Should You Buy, Sell, or Hold This Red Video Streamer Dreamer?

Coinstar (Nasdaq: CSTR  ) needs a name change.

Its namesake change machines long ago took a backseat to the real story: its Redbox DVD rental kiosks. Redbox comprised an overwhelming 84% of last quarter's $465.6 million in revenue. On top of that, the red brand has been dreaming of streaming online video and taking on Netflix (Nasdaq: NFLX  ) for ages, and there are signs that those plans may finally be coming to fruition.

Are Coinstar shares currently a buy, sell, or hold?

Buy:

• Redbox: Physical DVD renting will always have a place in our hearts, although its relative significance is certainly on the decline in the face of online video offerings. Assuming Netflix doesn't try any more boneheaded rebranding flops, it will continue to offer its namesake mailing service. Sometimes though, instant gratification does have value. Redbox has a pretty compelling value proposition through its convenience and low pricing. I frequently find myself perusing its kiosks if I'm looking for something same day, and the automated machines are much more efficient than DISH Network's (Nasdaq: DISH  ) flailing Blockbuster locations that continue to go by the wayside.
• The segment is what's driving revenue growth. Last quarter's 22% top-line growth is literally entirely attributable to Redbox. The segment's $84.4 million in sales growth represented substantially all of the $85.4 million growth that the entire company saw. Coinstar was even able to crank up prices by 20%, from $1 per day to $1.20 per day, with little to no fanfare, a stark contrast to Netflix's price-hike fiasco. I was a little skeptical at the time, but in this case no press is good press.
• Dreaming of streaming: Coinstar has been talking of entering online video streaming for years, with nothing to show for it beyond speculation and disappointed investors. Recent rumors have it that Coinstar may be teaming up with Verizon (NYSE: VZ  ) for a possible streaming service. The Redbox brand is easily recognizable within the realm of home entertainment, and if Coinstar is to finally launch a streaming offering, this could become its next growth catalyst.

Sell:

• Margins: The Redbox segment has historically carried slimmer operating margins relative to the Coinstar division. Last quarter, the DVD kiosks garnered a 13% operating margin compared to the 26% that the change machines saw. As Coinstar's revenue composition continues to increasingly shift towards relying on Redbox for growth, margins could see some downside pressure. This hasn't been the case quite yet, as last quarter's overall operating margin of 14% was higher than the prior year's 12%, but this possible margin contraction presents a risk factor.
• Dreaming of streaming: Launching a streaming service would be only the first step. The long-term viability of the service would depend entirely upon Coinstar's execution and its ability to maintain relevant content and grow its subscriber base. It would need to go head-to-head with Netflix, Hulu, Amazon (Nasdaq: AMZN  ) Prime, and DISH's BlockBuster On Demand, among others. Amazon Prime also continues to aggressively grow its collection, recently adding Glee to its mix. These are some bigwigs to go against, and Coinstar's streaming foray could potentially end up being a money pit.

Hold:

• Valuation: Trading at 13 times earnings, shares seem appropriately priced, especially when considering the 25% sales growth seen over the past five years. Coinstar's cheaper than the 21 multiple that Netflix is trading at, and Netflix's five-year sales growth is comparable at 26%. Coinstar's market cap sits just under $1.4 billion, which is pretty small considering how recognizable its brands are and the potential it has in streaming.
• Coinstar: Despite the higher operating margin that the namesake division carries, the coin-changing business has been relatively stagnant compared to Redbox. The past three quarters have seen little to no year-over-year growth in the segment, rising 2% or less. The machines keep chugging along and pitching in to the bottom line, but they're definitely not the star of the show.

The final verdict
At this point, I think Coinstar overall is a buy, mostly on the strength of its Redbox division. The current valuation is cheap enough to warrant picking up shares based solely on the growth that the DVD kiosks are putting up (28% sales growth last quarter), and the possibility of adding a streaming offering to the mix is merely the cherry on top. Last quarter's profit also jumped a healthy 90%.

Even if margins end up declining as Redbox continues growing, I'd rather have a smaller piece of a faster growing pie than a larger piece of one that's been sitting on the sill for too long. To follow up, I'm going to give Coinstar an "outperform" CAPScall today.

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