This past summer, Coinstar (NASDAQ:CSTR) suddenly lost more than 40% of its value when the company released news that its third-largest customer, Safeway (NYSE:SWY), had elected to end its relationship with the company.
For investors, this was one of the biggest fears facing Coinstar. This company puts coin-sorting machines in grocery stores and similar retail locations throughout the U.S., and is dependent upon the willingness of these companies to allow its kiosks to take up space in their stores. At the time, three companies -- Royal Ahold (NYSE:AHO), Kroger (NYSE:KR), and Safeway -- comprised the lion's share of Coinstar's business. When Safeway pulled out, choosing to go with its own internal coin-sorting program instead, the effect was a triple-whammy on Coinstar.
First, they were losing 10% of their revenue base. Second, a successful trial at Safeway would have the effect of introducing a viable competitor. Third, if Safeway succeeded, what would keep the other big customers from bolting for their own solutions as well?
As far as I was concerned, the rapid drop in price suddenly made the company a more compelling investment. And the more I studied the company, the more I believed that the turmoil offered a compelling investment opportunity, so I made it my selection for the Motley Fool Hidden Gems newsletter in November. Subsequent events have affirmed this decision, most recently the company's fourth-quarter earnings report, issued yesterday.
Coinstar turned in top-line growth for 2003 of more than 13% to $176 million. This is remarkable considering that the company lost a 10% customer in the middle of the year. Much of this increase came in the form of same-kiosk sales, which rose nearly 8%. This attests to a rising level of customer acceptance of the machines, and also goes some way to answering a nagging question about whether the existing success of Coinstar can be attributed to people recycling years' worth of coins, never to return. In the company's conference call (courtesy of CCBN), Rich Stillman, president of the company, noted that of the new trials, "80% of them become repeat customers."
Coinstar was able, in only six months, to refurbish and redeploy about half of the 1,083 units that it had pulled out of Safeway, and it expects to deploy most of the remainder this year. This has two benefits for the company. First, it lowers the ongoing need for capital expenditures for new machines, and second, it shows that what were potentially stranded assets were fairly easy to get back into the revenue stream.
Most important, the company announced that it has signed long-term contracts with both Ahold and Kroger, thus alleviating the fear that the companies would follow Safeway and bolt, or that they would take advantage of Coinstar's temporary weakness and attempt to increase their claim on its revenue stream. This suggests that these companies have watched Safeway's struggles to go into the coin-processing business alone, and have decided that it is worthwhile to continue allowing Coinstar to do the heavy lifting.
The company did not provide an update on the potential for Coinstar kiosks to go into Wal-Mart (NYSE:WMT) stores. Wal-Mart had been negotiating with the company, but it (of course) wants a better deal than other customers. Coinstar has held the line thus far. Ideally they will continue to do so.
Coinstar does not make its cash flow statements available for its earnings report, something I don't understand given the company's straightforward business model. Since the level of annual depreciation and amortization -- $27 million -- is 50% higher than GAAP earnings, I'm anticipating that the company's operating cash flows will be even higher than earnings. We'll see when the 10-Qs are filed, but for now, it's a fine day for Coinstar.
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