Tuesday, December 13, 2005

Coinstair: Watch Your Quarters!

Coinstar, Inc. (CSTR - $23.90) is a leading owner and operator of self-service coin-counting machines and amusement vending services for retailers. Offerings include skill-crane machines, bulk vending, kiddie rides and video games.

What parent has not seen [and dreaded] those skill-crane machines that dispense plush toys and other novelties for $0.50 a turn. Try walking by one of those machines with change in your pocket and a six-year-old at your side. If you do not want the child to cry on the drive home in the car, say good-bye to all your change--and then some.

Do not underestimate the power of a child's whine. Coinstar disclosed in their most recent 10Q filing that total revenue during the three months ended September 30, 2005 was $118.7 million, driven primarily from skill-crane machines, which contributed $41.8 million, or 35.2% of this total. Now that's a lot of quarters! Before investors run out to load up on Coinstar shares, however, we thought it prudent to disclose two salient risks:
  1. Retail partner relationships are highly concentrated. For the nine-month period ended September 30, 2005, Wal-Mart, Inc. kicked in 27.5 cents of every dollar in consolidated sales, compared to 16.4% in the prior year. "[continued] success depends on our ability to continue to pay our retail partners a service fee that allows us to operate the units profitably. We have faced and are currently facing ongoing pricing pressure from our current retail partners to increase the service fee we pay or to make other financial concessions to win or retain business." In other words, in coming earnings' periods, Coinstar will probably suffer from ongoing pricing pressures [i.e. lower operating margins], in order to retain its distribution channels with the likes of Wal-Mart, Inc. and The Kroger Company.
  2. Coinstar's credit agreement restricts the Company from taking certain actions that could be beneficial to its business. On July 7, 2004, Coinstar acquired ACMI, another entertainment service vendor for $235.0 million in cash. To finance this acquisition, the Company borrowed money from a syndicate of lenders led by JPMorgan Chase Bank and Lehman Brothers Inc. Since this acquisition, Coinstar has repaid $43.7 million of the debt outstanding. Excluding goodwill of $152 million and prepaid expenses of $12 million, leaves the Company with approximately $401 million in total assets. This debt financing, therefore, swallows about 48% of total assets. In other words, servicing this debt may affect the Company's ability to effect future financings. Management has to step up and now show that it can leverage the acquisition of ACMI and grow revenues and EPS organically--instead of through buying other companies.

Hold on to your quarters!

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