Will Redbox Investors See Green?

A few words almost jumped off the page in Outerwall's recent earnings report, and that is just one reason investors may see some green from the company.

Feb 22, 2014 at 1:00PM

According to the company itself, more than 40 million people know Redbox, but far fewer know about its parent company Outerwall (NASDAQ:OUTR). That said, with Redbox generating more than 80% of the parent company's revenue and operating profit, as Redbox goes, so goes Outerwall. The company may not be installing a new Redbox on every corner as it used to, but there are at least three reasons to believe that investors in Redbox will see green in the future.

Goodbye shares = Hello better returns?
There is little question that Outerwall is committed to retiring its diluted shares, as the company retired 10% of them in the last year alone. While competitors like Netflix (NASDAQ:NFLX) and Amazon.com (NASDAQ:AMZN) are growing their revenue much more quickly, they have also grown their share counts by nearly 4% and 1%, respectively.

Netflix's streaming business poses a threat to Outerwall's Redbox unit because every stream could have been a Redbox rental instead. Every Netflix DVD customer (there are still nearly 7 million of them) has less incentive to make the trek to their local Redbox kiosk.

Amazon poses a similar streaming threat with its Instant Video offering. However, the company's online rental options are an issue as well. With more than 60,000 movies to rent, and more than 22,000 of them priced at $1.99 or less, customers may have a hard time turning down the convenience of staying home.

Even with all of this competition, the Redbox division generated positive revenue growth. With strong positive free cash flow, the company is committed to repurchasing its shares. In fact, the company plans on repurchasing $350 million in shares in a Dutch auction at a 5% to 20% premium to their last trade. Nothing shows that a company believes that its shares are undervalued like the willingness to buy them at a premium to their market value.

Is this a hint of things to come?
What about this sentence jumps off the page?: "The company is committed to return 75% to 100% of FCF [free cash flow] to shareholders, initially through share repurchases." The phrase "initially through share repurchases" seems to scream that a dividend is coming. After all, if the company was not considering a dividend, why say "initially" at all?

Neither Netflix or Amazon are either considering or hinting at dividends, but with revenue growth of better than 20% at both companies, this isn't the first thing on investors' minds. Outerwall's story has seemingly moved from growth alone to growth and income.

If the company were to use 50% of its free cash flow on a dividend, this would still allow 25% or more of it to be used for share repurchases. In the last three months, Outerwall generated more than $35 million in core free cash flow (net income + depreciation - capital expenditures). The use of core free cash flow helps strip away some of the accounting changes that don't really affect a company's cash.

At 50% of core free cash flow, the company would spend $17.5 million per quarter. With 25.5 million outstanding shares, this would equate to a $2.72 annualized dividend. At today's prices, investors would get a yield of about 3.8%. Needless to say, a near 4% yield is the second reason investors might see some green from Outerwall in the future.

A third leg of growth?
Netflix's future is international streaming, which showed better than 100% membership growth in the most recent quarter. Amazon's future could be the company's Web services division, which grew at better than 50% domestically and 25% internationally. Outerwall's future could be in the hands of its ecoATM business.

Today, this business of trading in used electronics for cash only accounts for about 3% of Outerwall's revenue. However, there are only 880 kiosks and they are mainly located in malls. The company plans to add 1,000 to 1,200 new locations and it also wants to begin placing these units in higher-traffic areas like large supermarkets.

With each unit generating an estimated $100,000 to $120,000 in annual revenue, 1,200 new machines could add as much as $120 million to Outerwall's revenue in 2014. For a company with $2.3 billion in revenue in 2013, this would represent a roughly 5% increase. If the company can successfully manage the ecoATM business, this third leg of growth could be the third reason Outerwall investors will see green in their future.

With strong share repurchases, a potentially lucrative dividend, and a new growth driver, Outerwall looks poised to continue delivering positive returns for investors. If you are looking to add some green to your portfolio, I would suggest adding Outerwall to your personalized Watchlist today.

Who will win the war for your living room?
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.

Chad Henage has no position in any stocks mentioned. 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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