Up 40% Time to Buy Outerwall Shares?

Stock ownership is never a one-time decision. Investors need to make sure they keep up with the companies they invest in, and continually reexamine if the story has changed. With Outerwall (OUTR) stock up more than 40% in the last year, this seems like a reasonable time to see if the growth story is intact amidst rising competition from Netflix (NFLX 1.43%) and Amazon.com (AMZN -2.47%) or if it might be time to look for other opportunities.

Time to buy?
Just two months ago, Outerwall's stock dropped by more than 20% on news that the company's third quarter and full year forecast was cut. In July, the company expected to report $5.76 in earnings per share for the year. Two months later, the company cut its EPS projection to just $4.72 .

With such a massive reduction in projected profit, investors rightfully discounted the stock. However, here we are just a few months later and the stock is higher than it was before. The call in September to buy the stock made sense in hindsight, but what about today?

The company said "heightened promotional discount activity...had an adverse impact on the expected transaction size." That being said, the company was able to produce positive free cash flow. This could be a reason for investors to stick with the stock.

In addition, the company said that it is committed to returning "75% to 100% of annual free cash flow to shareholders ." Since Outerwall doesn't pay a dividend, this return of capital will have to come by the way of share repurchases. Given that the company has retired more than 13% of its diluted shares in the last year, investors can see how serious management is about this capital return.

Or time to move on?
One of the biggest concerns facing Outerwall is the level of competition facing the company's Redbox unit. Between Netflix'(NFLX 1.43%) streaming catalog and Amazon.com's(AMZN -2.47%) Prime Instant Video expansion, Redbox's business could be in trouble.

Amazon said it added "millions of new Amazon Prime members ." Netflix now reports more than 40 million worldwide streaming subscribers . There is little doubt that these millions of customers are less likely to visit their local Redbox. Since Redbox represents nearly 84% of Outerwall's total revenue, any problems with this business could be devastating to the stock.

Though the company reported revenue growth of 9%, the company's core diluted EPS dropped by 23%. The company reported that Blu-ray rental volume increased from 8.6% to 13% of total rentals. Normally this would be good news and it could point to better revenue in the future. However, this increase occurred while EPS dropped so investors might want to question this thesis.

In addition, Outerwall expects a "significantly reduced investment in New Ventures." Just a few quarters ago, the company trumpeted its new ventures businesses as growth opportunities that were important to the company. When it released this report some of these promising businesses were barely mentioned.

It's possible that DVD and Blu-ray rentals will stay around longer than many anticipate. However, Netflix and Amazon as well as others are banking on streaming as the key to the future. Netflix is continually signing new licensing deals and developing new content to drive subscriber growth. In the most recent quarter, the company added over one million new domestic subscribers.

Amazon also realizes that its streaming catalog can be both a money maker and a doorway to get more shoppers to sign up for Amazon Prime. Amazon also holds a unique advantage in that the company's Kindle lineup is designed to direct users to the Amazon ecosystem. With multiple advantages from Kindle users directly related to Amazon Prime, the more devices the company sells the bigger the threat to both Outerwall and Netflix.

The counterpunch to these streaming services was supposed to be Redbox Instant. A few quarters ago, the company had big plans for this service, this quarter it warranted only a few sentences suggesting users were more engaged and interested.

With a commitment to return 75% or more of free cash flow to shareholders, this sounds good on the surface. However, core free cash flow (net income + depreciation – capital expenditures) was down more than 60% versus last year, so there is a lot less cash to return than before.

Outerwall sounds like a business that is retreating to what it knows best, the Redbox business. In the short term, the company may be able to squeeze better results out of the business. However, there is little doubt growth from this division is slowing. As physical media is replaced by streaming video, Redbox will ultimately suffer.

Investors need to watch the company's Redbox results carefully. If new ventures are no longer the future of Outerwall, then any challenges to Redbox will become a major problem for the stock. With shares up more than 40% in the last year and the company's earnings and cash flow suffering, there are red flags popping up already. The company's reluctance to invest in new businesses is worrisome. It might be time for shareholders to look elsewhere for better opportunities.