Can Outerwall, Inc. Keep It Up?

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Shares of Outerwall (NASDAQ: OUTR  ) were on fire last week, soaring 11% after the Redbox parent posted quarterly results and beefed up its buyback efforts.

The fresh financials weren't impressive on the top line. Outerwall's revenue climbed 5.4% to $593.7 million, but half of that growth was the handiwork of the ecoATM acquisition last year. Redbox itself grew at a mere 1.7% clip, and that organic growth's slowdown is significant since those DVD-spewing kiosks account for 88% of the parent company's business. 

The stock was still rewarded with an all-time high on Friday. That may seem bizarre for a company whose core business is barely keeping up with inflation, but Outerwall's earnings growth was far more impressive. Core diluted earnings from continuing operations soared to $1.68 a share during the holiday quarter, blowing past the $1.01 a share it rang up a year earlier and the $1.24 a share that analysts expected.

That's impressive, but it could also be problematic. After all, one of the reasons margins improved is that Outerwall scaled back its workforce. That doesn't sound very comforting. There's also this little gem: Redbox "adjusted its content purchases to better align with revised rental and revenue expectations." In other words, it wasn't buying as many DVDs and Blu-ray discs as it was originally targeting, because of softening demand.

We all knew that this was coming. Netflix (NASDAQ: NFLX  ) has seen its DVD-based subscribers shrink sequentially for a couple of years now, explaining why it's been leading the way in the streaming revolution. DISH Network (NASDAQ: DISH  ) thought it was getting a bargain when it snapped up Blockbuster in a fire sale, but now it's winding the chain down. Redbox was going to inherit some of the folks dropping Netflix's mail service or seeing their local Blockbuster become a burrito joint, but eventually it was going to be left with little choice but to eat itself.

The stock took a hit back in September after hosing down its guidance, and last week's report was enough to make an analyst at Northland Capital Markets downgrade the stock.

Analyst Darren Aftahi believes that Outerwall at current levels doesn't offer enough upside for the risks that shareholders are taking. He wasn't impressed by Outerwall's guidance for 2014. The midpoint of its guidance for the current quarter suggests a sequential decline in revenue, and Aftahi breaks down the company's full-year guidance to imply that Redbox and Coinstar will combine to grow its revenue by roughly 1% in 2014. The growth driver would be ecoATM, but he's left unimpressed by how slow that business has been ramping up. 

Given the soft guidance, Northland's downgrade, and even an executive shuffle, why did the stock shoot higher late last week? The catalyst for Outerwall's ascent is a modified "Dutch auction" tender offer that will result in the repurchase of $350 million in stock. Investors are drawn to the opportunity to get cashed out at a premium, and those who stick around welcome the reduction in the share count that will spruce up profitability on a per-share basis.

However, is spending money on a buyback when a stock is at an all-time high prudent? For a company seeing its legacy businesses slow to a crawl, shouldn't it be using that money to buy the next Redbox or another ecoATM instead of just gnawing on its own outstanding share count? Outerwall did have a great run last week, but 2014 isn't going to be easy as it realizes what Netflix and DISH Network have known for some time.

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Rick Munarriz

Rick has been writing for Motley Fool since 1995 where he's a Consumer and Tech Stocks Specialist. Yes, that's a long time. He's been an analyst for Motley Fool Rule Breakers and a portfolio lead analyst for Motley Fool Supernova since each newsletter service's inception. He earned his BBA and MBA from the University of Miami, and he now lives a block from his alma mater.

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