Analysts Downplay Redbox’s ‘Messy’ Quarter

30 Jul, 2010 By: Erik Gruenwedel

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The day after Redbox reported financial results below expectations, sending the DVD rental kiosk operator’s shares on a slight decline, analysts have circled the wagons, calling the quarter a hiccup on a burgeoning stock.

Parent Coinstar July 29 reported second-quarter revenue that fell nearly $40 million below market projections of $381.5 million, prompting some investors — already concerned about the company’s mounting expansion-fueled-debt — to cash out.

Indeed, Coinstar’s long-term debt obligations top $410 million, with short-term obligations of about $7 million, according to regulatory filings.

“[Coinstar’s] DVD business disappoints, until you dig deeper,” wrote John Kraft, analyst with D.A. Davidson & Co. in Lake Oswego, Ore., in a July 30 note.

Michael Pachter with Wedbush Morgan Securities in Los Angeles said Redbox ordered too many disc copies and was adversely affected by the 28-day window on 30% of new releases in the quarter, which led to a decline in transactional volume per kiosk.

Pachter said investors spooked by a “messy” quarter should realize that the addition of Blu-ray Disc titles will boost transaction revenue going forward.

“If standard DVD rentals (at $2 per rental on average) comprise 90% of sales and Blu-ray (at $3) comprises 10%, the average transaction would be $2.10,” Pachter wrote in a July 30 note. “Each 1% increase in Blu-ray rental share should drive average transaction size higher by $0.01.”

The analyst said Redbox’s biggest box office title in April earned just $1.7 million, leading to negative comp in the month. Also, he said an early spring break/Easter negatively affected revenue. Same-store (kiosk) revenue increased 3.5% in the quarter compared to a 21% increase in the previous quarter.

“Despite the solid finish to the quarter, we believe the positive momentum from June may subside somewhat as the availability of more copies of Avatar and Alice in Wonderland at the end of Q2 most likely skewed results,” Pachter wrote.

The analyst said the lower average cost of new DVDs (via revised distribution agreements) should more than offset the increased cost associated with destroying older DVDs as opposed to selling them as previously-viewed product.

“We estimate that the all-in cost of movies under these wholesale arrangements (net of the sale of previously-viewed merchandise) will be approximately $6 per disc lower [than what it was before the deals],” Pachter wrote.

In addition, he said Redbox was on the hook for $2.2 million in license fees to Sony and Paramount in the quarter, revenue share with retailers, credit card fees, and supply chain expenses, which all contributed to lower operating margin.

“Although operating margin did suffer in Q2, we expect it to increase in the long-term as the company’s distribution agreements allow Redbox to purchase more copies at lower prices,” Pachter wrote. “Despite the lower comp, we think that Redbox’s demise has been greatly exaggerated.”

Indeed, Eric Wold, analyst with Merriman Curhan Ford in New York, noted that Redbox’s rental market share grew to 25.2% from 18% a year ago and that Coinstar upped 2010 revenue guidance $15 million to $20 million, despite the windows and dearth of key releases.

“The [second-quarter] was an anomaly,” Wold wrote.

Finally, Pachter speculates Redbox will soon announce a major retail agreement with a marquee chain such as Target, which he said will help the kiosk company expand faster.

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