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Better Margins Than Netflix + Growth: The Stock?

A name change can’t hide the fact that Outerwall’s (OUTR) main business is renting DVDs in the era of video streaming, and quite suddenly, its investors are worried about that. Fearing the beginning of the end for Outerwall’s Redbox DVD rental kiosks, they’ve been dumping shares fast in recent weeks. But it’s possible that these sellers lost hope in old technology too soon.

As seen in a stock chart, Outerwall shares dropped 19% in four days last month after the company cut earnings and revenue forecast for the year. The news more than wiped out the run up in the shares this year through July.

OUTR Chart

OUTR data by YCharts

But demand for Redbox DVDs has not been dying. On the contrary, Redbox rented about 74 million DVDs from about 43,700 self-serve store kiosks in July, which was its best rental month in history. Last year, Redbox’s same kiosk sales grew more than 10%.

The company blamed its forecast cuts on discount coupons for single-night rentals. The promotion brought in new customers but led to shorter rental periods, which is problematic for a company that charges by the day. Overall, Outerwall now expects revenues to rise roughly 4.5% to $2.3 billion for the year, and diluted earnings per share to rise 7% to about $4.92.

It’s notable that these numbers reflect Redbox progress at a time when Netflix (NFLX) is adding more than 600,000 streaming subscribers every quarter. Some 87% of Outerwall’s revenue came from Redbox last year. The rest mainly are from Coinstar (the parent company name until June), which operates coin-counting machines. In the two years since Netflix has been streaming, Outerwall’s revenues are up 30% and net income is 53% higher.

OUTR Revenue TTM Chart

OUTR Revenue TTM data by YCharts

The inevitable demise of DVDs will understandably make Outerwall a non-starter for many investors. And we would not bother discussing the investment if Outerwall shares were priced like a Netflix stock, which has a PE ratio of about 400. But Outerwall trades at less than 9 times forward earnings now, generating higher free cash flow and profit margins than Netflix. At this price, there are several reasons to believe Outerwall and its shareholders could thrive despite streaming.

Jana Partners, an activist fund manager, apparently thinks so. Jana, it was disclosed late last week, took a 13.5% stake in Outerwall and wants discuss strategic options -- stuff like throwing out management, selling the company.

OUTR Forward PE Ratio Chart

OUTR Forward PE Ratio data by YCharts

OUTR Free Cash Flow TTM Chart

OUTR Free Cash Flow TTM data by YCharts

Redbox’s experience shows that consumers still want DVDs even as they sign up for streaming subscriptions. Redbox estimates that 20% to 30% of its customers already subscribe to a competing streaming service. Still, for not-yet-streamed video, consumers apparently like the immediate gratification of renting DVDs at the local Wal-Mart (WMT) or Walgreens (WAG) instead of waiting two days for a Netflix delivery. Outerwall is adding some 1,500 Redbox kiosks to stores this year.

Any success for Redbox Instant would be a good sign for DVD demand. Redbox launched the venture with Verizon (VZ) in March that gives customers unlimited movie streaming and four Redbox DVD movies a month for $8. Redbox Instant has an almost comically limited library compared to Netflix, so the draw would have to be the DVDs at store kiosks. No official word yet on how that’s going since users had to start paying for it.

Timing the pace of innovation change is risky; just ask those disappointed investors in Dell (DELL) or Hewlett-Packard (HPQ) that underestimated the speed in which smartphones and tablets would replace PCs. Outerwall investors shouldn’t get too comfortable unit it gets into an industry with long-term growth. (We suspect streaming won’t do it for them.) Right now though, Redbox is filling that void surprisingly well.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.

Read more articles about: Company Analysis  stocks that look cheap   

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