands as we roll into '14 and '15.

Eric: Just for some context for people out there, you talk about the business model being great. You went into some detail with [Fool analyst] Austin [Smith] about the Redbox machines and Coinstar. What kind of volume are we talking about?

I think you had mentioned 12 cups a day, and you're happy with that level, per machine. Is that about what we're looking at? What kind of level, as you're rolling this out?

Di Valerio: I believe from our analysts, that's what they were saying they've been getting. I think in some places we have quite a bit higher than that, and think it can actually get higher as people understand it's a great cup of coffee at a great value, so that model will move up.

What we're seeing is, again, machines cost less than the Coinstar machines, which is good. We're expecting EBITDA margins that are in the Redbox range of EBITDA margins, and an IRR that's in the 40%-60% range, which is where the Redbox and coin machines are today.

Eric: Great. I think some people would look at that and think about Starbucks [ (NASDAQ: SBUX  ) ] rolling through; you don't need that kind of model for it to work.

Di Valerio: Yeah.

Eric: We're looking at new ventures. Austin didn't get to talk much about some of your other food and beverage ones, but it's the largest vertical in terms of total addressable market. Could you talk about some more bets that you're making there? I know, specifically the office building ones, offering more prepared food... ?

Di Valerio: Yeah, Crisp Market is our prepared food in the breakfast and lunch daypart. It's really focused, out of the gate, in the office space, so offices that have roughly 1,000 employees or so, that don't have a cafeteria or one that people that are frequenting a lot.

A lot of times people want to be able to get their food quickly and go back to their office and have a high-quality place to be able to do that, and that's what Crisp Market addresses. We have a couple of them in the Chicagoland area now that we're testing out and making sure the kiosk is doing what it needs to do, and understanding the customer's demand points and all that.

We're pretty excited about that business. We've tested it out over about a year and a half, and think that it's a good business to be in.

That office channel is a new one for us, and we're also figuring out how to work that sales model as well, because you don't have -- like in the grocery channel or the convenience channel or the drug channel -- where you sign one contract and get hundreds and hundreds of spaces, or thousands of spaces.

In the office space it's a little more condensed, so at the same time we're working the business, we're working on the sales side also and understanding how we do that in a more captive market.

Eric: Got you. As far as inventory management, there are obviously... if you watch a bad DVD you're not going to get sick the next day.

Di Valerio: Yeah.

Eric: Food: How has that been from a business model perspective, and being able to get the right amount of sales and manage that so that you're not having to throw too much of your inventory away?

Di Valerio: Right. That's a key. That's, again, something when you have a couple kiosks in a market you're testing out and figuring out what the right rotations are, what the demand is, what the highest demanded products are in the kiosks so that you have it stocked at the right levels.

That's certainly something that we're testing out. We have a very good food supplier. We tested and surveyed, I think, seven different companies and selected one for right now. We have a couple others as we begin to go more regional, if we decide to move the business at a faster pace.

That's one of the things that we're working, and what we put in the model, is having the correct inventory control, and how many times do you have to visit the kiosk to fulfill the kiosk because it's going to be on a different pattern than a Redbox machine or a coin machine, or even a Rubi machine from that perspective.

That's all the stuff that we're testing out right now. We feel confident in the overall business model, and I'm sure we'll learn a lot; as we put three, four, five, 10, 15 of these kiosks into different offices we'll learn a lot more.

Eric: Got you. We've talked a bit about Redbox Instant. Not to push you too much on this, but how much more innovation do you expect we'll see on this? Just as one example, I know ABC, which is owned by Disney, has been in discussions with Verizon Wireless about excluding the data rates for watching their television shows, as part of a deal there.

You are partners with Verizon Wireless. Are you expecting to be able to leverage some more strengths about Verizon? Right now it's got the unique model that you can get DVDs from your kiosks and be able to watch their library, but how close to the complete vision are we, I guess is what we're asking? How much more do you see coming forward?

Di Valerio: Oh, we're in early days. Again, our partnership is with the Verizon Wireline business, and then we are going to be able to lever the Verizon Wireless out of the house as well. Really, what the JV is focused on today is making sure that the technology is set up to where every time that you turn it on, Redbox Instant, that the stream is good and that there's not buffering, those kinds of things; that we're merchandising the content in a good way.

That's, honestly, one of the things that we're working on from the surveys of our customers; that "Hey, I've got to be able to figure out what's in the kiosk, what's on the subscription, and what do I have to pay extra for, if I want to do a video on demand?" because you can do that, or purchase an electronic version of a movie as well, which you can do on Redbox Instant.

We've really been working on making that a little simpler, a little more clear and intuitive from that perspective, so we're very early days.

Again, we have around 5,000 titles, plus what you get at the kiosk, which is a nice number, focused really on movies. I think as we move along and bring on more subscribers and bring on more CE device manufacturers into the hopper, what you'll see is an expansion of the product as well, over time if you look at the roadmap for Redbox Instant.

I think we're in very, very early days.

Eric: Very early days, all right.

Di Valerio: But it's a great business, and again as I talked about with Austin, it's not a business that we have to be the No. 1 or No.2 streaming service. It's a great business and it's really not set up to try to be a streaming Netflix [ (NASDAQ: NFLX  ) ] or an Amazon [ (NASDAQ: AMZN  ) ] killer on the streaming.

It's really set up to provide customers with a great experience at a great value, that bring on a good number of customers, but, again, we can be three or four and be very, very successful at it when you match it up with the overall Redbox business.

Eric: You talk about the company being very strong and cash flow positive. You had talked about this, again, a little with Austin, but you're at eight times free cash flow, relative to where your guidance is for this year.

How do you strike the right balance between "We want to be able to return capital to shareholders when we're cheap, but we've got growth opportunities"? You can't box yourselves in a corner by getting too aggressive with this. How have you approached that problem? What are the compromises you're making here?

I know that may be not the right word there, but I know that you guys had restructured some of your capital structure recently. How are you approaching this problem, as "We have a market that's obviously, right now, trading at very high levels," and you're a cheap company; but at the same time, again, growth opportunities you want to be able to exploit.

Di Valerio: Yeah. We go through a very structured process to be able to do that, about how much do we want to invest in our current businesses, our core businesses, and innovations in those businesses, obviously within their growth patterns and what we want to bring from the bottom line.

For our new businesses, we do allocate a certain amount of money that we believe is going to invest in the business from a long-term perspective and bring long-term returns. We layer that into our analysis, and then certainly share buyback is another piece of that.

When we lay those all up, we actually look at both the short-, mid-, and long-term returns to shareholders off of that, so that it is a very structured way to do it.

We're not always 100% right, but we've been quite aggressive in the market and buying shares back over the last 18 months, and we've made a $100-million-a-year commitment that we're going to buy at least $100 million of stock back a year at our shareholders, at our analyst day.

We'll look to be opportunistic if we think we have to ratchet that up as we go through the years, if we think that's the best return of the cash for us. We certainly are a very strong cash flow business. We're a very strong profitable business.

I'm not one that thinks that you have to buy shares back in order to support the stock. You buy shares back to get the right return for shareholders, and we look at that both from an intrinsic, but also from, "What are we returning to shareholders?" -- from a savings in the business -- a pure return to the shareholders -- as well. We try to balance it that way.

Eric: Got you. I guess I'll just close here. I liked walking in the building here. You've got a history timeline of the company and milestones, and you've got "The best is yet to come." It's a nice way of motivating people to do better. It's much better than "Maximize shareholder value," and then some smiling guy in a suit.

Di Valerio: Right.

Eric: When you're looking at "The best is yet to come" and getting people to think about that, when did the company culture change in that respect? Was it optimized along Coinstar from the start, and once you hit Redbox you said, "You know what? We're an automated retail company"?

How long has this thought process on becoming a larger place of the retail chain been in place?

Di Valerio: You know, companies always evolve. About four years ago, we set a strategy around the automated retail space, and really focusing the company in that area.

The company had done a number of acquisitions over the four years ago -- some which made good sense, like Redbox -- some that were kind of outside of the automated retail space and stretched the company out where it wasn't really strong.

What we went about was a process of divesting those businesses and then really getting innovation energy around, an engine around, bringing new automated retail solutions to the marketplace; not just for what retailers are doing today, but we're really trying to look out five and 10 years as to, "Where are retailers going and how can we then help them in that regard?"

One of the things we're able to do in very small square footage is be a very high-profitable part of the store for our retailers. In most cases, we're the most profitable square footage for our retailers. What we want to be able to do is continue that on and bring great value to our retailers, but also do it in thinking on where they're going with their business over time.

That's what we'll stay focused on. That's why we think the best is yet to come. That's why we think we can continue to grow this company and bring great employees into the company and bring great returns for our employees and for our shareholders, by making it a fun place to work, an inclusive place to work, and one that really focuses on the right things, which is doing the right things for our customers, our retail partners, and for our employees.

Eric: Do you have any specific company values that everyone at the company knows?

I know with The Motley Fool, we have several. The last one's "motley." Just do whatever your best trait is. Do you guys have something in place like that, that you espouse to keep people with that vision on "The best is yet to come" and "We're looking forward to more"?

Di Valerio: We do. We have a set of great values at the company, that we established about three-and-a-half years ago. We also have turned the company around three commitments. All the employees have the same commitments as their teams do, as their bosses do, as the company does, so everybody knows the direction that we're going, and then how they fit into the company.

It's something we put in place this year, which, if you think about it, everyone has to make up goals or commitments each year, and then a lot of times you put them away until review time. Then there's also a lot of work that tends to have to go to match all of them up to see if we're going to achieve what our annual plan is, but what our strategic vision is as well.

What we've done is we've made the company around three commitments, and all the employees have the same commitments so you know how you snap into the course that we're going. You match that up with the values that we have, as well as the work we're doing and continue to do, and build out around corporate social responsibility and sustainability and those types of things that we've added into the company over the last couple of years.

The employees are pretty energized about where we're going, and pretty energized about how we're going about it. It's sometimes easier to get there if you don't really worry about the "how," and our employees are great about worrying about the "how" as well as the "what."

Eric: How many employees worked here when you got started?

Di Valerio: When I got here -- we're at about 3,000 today -- we were about 2,000 or so when I got here, so it's grown quite a bit.

Eric: It probably helps everyone's aligned, then, as you're getting so much bigger.

Di Valerio: Yes, definitely.

Eric: Great. As we're looking at the different lines that you have -- Coinstar, Redbox, Rubi on the new ventures front -- what are the metrics for success? We already talked about Rubi at, initially, 12 cups a day, a great rate for that.

How would you evaluate success, especially now that you're in a phase with Redbox where it's more optimization than building out the level of machines?

Di Valerio: You bet. For the coin machine, for example, we look at transactions and size of transactions for the coin machine, so how many transactions per day and what are the size of the transactions?

We're also weaving in the fee-free side of the business a little bit as well, which is where you can pour your coins and get a gift card out -- get a card out that, if you pour $50 in you get $50 out -- because that retailer pays for the fee. We think that's going to help us bring new customers in. Those are the metrics we look at to try to grow the coin business.

For Redbox, you certainly are looking at rents per kiosk per day as a key metric, but we're also looking at revenue per kiosk, because with Blu-ray and games, that increases the overall revenue out of the kiosk in order to be able to drive the business as we look forward.

We're beginning to track a little more, too, the online reserving because that, again, helps us standardize the business out a little bit. Those are some of the key metrics.

You talked about Rubi with cups per day. As we look at the Sample It! business, it's certainly number of samples per day that are bought, but it's also the coupon redemption, tracking the percent of coupons that are taken out of the machine; how many of those are actually getting utilized at retailers in order to purchase the product?

The Star Studio one, we certainly have... not only do we look at the number of transactions that happen -- how many people come in and do a photo session -- but how many people uplift what they're doing. They might start with a particular thing that they plan on doing, and they add people, or they add some of the features that they want to do, so you look at both the number of transactions plus the revenue per transaction.

Each of the businesses are slightly different, but we try to pick out the ones that we think show the businesses performing at the right levels.

Eric: Just to add onto that a little, what about tickets? Redbox tickets: How would you evaluate something like that, that could both increase people coming to the machine by added revenue on top? How are you evaluating an opportunity like that?

Di Valerio: Yeah, we're going deep in Philadelphia and Los Angeles to really see what kind of tickets people will want to get, and does the business model really work.

How we evaluate that is what you would normally think -- How many transactions are you getting? What's the size, so how many tickets per transaction are getting purchased, and what's the dollar value of those tickets that are getting purchased? -- are all key aspects because if you're getting lots of transactions but they're to low-dollar events, you might tweak the business model a certain way.

The other thing that's really interesting for the tickets business is there's an online component to that, so you can buy tickets on Redbox.com, or you can do it certainly at the kiosk, or you can go to the kiosk and ask the kiosk to send you an email to remind you about the tickets so you can buy them online.

Really, we're looking at how are people utilizing it online, versus how many transactions are actually happening at the kiosk, because again we can tweak the business model around that if people are more comfortable doing the transaction online, but discovering that an event is happening at the kiosk.

One of the reasons why 30%-40% of the tickets go unsold to events around the country each year is lack of awareness that an event was actually happening. We have 40,000 points of presence where people are going up, and 40 million unique credit cards transacting with it each quarter; it gives us a great opportunity to let people know that a particular event is happening in their area and they might want to go ahead and purchase a ticket for it.


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