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Packaged Media Gets Confidence Vote

27 Jul, 2016 By: Erik Gruenwedel

Private equities group’s $1.6 billion acquisition of Redbox parent, Outerwall, underscores confidence in physical distribution channel

In an era of low-cost subscription streaming and ubiquitous digital access, Apollo Funds’ $1.6 billion acquisition of Redbox parent Outerwall would appear to be a shot in the arm to packaged media and physical distribution of DVD and Blu-ray Disc.

The $52 per share purchase price represents a 51% margin on Outerwall’s first-quarter stock price.

Redbox is the largest disc rental service in the country. With $84.2 million in first-quarter operating income on revenue of $421.5 million and a 20% operating margin, the kiosk vendor is a friend to the corporate bottom line. It’s also a proverbial cash cow, which in economic terms means a mature — not growing — business.

That’s a signal of death to investors, many of whom have long questioned physical media’s staying power in an age of Netflix, Hulu and Amazon Prime Video.

Not to Eric Wold, media analyst with B. Riley & Co. who believes Apollo is actually paying too little. Wold contends the offer is below his prior $58 per share price target, and does not take into account Redbox’s near 80% share of Outerwall’s business.

“While we acknowledge the physical rental industry is in decline, we have stressed for years that rental trends are not falling off a cliff — especially since, in our opinion, there is not a direct competitor to Redbox,” Wold wrote in a note.

The analyst reiterated that Blockbuster went out of business because Redbox was able to offer the exact same product in a more convenient manner and for a cheaper price. Additionally, Wold contends that while transactional VOD is arguably more convenient, the price is upwards of six-times the price of a Redbox rental.

“We continue to see an opportunity for Redbox to leverage that price gap by raising prices slowly each year as its owns [the rental] market — which would be incremental to our cash flow outlook,” Wold wrote.

Michael Pachter, senior analyst with Wedbush Securities, said he expects Redbox revenue to rebound in Q4 following the Summer Olympics in Rio de Janeiro. He said the pending bow of Redbox Digital, a transactional VOD platform, would not incur the upfront content costs that undermined Redbox Instant.

“While we believed that the DVD rental business was likely to stabilize later in the year, investors had grown frustrated waiting for a turnaround, and we believed that Outerwall shares were ‘dead money’ for the foreseeable future,” Pachter wrote in a note.

But in a separate email response, Pachter scratches his head trying to understand how Apollo believes Redbox will generate sufficient returns to pay back its 10-figure investment.

"I'd say they expect single-digit declines, instead of the double-digit declines we've seen over the past year. Hard to get inside their heads on this one."

Redbox reports Q2 results July 28.

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