Is Coinstar a Buy?

Coinstar (Nasdaq: CSTR) is reeling from an 6% blow to the kidneys after releasing second-quarter results. That generous discount could make this the perfect time to buy in.

Sales fell short of analyst expectations, despite growing 35% year over year to $342 million. Strong demand for DVD rentals and coin-cashing services couldn't overcome the loss of e-payment and money-transfer revenues, which are now classified as discontinued operations. Earnings from continuing operations surprised in a positive way, creeping up to $0.39 per share, from $0.35 per share last year. Free cash flow was $52 million, up from negative territory a year ago.

As you can see, there's not much wrong with the ongoing operations here. Redbox rental sales jumped 44% year over year, and now contribute a whopping 79% of Coinstar's total sales. Don't expect the coin-counting segment to go away anytime soon, though. It's slower-growing than the DVD operation, at just an 8.5% annual clip, but its 38% operating margins beat the DVD division’s 14% every time. There's nothing wrong with some reliable cash-machine operations to help finance Redbox's exciting growth opportunity.

Chief rival Netflix (Nasdaq: NFLX) keeps up with Coinstar in some ways, reporting 42% more subscribers in the second quarter of 2010, compared to the year-ago period. The rate of growth is still accelerating there, and if I were Comcast (Nasdaq: CMCSA) or Time Warner Cable (NYSE: TSC), I'd be worried about these two strong upstarts.

Coinstar's Redbox has beaten Netflix's growth rate in the latest quarter, partly reflecting new Netflix subscribers' tendency to pick lower-priced rental plans and get the streaming library for cheap. Coinstar is starting to rack up distribution deals with big Hollywood studios, lowering its library acquisition costs, and presumably growing the field of available movies. The company also announced Blu-ray rentals for $1.50 per day, available now at 13,000 kiosks and in more than 23,000 by year's end. If Netflix and Redbox were apples-to-apples competitors, I'd worry for Netflix in the short term, too. Since they appeal to somewhat different demographics, I see both of them growing for a while.

Redbox is a vibrant business today, and it will continue to grow over the next couple of years. After that, it may take some time before consumers wean themselves off renting physical discs, and moving on to the sort of digital distribution models that Netflix or Amazon.com (Nasdaq: AMZN) are doing. After that, all bets are off, as DVD and Blu-ray alike start to fade into the shadows.

Still, Coinstar looks cheap relative to its growth potential in general -- especially right now. Would you buy Coinstar at a discount today, or are there greener fields elsewhere? Discuss in the comments below.