Coinstar Sees Physical Disc Rentals Inching Forward

Coinstar has dialed back its installation rate for Redbox kiosks amid a slowing physical disc rental market, executives said on the company’s Q4 earnings call Thursday. Coinstar plans to install 500-1,000 additional kiosks “in the right locations,” said Chief Financial Officer and Interim President of Redbox Automated Retail Scott Di Valerio: “The kind of install rate that we're at is probably where we're at.” The company’s kiosk strategy is now about “optimizing the network versus further expansion,” Di Valerio said.

Premium Redbox Blu-ray rentals roughly doubled from the year-ago quarter to 12.5 percent of revenue in Coinstar’s Q4, executives said. While CEO Paul Davis trumpeted the return of frequent customers to its rental business following a lackluster title selection in Q3, analysts cautioned about an overall declining physical disc market. The company was profitable in videogames and plans to “maximize our revenue and our profit generation” in videogames this year, Di Valerio said.

Coinstar has 45 percent of the U.S. DVD rental market “that has just entered a decline phase,” said Paul Coster, analyst at JPMorgan. Coster said Coinstar is still posting strong year-over-year revenue from its Redbox kiosk business as it penetrates the market further, and said the completed acquisition of NCR’s Blockbuster Express kiosk business should add 5-10 percent market share for Coinstar in the DVD rental market. A forecasted 50 percent of the DVD rental market by year-end “could yield some pricing power,” Coster said.

Coinstar executives did not discuss the possibility of another rental price hike, following its October 2011 increase of 20 cents per disc. Revenue grew 9.6 percent in Q4 2012 as the company lapped that price increase, Di Valerio said. Coinstar is banking on gains from the decline of brick-and-mortar DVD business, Di Valerio said, saying the $5.5 billion physical rental business is expected to grow to $6 billion over the next few years.

Redbox rentals per kiosk are expected to be down to 2011 levels over the first half of 2013, Di Valerio said, and then to “come up to 2012 levels.” January rentals were impacted by a dearth of content, with 12 new release titles for the month compared with 23 last year, he said. Among the factors challenging profitability for Q1 2013 are the company’s expansion into Canada, its $14 million investment in digital content for the Redbox Instant by Verizon service, consumer marketing costs and a $6 million hit due to older NCR kiosks, he said. The company is in the process of replacing NCR kiosks and will feel the impact of those costs through Q2, he said.

Asked whether shifting consumer preferences toward streaming are driving a projected five straight quarters of lower rentals per kiosk through mid-year, Di Valerio said physical rentals are still “a thriving business.” Citing an overall sell-in and rental disc business, he said Coinstar still has “a lot of confidence that there’s still a lot of demand” and opportunity to grow the business.

Coinstar expects to improve turns per kiosk over the course of the year due to a change to kiosks called vertical merchandising zones that will allow the company to add 80 discs to the capacity of each unit. In the past, discs would be replaced while they still held rental value, but the company had to remove them before their time to make room for new releases, Davis said. “We'll be able to keep them in and hopefully get another turn or two, which is really, really good,” he said. No product cost increases will be incurred, he said, calling the strategy a “better utilization of inventories.” Di Valerio said having more discs in a kiosk for a longer time means more revenue. “When you get to the kiosk, your first, second or third choice is there more often,” he said.

On the Redbox Instant by Verizon digital streaming venture, Davis said “tens of thousands” of users are beta-testing the service and the goal is to roll it out to all customers this quarter. Coinstar provided “no visibility” on when the joint venture would contribute revenue or profit after announcing the venture more than a year ago, said Michael Pachter, analyst with Wedbush Securities, saying it’s “troubling that the actual rollout beyond beta is taking so long.” Coinstar already took charges of $20 million and will incur additional charges of $9 million-$11 million this quarter, Pachter said. “The magnitude of the Q1 loss and the existence of additional losses for the balance of the year suggest that a Q2 rollout is contemplated,” he said.

Meanwhile, Coinstar’s coffee kiosk business, Rubi, fell short of company forecasts in Q4, as the finalization of production kiosks “shifted out several months,” Davis said. The company expects to begin the rollout in Q2. Coinstar shares fell 6.9 percent Friday to $48.47.