Outerwall (NASDAQ:OUTR), the company behind the Coinstar and Redbox machines, is in a tough position. More than 80% of its revenue comes from Redbox, and the inevitable decline of physical media in favor of digital distribution services like Netflix (NASDAQ:NFLX) promises to ravage the company's main source of income. Over the last few years, Outerwall has launched a variety of new vending machine concepts, some that seemed quite promising, but none of these could come close to replacing Redbox anytime soon.
Kiosks that served coffee from Starbucks (NASDAQ:SBUX) seemed like the most promising initiative, but the concept still wasn't a Redbox replacement. With the company recently announcing major job cuts as well as the scrapping of three of these concepts, it seems that there is simply no path to long-term growth for the company.
A bad sign
Outerwall is eliminating 251 jobs, or 8.5% of its workforce, with the move expected to save about $22 million annually. With net income of $175 million in the trailing 12 months, these layoffs will boost earnings by a considerable percentage. Along with these job cuts, Anne Saunders, president of the Redbox division, has left the company after a little more than a year on the job.
There are two ways to interpret this story. The first is to assume that Outerwall is cutting out the fat and getting more efficient. The company raised its EPS forecast for the full year to $5.44-$5.59, up from $4.89-$5.04 previously, a move which was well received by the market.
Another interpretation is that, with more than 40,000 Redbox locations already, there's simply little room to expand. The slower growth, along with the shuttering of three concepts, means that the company doesn't need as many employees going forward. This is not a good development.
The problem with Redbox
There are few other companies for which the short-term picture and the long-term picture diverge more than Outerwall. Redbox is a wonderful product, providing an extremely convenient way to rent movies and games. The huge number of locations, coupled with the ability to reserve discs online as well as return discs to any kiosk, gives Redbox a competitive advantage in the DVD rental business.
But this competitive advantage is not durable, and technology is already disrupting the business. Internet connections are becoming faster. Services like Netflix are becoming even more ubiquitous. Add in the rise of digital downloads of video games on new game consoles, and the convenience of Redbox will slowly disintegrate.
Outerwall, in a partnership with Verizon, launched a video streaming platform last year in an attempt to better compete against Netflix. The service, called Redbox Instant, has so far failed to take any meaningful market share away from Netflix, which has a far larger library and is integrated into a huge number of devices. It's doubtful that Redbox Instant will ever amount to much of anything, and it certainly won't save Redbox from an eventual slow decline.
No plan B
The only glimmer of hope for Outerwall came from some new concept vending machines, such as the Rubi coffee kiosk. The company signed a deal for the kiosks to sell Seattle's Best Coffee from Starbucks last year, and in an analyst day presentation in February, the company announced an accelerated roll-out of the kiosks. Outerwall touted significant potential for growth, putting the potential at 70,000 kiosks and $800 million of annual revenue.
Less than a year after that presentation, the Rubi concept is being discarded, along with a few other failed initiatives. This is quite a shift for the company, and it seems that these new concepts didn't have the potential to become the next Redbox.
Coffee is a competitive industry, with Starbucks at the high end and McDonald's increasingly boosting its portfolio of value-oriented coffee drinks. Starbucks has managed to turn a cup of coffee into an experience, and a kiosk can't mimic that. Rubi isn't necessarily a bad idea, but it isn't differentiated from other coffee kiosk concepts out there. There's no advantage of scale like there is with Redbox, and margins would certainly be far lower.
The bottom line
Without any concepts capable of growing to the scale of Redbox, Outerwall is left to manage the decline of its DVD rental empire. The company can certainly extract profits for a long time, but I don't see any path to long-term growth. The stock seems inexpensive, considering the rapid growth of the past, trading at just 12.3 times the high end of its full-year EPS estimate. But with the long-term picture fuzzy at best, I don't see Outerwall as a viable investment.
Fool contributor Timothy Green has no position in any stocks mentioned. The Motley Fool recommends McDonald's, Netflix, and Starbucks. The Motley Fool owns shares of McDonald's, Netflix, and Starbucks. 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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