Don't Write Off Redbox Just Yet

To hear most analysts tell it, Redbox has become a zombie for its owner Outerwall (NASDAQ: OUTR  ) , the former Coinstar movie rental and coin-counting machine maker. It's dead but it just doesn't know it. Let me be the one to misquote Mark Twain and say that reports of its death are greatly exaggerated.

On the surface, the Wall Street diagnosis looks correct. While total revenues came in 4% higher for the quarter, they broadly missed analyst expectations and comps on its Redbox machines tumbled 7% from the year-ago period. Even with what might be considered a bright spot for the quarter, that it surpassed Netflix (NASDAQ: NFLX  ) in market share and now owns more than 50% of the entire DVD rental market, can be cast in a different light as its rival has been focusing more attention on its streaming business and, with the demise of Blockbuster, it better be the dominant disc rental player.

But I think there are some key components that are missing here. In the latest quarter, it had 43,600 Redbox kiosks in service, while last year it had 38,500, or 13% less. I know that within a mile or two of my house, I have a choice of at least a dozen Redbox machines. While it wasn't mentioned during the call, I'll wager a lot of the degradation in same-machine sales was a result of Outerwall cannibalizing sales. It generated $11,900 per machine in the second quarter of 2012 but just $11,000 per machine this time around even as segment revenues rose 4% (though it expects to reverse that trend in the back half of 2013). 

Yes, the DVD market is dying, but what we're hearing now might not be its death rattle, particularly because of the seemingly surprising strength Outerwall got out of its Blu-ray offerings, which, combined with the game titles available, saw 69% growth this past period.

It's true an investment Redbox does need to account for the fact that 86% of Outerwall's total revenues come from the kiosk so any fluctuation in that business will impact performance, but it's not standing still either, introducing more of its self-serve Rubi coffee machines, introducing "green" ecoATM's, and launching its mobile tech kiosks that allow consumers to buy mobile phones, tablet computers, and mp3 players. Nor is it sticking to its guns with DVDs as the joint venture with Verizon (NYSE: VZ  ) for a streaming service continues to be developed.

While we might be getting our entertainment from more sources these days, the DVD player is still a place where viewers are checking out Hollywood's best, which might be more of a problem than kiosk cannibalism.

The industry has produced a bunch of bombs this summer, from Lone Ranger to R.I.P.D, After Earth to White House Down. Even so, revenues are still 12% higher, no doubt due to the success of surprise hits like The Conjuring. Yet average ticket prices are also higher than a year ago, up 5% as a result of 3-D and Imax movies pushing them up.

If I were to worry about any one thing with an investment in Redbox, it wouldn't be the DVD, at least not yet, but whether Hollywood can produce quality fare that moviegoers will want to see -- and then rent when it shows up in their local Redbox. Otherwise, it will be a horror show bigger than The Walking Dead.


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