Can Redbox Profitably Coexist With the Netflix and Amazon Video Empires?

Shares of Outerwall spiked higher in early February, partially due to better-than-expected financial results at its Redbox video retailer unit. With Netflix and Amazon targeting the unit's customers with their streaming offerings, is Outerwall a good bet for investors?

Feb 20, 2014 at 11:20AM

Despite fast-growing video empires at Netflix (NASDAQ:NFLX) and Amazon.com (NASDAQ:AMZN), Outerwall's (NASDAQ:OUTR) Redbox unit seems to be holding its own, reporting higher rental volumes in its latest fiscal year.  Indeed, the company's latest financial results led to a recent spike in its shares, no doubt helped by the announcement of a large stock repurchase offer. While Outerwall remains a favorite of short-sellers, some of the so-called smart money has been picking up shares, including mega hedge fund Jana Partners.  So, is Outerwall a good bet at current prices?

What's the value?
Outerwall's Redbox unit has built a huge retail footprint, roughly 44,000 kiosks at last count, by providing its retail partners with a nice ancillary revenue stream at minimal cost, otherwise known as a can't-lose proposition. The company is virtually the last man standing in the physical video retail space, having outlasted or bought most of its major competitors, including its 2012 purchase of NCR's sizable kiosk business.  Naturally, the major video streaming networks are also a source of direct competition, but so far Redbox has been able to maintain the size of its customer base, estimated at 40 million users, due largely to its unbeatable convenience, which is highlighted by customers' ability to return rentals to any kiosk in its network.

In fiscal year 2013, Redbox reported a modest top-line gain, up 3.4%, aided by higher transaction volumes and stable average pricing. While its basic rental charge is $1.20 per day, Redbox generated an average transaction value of more than twice that level during the period, thanks to multiple-day rentals and a greater percentage of sales from higher-priced Blu-ray and video game rentals. The net result for Redbox was a continuation of strong operating profitability, thereby providing the capital to procure a greater and more diverse amount of content.

Trying to protect the moat
While Redbox has some international expansion opportunities ahead, notably in Canada, its operation is primarily in maintenance mode, due to a national domestic network that already covers virtually all major markets of interest. As such, the company's focus seems to have shifted toward protecting its customer base from encroachment by the streaming networks, a change in strategy that was the likely impetus for the creation of its Redbox Instant streaming venture, a partnership with telecom heavyweight Verizon.

Meanwhile, the streaming networks are trying to siphon customers away from Redbox, as well as from the traditional cable networks, by offering exclusive content that customers can't find anywhere else.  Netflix, in particular, has been especially successful in that regard, with a strong slate of Emmy-nominated original programming, including its House of Cards, Orange Is the New Black, and Arrested Development series.

In FY 2013, Netflix continued its strong growth trajectory, with a 21.2% top-line gain that was primarily a function of a quickly expanding customer base, which topped 44 million globally at year's end. More important, Netflix's in-demand content offerings are doing much of the selling for the company's service, lowering its required marketing spending and improving its operating margin. As a result, Netflix has higher cash flow to invest in content procurement and development, which drives incremental customers to its service and completes a positive feedback loop.

Likewise, Amazon took a page from Netflix's original programming playbook in 2010, setting up its own studio, aptly named Amazon Studios, which has been responsible for popular series like Alpha House and Betas. The company has also been aggressively utilizing its cash hoard to lock up exclusive content arrangements with major Hollywood studios, including its latest deal that makes Amazon Prime the online video subscription home for Twentieth Century Fox's The Americans series. While Amazon doesn't break out its video subscriber totals, independent estimates have pegged it at 3 to 10 million, making it a formidable competitive threat for Redbox, given the vast technological and financial resources of the Amazon ecosystem.

The bottom line
The naysayers have sounded a death knell for Outerwall and its Redbox unit, despite Redbox having a domestic user base that is actually larger than that of either of its two major streaming competitors. While the company may have trouble finding top-line growth in an increasingly digital world, Redbox's customers may be stickier than the naysayers think, ensuring continued profits for its retail franchise and making Outerwall a stock that investors want to own.

Which of the cable disruptors should you want to own?
You know cable's going away. But do you know how to profit? There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. Hint: They're not Netflix, Google, and Apple.

Robert Hanley owns shares of Netflix, Amazon.com, and Outerwall. The Motley Fool recommends and owns shares of Amazon.com and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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