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BRIGANTINE ADVISORS DIGITAL MEDIA November 6, 2009 1 COINSTAR BUY (CSTR, $29.80) Solid Quarter But Investors Wanted More November 6, 2009 Steven B. Frankel, CFA (617) 652-0179 steve.frankel@brigantineadvisors.com Conclusion: Coinstar posted solid Q3 results – beating on the top line (adjusting for the sale of the Entertainment business) and EPS and coming roughly in-line in terms of EBITDA. However, a downtick in comparable store sales at Redbox and the fact the company didn’t raise forward guidance sent the stock down in the after-market. Despite the near-term disappointment in terms of Q4 guidance, we continue to believe Redbox is a concept that still has plenty of room to run and should fuel strong growth in 2010 and beyond. We are maintaining our Buy rating and $38 Price Target, based on 5.8x EV/2010E EBITDA, and see the post-quarter weakness as a buying opportunity. ■ Q4 Guidance Unchanged: Despite some upside in the quarter, management did not raise guidance, which is a clear disappointment. We believe the company is being conservative, especially given the slate of hit movies coming in Q4, including tent pole titles from Redbox- friendly studios like Up (Disney) and Star Trek (Paramount). Reflecting the sale of the Entertainment business, our Q4 estimate goes from $351.3M/$0.30 to $324.8M/$0.30 and our full year estimate is now $1.14B/$1.04 (up from $1.259B/$0.85, reflecting the removal of losses in the Entertainment business). Looking to next year, we going from $1.6B/$1.40 to $1.5B/$1.45. ■ Valuation: The stock was trading in the after-market at $29.80, implying a multiple of under 5x EV/2010E EBITDA, well below the 7.4x our Digital Media Group is trading at currently. We believe a solid Q4 performance should restore investor confidence in the story and expand the stock’s multiple. Our Price Target on Coinstar remains $38, which is based on 5.8x EV/2010E EBITDA. Despite the near-term disappointment, we are maintaining our Buy rating on the stock and would use the weakness as a buying opportunity. CSTR $29.80 EPS 2008A 2009E 2010E Mkt. Cap $M $900.0 1Q 0.10 NA 0.30E FYE De 2Q 0.09 NA 0.33E Dil. Shr. M 30.2 3Q 0.16 $0.31 0.40E 52 Wk. Range $38 -$16 4Q 0.15 0.30E 0.42E P/S FY09 0.8x Year $0.50 $1.04E $1.45E P/Book 2.2x P/E 57.8x 28.6x 20.6x FCF/Share $0.99 Revenue $M FCF Yield 3.3% 1Q 190.5 NA 327.2E EV/EBITDA 7.8x 2Q 219.9 NA 363.5E Debt to Cap 51% 3Q 240.5 295.9 381.0E BV/Share $13.46 4Q 260.9 324.8E 427.2E Source: MSN Money Note: Estimates include stock-based compensation and past periods not yet restated for sale of entertainment business. Please see addendum for disclosures. Net Debt/Shr. $11.82 Year 911.9 1,141.6E 1,498.9E BRIGANTINE ADVISORS DIGITAL MEDIA November 6, 2009 2 Coinstar posted solid Q3 results – beating on the top line (adjusting for the sale of the Entertainment business) and EPS and coming roughly in-line in terms of EBITDA. However, a downtick in comparable store sales at Redbox and the fact the company didn’t raise forward guidance sent the stock down in the after-market. Despite some near-term disappointment in terms of Q4 guidance, we continue to believe Redbox is a concept that still has plenty of room to run and should fuel strong growth in 2010 and beyond. We are maintaining our Buy rating and $38 Price Target on the shares and see the post-quarter weakness as a buying opportunity. Details Coinstar reported $295.9M/$0.31, including the impact of the sale of the Entertainment business and a $1M charge for the early retirement of debt. EBITDA was $52.3M and Adjusted EBITDA was $54.9M. We had modeled $323.3M/$0.25, or $293.7M excluding the Entertainment business. ($Mil.) Q308 Q309 Brigantine Estimates Q309 Actual Redbox Revenue $104.2 $197.9 $198.1 Y/Y Change NA +90.0% +90.1% Total Revenue $240.5 $323.3 $295.9 Y/Y Change +67.8% +34.4% +23.1% Operating Margin 8.5% 6.9% 9.2% EPS $0.16 $0.25 $0.31 EBITDA $39.9 $53.0 $52.3 EBITDA Margin 16.6% 16.4% 17.7% Cash $64.4 $68.4 Total Debt $367.1 $425.3 Revenues from Redbox were $10M ahead of our estimate and operating margins increased to 17.4% from 17% a year ago, despite the dual pressures of falling used DVD prices and the workaround of content from Warner. The company now has 20,600 kiosks and recently averaged a mind blowing 31.6M rentals/mo. The company believes it now has 14.6% of the rental market, up from 7% a year ago as Redbox continues to take share from the brick and mortar outlets. However, comparable store sales did slow from 33% in Q2 to 26%, still an impressive level but the trend bears watching in Q4. Looking ahead at Redbox, the company is now executing work arounds for Warner, Fox and Universal. Management commented that logistics are not an issue but that they are not getting as many copies of these titles into the kiosks as they would like. The question then becomes will consumers turn away if the latest movie from Warner or Fox is sold out or instead rent something else. Given the convenience factor of Redbox, our gut says most consumers will substitute another movie rather than getting in the car and driving to the closest Blockbuster. BRIGANTINE ADVISORS DIGITAL MEDIA November 6, 2009 3 The company tightened its full year revenue guidance for Redbox from $750- $780M to $760-$780M. The Coin business was down 2%, which was mostly due to currency. The company continues to roll out coin-to-card machines, but it has yet to lift comps, which were -5.4% in the quarter. We think it will take both an improving economy and some targeted marketing to up-tick this business. Guidance and Estimate Changes At the end of the second quarter, guidance for the full year 2009 was $1.225-$1.300B, EBITDA of $200-$210M and GAAP EPS of $0.80 to $0.86. Excluding the impact of the sale of the Entertainment business, revenue guidance is now $1.115-$1.165B, which implies flat guidance after subtracting the Entertainment business. Similarly, EBITDA guidance remained at $200-$210M and EPS guidance is now $0.98-$1.04. So, despite some upside in the quarter, management did not raise guidance, which is a clear disappointment. We believe the company is being conservative, especially given the slate of hit movies coming in Q4, including tent pole titles from Redbox-friendly studios like Up (Disney) and Star Trek (Paramount). Our fourth quarter estimate goes from $351.3M/$0.30 to $324.8M/$0.30 and our full year estimate is now $1.14B/$1.04 (up from $1.259B/$0.85, reflecting the removal of losses in the Entertainment business). Looking to next year, we going from $1.6B/$1.40 to $1.5B/$1.45, with Adjusted EBITDA of $260.9M. These numbers should prove conservative, especially given the absence of the money-losing Entertainment business but we are going to stay conservative for now waiting to see the performance of Redbox in Q4. Valuation and Conclusion While we didn’t get the beat & raise quarter out of the company we expected, we still believe Redbox is a powerful concept with lots of runway left, especially with consumer behavior favoring rental over disc purchases. The stock was trading in the after-market at $29.80, implying a multiple of under 5x EV/2010E EBITDA, well below the 7.4x our Digital Media Group is trading at currently. We believe a solid Q4 performance should restore investor confidence in the story and expand the stock’s multiple. Our Price Target on Coinstar remains $38, which is based on 5.8x EV/2010E EBITDA. Despite the near-term disappointment, we are maintaining our Buy rating on the stock and would use the weakness as a buying opportunity. Steven B. Frankel, CFA 617.652.0179 BRIGANTINE ADVISORS DIGITAL MEDIA November 6, 2009 4 Risks Studio Relationships – The battle lines have been drawn, with three major studios, Fox, Universal and Warner Brothers, which represent roughly 40% of the DVD market, seeking to delay the company’s access to new releases. As mentioned previously Universal Studios has taken issue with the company’s use of the First Sale Doctrine to purchase DVDs from distributors and rent them out. Traditionally, the large brick & mortar operators like Blockbuster purchased content under revenue sharing arrangements with the Studios. Universal seeks to delay the release of its content to kiosk vendors like Redbox until 45 days after the release of the DVD for retail sale and to prevent the company from selling excess discs on the used market. In response, Redbox has sued Universal and the dispute is in the early stages of what is likely to be a protracted process and is currently obtaining Universal content through other channels. Now, Fox is seeking to impose a 30-day blackout, delaying Redbox’s access to new titles and like the Universal situation, Redbox is suing Fox. Warner is the most recent to jump on the anti-kiosk bandwagon, attempting to institute a 28 day delay. The attitude of Fox and Universal is in sharp contrast to Sony and Lionsgate, which were willing to strike long-term deals with Redbox. Building stable long-term relationships with Hollywood will be a critical element in reducing content costs and improving customer service. Electronic Distribution – The DVD format is mature, but not disappearing overnight. However, over the next five years or so, digital distribution will gain increasing traction at the expense of DVD. We believe the company can add a digital distribution strategy that leverages its existing customer relationships but it is very early in the transition. In the near-term we will be watching the progress of key suppliers in this digital transition such as Sonic Solutions (SNIC, $6, Hold), with its CinemaNow subsidiary. BRIGANTINE ADVISORS DIGITAL MEDIA November 6, 2009 5 BRIGANTINE ADVISORS DIGITAL MEDIA November 6, 2009 6 BRIGANTINE ADVISORS DIGITAL MEDIA November 6, 2009 7 Analyst Certification The research analyst(s) primarily responsible for the preparation of this research report hereby certify that all of the views expressed in this research report accurately reflect their personal views about any and all of the subject securities or issuers. The research analyst(s) also certify that no part of their compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. Stock Rating 1-Buy - The stock is expected to deliver a total return of 15% over a 12-month investment horizon. 2-Hold - The stock is expected to deliver less than a 15% positive return or less than a 10% negative return, over a 12-month investment horizon. 3-Sell - The stock is expected to deliver a negative total return of 10% over a 12-month investment horizon. Important Disclosures This report has been prepared by Brigantine Advisors LLC. This publication does not constitute an offer or solicitation of any transaction in any securities referred to herein. Any recommendation contained herein may not be suitable for all investors. Although the information contained in the subject report (not including disclosures contained herein) has been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. This publication and any recommendation contained herein speak only as of the date hereof and are subject to change without notice. Brigantine Advisors and its employees shall have no obligation to update or amend any information or opinion contained herein. This publication is being furnished to you for informational purposes only and on the condition that it will not form the sole basis for any investment decision. Each investor must make their own determination of the appropriateness of an investment in any securities referred to herein based on the tax, or other considerations applicable to such investor and its own investment strategy. By virtue of this publication, neither Brigantine Advisors nor any of its employees, nor any data provider or any of its employees shall be responsible for any investment decision. This report may not be reproduced, distributed, or published without the prior consent of Brigantine Advisors. All rights reserved by Brigantine Advisors. Brigantine Advisors and its logo are registered trademarks of Brigantine Advisors LLC. This report may discuss numerous securities, some of which may not be qualified for sale in certain states and may therefore not be offered to investors in such states. This document should not be construed as providing investment services. Investing in non-U.S. securities including ADRs involves significant risks such as fluctuation of exchange rates that may have adverse effects on the value or price of income derived from the security. Securities of some foreign companies may be less liquid and prices more volatile than securities of U.S. companies. Securities of non-U.S. issuers may not be registered with or subject to Securities and Exchange Commission reporting requirements; therefore, information regarding such issuers may be limited.
