Netflix reported earnings Wednesday January 27, after the close. The numbers were better than expectations of analysts so the stock was up more than 20% in the after hours and the next day. One of the better than expected numbers was the number of subscribers as well as the lower ratio of free trial members to paying members. So the company is doing well in an era where Blockbusters, Movie Gallery, and other mom and pop small shops are closing down. There is, also, the topic of online movie rentals which Netflix offers an unlimited amount with a paying membership, which sounds like an amazing deal for computer savvy people that can connect their computers to their TVs or people who are content to watch a movie on their computer monitor which is not the best movie watching experience for sure. A similar concern is that not a lot of people are that computer savvy. At least when you check the demographics of people who watch a lot of movies -the kind of people Netflix and other movie rental businesses would love to have as customers- you see that they tend to be lower educated, lower income people who do not own the best equipment and who lack the technical skills. This is one of the roadblocks for online rental businesses and the reason why video on demand from cable companies despite being overpriced makes over a billion dollars a year.
As you have heard me say about other stocks before, Netflix, too, is a great company, but not necessarily a great stock. From any valuation perspective you look at the stock you realize it is very overvalued and the expectations are too high for the future. The industry is and will increasingly face more issues with the studios who will most likely want a bigger piece of the pie as their industry is in shambles and the DVD sales and rentals are going down the tube. They might even start their own online rental businesses and if I were their managers, I would be pushing the company in that direction since I would have the resources and most importantly the content and that would put my company in a great advantage and the others such as Netflix at a huge disadvantage. Netflix for all I know might be better of buying a studio if they can afford it.
On a trip down south (anything lower than NYC on a map that is) I ran into a new way to rent DVDs. There were these red kiosks, or boxes, in Walmarts and grocery stores and even some McDonald's stores. It reminded me of the first book I read about stock markets: One Up On Wall Street by Peter Lynch and I decided to a little research on the company that produces and runs these kiosks. It turned out that the producer is Flextronics and the company that runs these is Redbox. Redbox is owned by Coinstar. Coinstar started by a Stanford graduate as an automated coin counting machine company grew over time nationwide and currently provides self-service kiosks that are used in coin counting/turning into paper money, pay as you go retailer products/solutions, money services, and DVD rentals via Redbox. Personally, I am not a huge of of most of the businesses of Coinstar in the sense that I do not find them lucrative enough. However, the Redbox business by itself could be worth more than the current market cap of the company, which means you get all the other business as a bonus if you agree with my analysis. To make it as simple as possible here is how I look at it:
Redbox started as part of McDonald's Ventures LLC in 2002 to drive more traffic to the McDonald's restaurants. By 2005 these kiosks were placed in over 800 restaurants. In November 2005, Coinstar bought 47.3% of the business and in February 2009 purchased the remainder of the business for an amount between $169 million to $176 million. Today Redbox has around 19,000 kiosks in several states in a variety of stores such as Walgreens, other leading grocery stores, 7-Elevens, Walmarts, McDonald's among others as well as stand alone machines and other small businesses. Each box holds around 200 titles and 630 DVDs. These are rented at $1 per night and if a renter loses or holds it for more than 25 days (in which case they can just keep the DVD) they pay $25 dollars and own the DVD. Just doing simple math, if we assume a modest rental rate of about 10 DVDs each day, that would make 10 times 365 times 19,000 which is $69,350,000 of sales. Currently the kiosks amount to around 19% of the DVD rental market which is bound to go up with the bankruptcies and closings of the traditional DVD rental stores. They are being replaced by these lower cost kiosks. In that sense there is a huge potential in the next several years. Depending on the growth rate you assign to this business, which I personally would assign a big one, you realize that the CSTR stock could be an opportunity at current levels and the multiples it is trading at especially when you compare it to overpriced companies such as NFLX.
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