Does Outerwall's Valuation Outweigh the Negatives?

Redbox and Coinstar's parent, Outerwall (NASDAQ: OUTR  ) , appears to be a polarizing business and stock. The company generated some positive press over the past few days as it crushed recent earnings estimates, despite mediocre sales gains and falling same-kiosk sales figures. On the other end, some are worried about the potentially eroding DVD business, kiosk cannibalization, and the unfavorable terms of its streaming deal with Verizon. With valuation at an appealing level and some potential freebies in the stock price, is Outerwall a buy today?

The positives 
At a quick glance, Outerwall's DVD kiosk business, Redbox, might not look that appealing. In the recent quarter, the company reported it had increased its kiosk count by 13%, while sales climbed less than half of that. As more and more consumers turn to streaming, the concept of a disc-less world is not that far off. But even though management lowered guidance on the number of new kiosks (actually, a smart move), Redbox could easily see a boost in coming quarters on the back of a strong release schedule -- including the summer blockbusters.

A Wedbush securities analyst has Redbox sales up 12% by year's end.

In addition to Redbox, Outerwall has its Coinstar business -- which could be worth $500 million, according to a Barron's article, which cites an analyst at Gabelli & Co. If that were true, investors get the remaining businesses for an extraordinarily cheap multiple, greatly limiting the downside and assuaging fears of the streaming takeover.

The negatives
Not all is well with the company, though, as activist investor ADW Capital recently illuminated in a public letter to the company.

Mainly, ADW takes issue with management's capital allocation practices -- or lack thereof. The letter addresses the fact that Outerwall has done relatively little to deliver value back to shareholders from its high-cash-generating businesses (nearly $400 million in EBITDA for Redbox by year-end 2013). Instead of finding the corner of the United States that doesn't have a Redbox and throwing money at a profit-less New Ventures segment, the company could focus more attention on its promising EcoATM concept. The EcoATM buys used phones and tablets and offers appealing ROI figures.

ADW's strongest argument is the company's third-party relationship with Verizon, in which it provides on-demand streaming services to cable customers. It may only seem natural to claim a stake in the streaming business, but Outerwall is on the outside of a densely competitive, extremely well capitalized group of competitors. Netflix, Amazon.com, and Hulu all can easily crush Outerwall's efforts, and Verizon doesn't pay enough to make it a worthwhile arrangement. Outerwall would do better to focus on the area it knows best -- mass marketing proven concepts such as money-changing machines and DVD dispensers.

Bottom line
The claims of Outerwall as being "The next [fill in the blank]" are a bit shortsighted and perhaps reaching, but the company is appealingly priced at less than 11 times forward earnings. If management can stabilize the kiosk cannibalization issue, continue its pipeline of high-value titles, and begin to deliver value back to shareholders, investors will do great.

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