Kerrisdale Capital Investment Case Study
Competition:
Find a Zero: Which Billion Dollar Company Will be
Bankrupt by 2020
Team Name & University:
University of Colorado
Rick Brubaker
Everett Randle
Iana Stoytcheva
February 2015
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Tables of Contents
1. Investment Thesis ……………………………………………………………… 3
2. Business Description …………………………………………………………… 4
3. Key Thesis Factors ……………………………………………………………... 5
a. Failed New Ventures …………………………………………………… 5
b. Redbox on the Decline …………………………………………………. 7
c. Competitive Pressures for Additional Segments …………...……….. 10
4. Financial Analysis …………………………………………………….………. 13
a. Debt & Obligations ……………………………………...……………. 13
b. DCF Analysis ……………………………………………………..…… 14
5. Appendix ………………………………………………………………………. 16
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The Next Billion Dollar Company to go Bankrupt: Outerwall Inc. (NASDAQ:OUTR)
Investment Thesis
Outerwall operates an outdated and quickly declining business model in its Redbox division,
and possesses no sustainable competitive advantages in its CoinStar or ecoATM segments which
make the firm vulnerable to increased competition from banks and telecom companies that create
similar services. The firm’s search for a new source of growth has been unsuccessful, as their
two most recent ventures – Redbox Instant and Redbox
Canada – both failed within two years of launch due to a
lack of demand coupled with operational miscues. As
Outerwall’s current business segments continue their
Market Profile
Closing Price (2/19/15) ($USD)
Avg. Daily Volume
Shares Outstanding (millions)
Market Capitalization ($B)
Revenue ($mm)
P/E (LTM)
P/B (LTM)
Debt/Equity
$66.57
714,535
18.97
$1.3
$2,303
12.8x
13.0x
9.7x
transition from cash cow to dog status, the firm becomes
more desperate to find a new venture to provide much needed growth. This will lead Outerwall
to sink cash into R&D and other investment related expenses, just shortly after management
refinanced the firm’s debt raising its total long-term borrowings close to $1 Billion. If the firm is
unable to find a new star venture – and all evidence points to them being unable to – Outerwall
will not be able to meet its principal repayment obligations from 2019-2021. Because of these
factors, OUTR will file Chapter 11 bankruptcy by 2020.
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Business Description
Outerwall Inc. (“OUTR” or “the Company”) is a provider of automated retail solutions that offer
products and services that benefit consumers and drive incremental retail traffic and revenue for
retailers.
Business Segments
Redbox - OUTR owns and operates 43,680 Redbox kiosks, in 36,140 locations across the U.S.
where customers can rent or purchase movies and video games. Kiosks are installed primarily at
leading grocery stores and convenience stores such as Kroger, Walgreens, and Walmart. Kiosks
require ten square feet and allow the customer to efficiently rent a movie or video game via debit
or credit card. Return of products is allowed to any Redbox location. The Company pays retailers
a percentage of their revenues generated at the machine and obtains movie licensing through
revenue sharing and licensing agreements with studios.
CoinStar - OUTR owns and operates 21,340 CoinStar kiosks in 20,250 locations. Consumers
feed loose change into the coin-counting machines, which count the change and dispense
vouchers redeemable for cash, gift cards, or store credit. Revenues are generated through
transaction fees charged to customers and product partners.
“New Ventures” - The Company is exploring other self-service concepts to build their business.
The main growth product in this area is ecoATM which provides an automated self-service kiosk
where consumers can recycle mobile phones for cash and OUTR generates revenues from this
venture by selling the recycled phones to third parties.
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Past performance
In February 2009 Outerwall purchased Redbox from McDonalds for $175M to end their
previous joint venture (McDonalds and OUTR both owned 47% of the company). Since the
acquisition, sales growth has exploded from $766M (with around 20,000 Redbox kiosks) in
Redbox revenues to over $1.9B in 2013 with 43,000 kiosks in North America while the stock
price has risen nearly 100% during the same period. However, though total kiosk growth has
been robust, OUTR has struggled over the last two years with declining same store sales growth,
total kiosks, average revenue per kiosk, and total revenues.
Key Thesis Factors
Failed New Ventures:
Obsolescence of Physical Rentals Shows in Canada
Redbox recently announced that they were abandoning their Canadian operations with an
associate loss of $1.5 million. A quote from the company’s Redbox Canada website states
“unfortunately, demand just didn’t meet our
expectations.” The company will be moving
the 1,400 rental kiosks from Canada back to
the United States, where they will be
distributed to new locations. In an interview
with a local newspaper, a Regina, Canada
resident named Chris said of the Redbox
closing, “I really don’t know a lot of people who have used them because a lot of people I know
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go through Netflix.” Chris’ comments reflect a larger consumer trend taking place not only in
Canada, but in the United States. The primary selling point of Redbox when it was founded in
2002 was to give consumers greater place utility by offering a quick and easy way to rent new
releases while visiting the grocery store, or fast food establishments. When examining the
current marketplace for movie rentals, this utility has been completely outdone by brands like
Netflix, Hulu, and Amazon. These firms have taken the same principle of place utility that fueled
Redbox’s original success, and brought it to the next level. Now, consumers don’t have to leave
their homes (more specifically their couches) in order to enjoy a movie rental, and often at a
comparable price. Online renting also eliminates the responsibility of keeping track of DVDs and
ultimately returning them to their source.
Redbox Too Late on Addition of Online Rentals/Streaming
In March 2013, Outerwall launched Redbox Instant, a partnership with Verizon that offered four
one-night movie rentals per month as well as unlimited video streaming. The move followed in
the steps of rival Netflix, and was designed to carve Redbox a sizeable share of the online rental
market. Ultimately, Redbox entered the market too late with too weak of a value proposition to
steal any significant market share from the dominant players Netflix, Hulu, and Amazon. The
service operated at a loss for a year and a half until Outerwall shut it down in early October of
2014. A lack of demand coupled with security issues related to customer’s credit card
information led to the poor performance of the service. A Redbox spokesman commenting on the
closing said that “the service had not been as successful as either partner hoped it would be.”
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Internal Distress
On January 18th, 2015, Outerwall CEO Scott Di Valerio resigned from his position and also
stepped down from the company’s board of directors. Di Valerio’s resignation came in the wake
of a decision to raise the daily rental prices of DVDs and Blu-ray Discs in their Redbox segment,
which the firm stated would have an “adverse impact” on rental volumes. Analyst reports after
the decision predicted that the move would shift rental market share further away from Redbox.
While the Outerwall board continues to insist that Redbox is “well-positioned for success,” Di
Valerio’s abrupt departure shows that the company may be in more turmoil than they’d like to
admit.
Redbox on the Decline:
Macro Factors & Consumer Preferences
Over the last ten years, the movie rental industry has experienced a remarkable change in
customer preference and distribution channels. In 2005, the United States physical video rental
spending was over $8 billion. This spending is estimated to have been near $4 billion in 2014; a
50% decrease in consumer spending through this medium over the last decade. While the
physical DVD rental market has been diminishing, online streaming/renting of movies has been
growing exponentially. According to IHS Screen Digest Broadband Media Market estimates in
2012, the paid consumption of movies online had nearly $1 billion more transactions than the
physical rental of movies in 2012, and is projected to account for twice as many transactions as
physical rentals in 2016. This increase in online movie streaming has led to the emergence of
new market players such as Netflix, Hulu Plus, and Amazon. Currently, these three companies
are the main competitors for Outerwall’s kiosks, but on a higher level, it is the online rental
market as a whole that represents the biggest threat to the firm, not any individual competitor.
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Competitive Factors
Hulu, Amazon, and iTunes are the most direct competitors in the movie rental industry. To
compare price points, the DVD rental market can be standardized in 48 hour periods. Redbox
currently charges $3.00 ($1.50 per day) for physical rentals. Amazon charges $3.99 - $5.99 for a
digital rental, and iTunes commonly charges $0.99 - $4.99. Collectively, Hulu, Amazon, and
iTunes represent a large market share within the online streaming market. With competitive
pricing, and additional place utility, these online
channels represent an attractive alternative to
physical movie rentals.
The products provided by iTunes, Hulu Plus, and
Amazon Video are direct substitute goods for the
DVDs provided by Outerwall’s kiosks. As economic principles suggest, if the demand for a
substitute good increases – as it is projected to grow exponentially - the demand for the primary
good will decrease. Given the historical and forecast projected increase within the online
streaming industry, the physical rental market is projected to face steep decreases in demand.
Operational Evidence
Redbox has begun to see the macro effects of shifting consumer preferences in their segment
operations. Since 2012, the average revenue per Redbox kiosk per quarter went from $12,000 in
2012, to an estimated $9,800 for 2015. Redbox was able to offset this decrease in average
revenue per machine for a few years by building out more kiosks, but in 2014 the market appears
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to have become saturated, and Redbox was no longer able to continue purchasing growth. This
trend is projected to continue in a large way in 2015, where total Redbox revenues are projected
to decrease by 5-10%.
PP&E Offers Little Value in Divesting Scenario
Outerwall currently holds 43,680 Redbox kiosks. The kiosks are designed specifically for the
business and cannot be quickly repurposed for other uses. Due to this specialization, the kiosks
are not easily transferable to other business segments, which limits their liquidity for potential
sale in the future. Market research suggests that one kiosk has an approximate value of $3,500.
Using this estimation, Outerwall owns approximately $152,880,000 in kiosk equipment. Due to
the declining business demand for the Redbox segment, it is likely that in the near future
Outerwall will be forced to liquidate some of its kiosks, and because of their illiquid nature,
those sales will have to come near scrap value, and will not provide a significant amount of cash
for the firm.
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Competitive Pressures for Additional Segments:
CoinStar vs. Banks
Outerwall’s CoinStar segment provides 13% of the company’s total revenues. The
segment was founded in 1991 and has grown to over 21,000 locations. For a long time, CoinStar
faced little to no competition in the coin counting market, but that has changed drastically over
the past few years. The division now faces competition from traditional banks such as TD
Ameritrade, JPMorgan Chase, and Wells Fargo. TD Ameritrade’s Penny Arcade platform has
over 1,300 machines and allows current TD Ameritrade customers to exchange their coins to
bills for free and charges other customers a
Coin Counting Market:
Company:
# of Locations:
Fee:
6% fee (3.8% less than CoinStar). Chase and
21,340
9.8% or Gift Card
1,300
Free (TD Customers)
6% Other
Wells Fargo allow customers of the bank to
exchange their coins for free. Additionally,
CoinStar faces competition from grocery
Over 5,000
Free for Customers
stores who purchase coin counting machines
Over 5,000
Free for Customers
from ScanCoin, a private competitor which charges competitive rates.
Overall, the future outlook on CoinStar isn’t promising. Stagnant revenue per machine
has been being masked by total segment revenue growth due to additional kiosk openings. This
capability to purchase growth will soon cease to exist as the market becomes increasingly
competitive with a presence from both new private upstarts as well as large financial institutions.
Lower coin-exchange rates for non-customers from banks also threatens to compress CoinStar’s
margins as it’s forced to compete on price. These competitive factors create considerable
uncertainty for the future viability of CoinStar operations.
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ecoATM vs. Telecom
Outerwall’s “New Ventures” segment - which is primarily comprised of its ecoATM kiosks generated $94 million in revenue in 2014 while operating at a $30 million loss. The ecoATM
division faces direct competition from major wireless companies and retailers. AT&T, Verizon,
T-Mobile and Sprint all have buyback programs that value the customers’ phone online, provide
a free shipping label, and exchange the phone for credit towards a new one. Best Buy and
Amazon also feature trade in programs for
phones, tablets, computers and more in exchange
for company credit. The most popular trade-in
platform is a start-up company, Gazelle, who
already has 2 million total trade-ins for phones,
tablets and other devices. The company allows
customers to trade in their phones for cash and also resells refurbished phones on the same
website. While the market for buying back phones and other mobile devices is set to grow
exponentially in coming years, Outerwall is going to have a hard time capturing market share.
Outerwall is competing in a market where wireless companies can offer additional incentives
such as discounts on new phone models when a customer sends in their phone in addition to the
store credit provided. Retailers like Best Buy offering trade-ins for additional products such as
tablets and gaming consoles makes it especially difficult for this “new venture” to take off and
blossom into the star that Outerwall desperately needs.
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BCG Portfolio Analysis
The easiest way to bring together all of the research on Outerwall’s segments is to create a
Boston Consulting Group Matrix, a tool used by firms to observe current product positioning and
identify possible future investment strategies. The general idea is that a firm should use their
cash cow operating units (high market share, low market growth rate) in order to fund new
ventures that become stars (high market share, high market growth rate), before those cash cows
become dogs (low market share, low market growth rate). Outerwall has been trying to complete
this process, but as our BCG analysis illustrates, the firm has had been unsuccessful in bringing
two question marks (low market
share, high market growth rate,
where most new ventures start), to
star status. Instead, the ventures
quickly became dogs and were
harvested. As time goes on, and
Redbox and CoinStar continue to
make their shift from cash cow to
dog, it becomes more and more vital for the firm to find a venture that can become a star. Right
now, the firm is counting on ecoATM to be that star. As our previous analysis suggests, though,
the probability of that happening is marginal. If ecoATM is unable to make the transition to
becoming a star, Outerwall will be in an extremely vulnerable position as all of its segments slide
into becoming dogs. This positioning would leave little opportunity for the firm to generate cash
without raising more debt, an option which is restricted by protective covenants present in the
firm’s current notes.
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Financial Analysis
Debt & Obligations
Current Obligation Overview
The company maintains two senior unsecured loans due at 2019 and 2021 (callable) with coupon
rates of 6.000% and 5.875% respectively. The bonds are non-investment grade and have an S&P
rating of BB-, meaning the business is less vulnerable in the near-term, but faces major ongoing
vulnerabilities toward financial and economic conditions. OUTR also entered into a senior
secured revolving line of credit with repayment in 2019 and convertible to 2018 if the 2019 bond
is still outstanding.
Debt Covenants
The Company must comply with its Amended and Restated Credit Agreement governing their
Credit Facility and the indentures that govern the Senior Notes due 2019 and 2021. These
covenants state that the company cannot incur any additional debt without lender approval
(limiting liquidity if the company is short on cash), is restricted in the ability to liquidate assets
and engage in M&A, pay dividends, or make investments into capital expenditures. Finally,
OUTR must maintain certain leverage and interest coverage ratios or they risk the threat of
default. While all of these covenant agreements appear to be standard, the company has
addressed them as a significant risk to the firm as they state in their 2014 10-k filing, “If we do
not comply with the covenants in the Amended and Restated Credit Agreement that governs our
Credit Facility, the indentures that govern our Senior Notes due 2019, or our Senior Notes due
2021, respectively, we may not have the funds necessary to pay all of our indebtedness that could
become due.” The significant debt burden that OUTR holds coupled with its questionable future
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profitability should be considered a major risk when considering the future viability of the
company.
DCF Analysis
Equity is Essentially Worthless
After running a discounted cash flow analysis, it becomes evident that OUTR’s business model
is not sustainable and that the firm’s equity is essentially worth nothing zero. The assumptions
we use in our model include a 5% year-over-year (yoy) decline in total revenues driven primarily
by the decline in Redbox sales, and the lack of significant growth in “New Ventures.” We also
factored in a yearly 0.5% margin compression factor for net income to reflect increased R&D
expenses associated with the new ventures and general compression of margins due to
decreasing revenues. Depreciation and amortization were projected based on a five year
historical average (D&A as a % of sales) and capital expenditures were calculated based on a
five year historical average as a percentage of D&A. Projected interest expense was generated by
examining the coupon rates of the company’s two outstanding bonds to generate an annual
interest payment. Unlevered free cash flows were generated based on a discount rate of 10% with
a terminal growth value of zero (using the perpetuity growth method). This yielded an enterprise
value of $732.5M. With net-debt currently at $731.0M, the model yields an equity valuation of
nearly zero, illustrating that with slight revenue and margin declines in coming years, Outerwall
equity is essentially worthless.
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Appendix A: New Venture Revenues vs. Total Number of Kiosks
Source: Investor Relations
OUTR has a “New Ventures” business segment that participates in the development of various
kiosk concepts. Currently the company has ecoATM as the primary product from this category.
Revenues have increased from nearly $500,000 and have grown to almost $100 million in annual
revenues. The trend can be traced with the total kiosk growth as well with the segment having
just fewer than 2,500 kiosks. In 2014, the company also discontinued four product lines in this
business segments including Orango, Rubi, Crisp Market, and Star Studio. The operating results
of these segments have been moved to other comprehensive income and are not included in
reported segment results.
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Appendix B: CoinStar Kiosk Growth & Sales vs. Operating Income
Source: Investor Relations
CoinStar has added around 2,500 kiosks in the past five years. During the same period, revenue
has grown at a CAGR of 2.7% while operating profit has grown to $120M. While revenues have
operating profits have gone up, revenue per kiosk has actually declined during the same period.
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Appendix C: Redbox Segmented Data
Source: Investor Relations
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The Redbox business segment experienced considerable top line growth from 2010-2014
primarily driven by the large increase in kiosks in 2010 – 2012. However, total Redbox kiosks
have stayed completely stagnant since 2012 and even declined by 1% year-over-year to 43,680
total units. The decline was coupled with a tumultuous 2014 for the business segment; same store
sales growth was negative for 3/4 quarters during the year with revenues declining $81 million.
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"How to Deposit Coins: TD Bank's Penny Arcade vs. Coinstar vs. Chase vs. Bank of America –
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Fortune, 11 Oct. 2011. Web. 18 Feb. 2015.
"Moody's Says Outerwall's New Dividend Policy and Increase in Share Repurchase
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"Outerwall (OUTR) Stock Tanked Today Following CEO Resignation." TheStreet. TheStreet, 20
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