by Jamie Dlugosch | October 31, 2011 9:02 am
Sometimes, the intelligent quotient of the market is remarkably low. Institutional investors are adept at taking advantage of this fact with a manufactured story that results in the masses taking the bait. Case in point is Friday’s selloff in Coinstar (NASDAQ:CSTR).
The owner and operator of the DVD rental system Redbox saw its shares drop 7% after the company reported earnings that crushed estimates. That’s right — Coinstar delivered a stellar earnings report and the stock is getting whacked. Why?
Netflix (NASDAQ:NFLX). The massive blow-up of the former high-flyer has made Coinstar an easy target. The argument easily spread by hedge fund short sellers is that, like Netflix, Coinstar will be easily bumped from its perch by competition from streaming movies or bigger players that eventually will take over the kiosk model.
The story is easy to sell to gullible investors, but the case against Coinstar is thin. The simple explanation for the selling was that CSTR somehow disappointed investors by lowering guidance for the fourth quarter. In reality, the company raised guidance for the full year thanks to a huge beat in the third quarter. Indeed, guidance for the fourth quarter was less than what Wall Street was looking for, but net-net, the company is ahead of the game. Anyone with half a brain can understand why the outlook for the fourth quarter is lower: Management is being prudent.
Coinstar is raising prices on its rentals from $1 to $1.20, and it knows there might be a slight push-back from consumers, a la Netflix. At the same time, economic uncertainty is enough to make any management team take a more cautious approach to running its business. But does that conservative stance mean the company should be valued any less? I don’t think so. At the end of the day, CSTR is going to put up an annual profit number higher than what Wall Street was looking for before earnings were released.
As for comparisons to Netflix, there is no comparison. The two situations are entirely different. Here are three reasons why:
Anyone comparing Netflix to Coinstar clearly has a limited grasp on the importance of valuation. Prior to releasing earnings, Wall Street was looking for Coinstar to make $3.09 per share in 2011. For 2012, the estimate was for the company to make $3.79. That represents a jump of 23%. At Thursday’s close of $52.95 per share, Coinstar was trading for a very modest 17 times current-year estimates of earnings.
Netflix was an entirely different story. Prior to NFLX releasing earnings, management had made a series of massive missteps that justifiably raised issues with respect to future earnings. At the same time, shares of Netflix traded for a hefty 27 times current-year estimated earnings. It doesn’t take a doctorate to realize that if earnings are in question, valuation must come down.
Specifically, the issue for Netflix was future growth. Having maxed out the home delivery model, the company is in the process of transitioning its business further to streaming content — a pool with significantly greater competition. Coinstar does not face the same issue. It can continue focusing on blanketing the U.S. with its kiosks. Instead of having to depend on streaming for its future, streaming content for Coinstar represents an opportunity to grow sales beyond kiosks.
It is a subtle difference. Netflix likely will lose home delivery and therefore must transition to streaming. Coinstar, thanks to its price differentiation, will not lose its kiosk model in the same way. As such, these two companies are in entirely different places in their growth evolution.
Price differentiation matters greatly for future stock price. Netflix, already pricey, is a luxury product. Coinstar is positioned as an impulse buy for the stronger consumer; for the weaker consumer, Coinstar is priced so low as to still be attractive to this ever-growing segment of the economy.
It was a mistake for Netflix to raise prices on home delivery, but Coinstar’s hike doesn’t seem nearly as dangerous. Think about it: Will someone really not rent a movie because the price is 20 cents higher? Give me a break.
This is a facetious argument by Coinstar short sellers at best. I suspect Coinstar can raise prices several more times before running into any real resistance on the demand side of the equation. If anything, the increase in prices should be celebrated by investors. CSTR is flexing its muscle, confident in its market position and loyalty of its customer base. That said, Coinstar is not likely to abuse this fact with multiple price increases — this is the first increase in eight years.
Netflix enjoyed a first mover advantage with its business, and so does Coinstar. The trouble for Netflix is that by having to morph into a streaming media company, the door is open for big-time competition.
Coinstar dominates the kiosk model. It has secured prime locations in the market, and over time it will only solidify this position. Competition might become an issue, but not anytime soon. If the company stays focused on that model and is opportunistic instead of dependent on streaming, profit growth is nearly assured.
Put it all together and there is no way Coinstar should be treated in a similar manner to Netflix. Their similarities end at renting movies. The selling in CSTR is a screaming buying opportunity.
As of this writing, Jamie Dlugosch did not own a position in any of the aforementioned stocks.
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