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I have been studying Coinstar for over a year now and have gone from believing Coinstar a clever idea to thinking hard about coin counting and much more. I believe Coinstar is a company with a few great ideas but whose valuation had gotten far ahead of itself, and may still be way ahead. As usual, the opinions are my own, do your own research, I cite sources for all figures but check them anyway, this is not a trade recommendation, a Pinata, or a techno beat.

The promise of Coinstar is not and never was just coin counting. It was nothing less than creating the ultimate free-standing financial kiosk. Pay bills, add money to your “cashless” cash cards, buy your honey flowers or a spa weekend, and schedule a doctors appointment were just a few of the hundreds of ideas imagined for free standing kiosks. Fewer kiosk companies were started than the Dot-Com movement promised, and few companies building free standing kiosks survived or accomplished even a fraction of what they set out to. More on one that did later.

The pitfalls, competition, and complexities in creating and running a successful free standing kiosk company were and are, many.

It was a very good idea, offer people a service, Coin counting, which has been one of the many casualties of the decade long service downgrade and fee increases going on at banks and other financial institutions. As financial institutions have backed off of their traditional retail service role by charging for tellers, charging for coin counting, etc., Coinstar stepped in. It worked, even in the face of an almost ten percent fee.

Using the money generated by coin counting, the company could remain less un-profitable than kiosk competitors until it added other services. The next step in its evolution would be using loose change as a “costless” gateway to persuade consumers to use cash value debit cards.

The capital cost of installing kiosks and the ongoing cost of maintaining them, is high. In addition to approximately (old versus new versus refurbished) 13,000 dollars initial cost per unit, the cost of emptying, fixing and upgrading the machines eats a large chunk of gross. The company announced over the past month that it is embarking on an upgrade program, putting in backlights into all old machines at a cost of 3,500 dollars per unit.

Coinstar hasn't made a net profit until recently, and even then not a very large one. After all tax, administration, unit servicing and debt payments and interest, Coinstar earns just one or two million dollars, although before lots of its expenses, its operating income is 4 million dollars a quarter.

Is Coinstar's Business Defensible

Coinstar's existing defensible business components, or moat as many like to call it, exist in the form of a few patents, coin counting brand and its business relationships with, primarily, supermarket retailers. None of these components is as secure as, say, Intel's lock on chip intellectual property. Here is why.

Patents

Coinstar has about 20 patents listed in the Delphion patent database, although it appears that some may be duplicates. Patent number is only a small part of the patent value story. If you look at Coinstar's competitors on the coin counting technology side (who it really doesn't compete with directly) their patent counts look like this (there may be overcounts in here because Cummins Allison may be listed in another companies patent references):

Cummins Allison 122
DeLaRue 121
Scan Coin 29
Klopp International ?
Coinstar 20

Does this mean Cummins Allison has better technology or has “beat” Coinstar? No, what it does mean is that it has been getting patents longer on coin counting technologies and probably does have a larger technology development team. Patent quality is also important in assessing how much better one set of patents can perform versus another. For example, Coinstar has patented a novel way of vacuuming coins before they are put through the counting mechanism to lower maintenance costs which other companies haven't developed yet. However, where Coinstar machines can count coins at 600 coins a minute, many Cummins Allison self service machines can count coins at 6,000 coins a minute and separate the coins into separate hoppers.

Why even look at Cummins, DeLaRue and others if they do not compete directly with Coinstar? Coinstar's patent portfolio does not exclude other companies from producing highly accurate, rapid, low maintenance coin counting machines and systems similar to Coinstar for counting coins and redeeming vouchers without patent violations, as most self service coin counting machines do. Coinstar's moat is smaller than many believe.

Coin Counting Competition

Coinstar has had no formal free-standing retail coin counting competition since Cash Technologies, a struggling coin counting company, lost a patent battle with Coinstar. However, a massive amount of informal competition exists for Coinstar's basic coin counting service in the United State's banking institutions, or as Economic Census of the US Department of Commerce puts it, “Depository Credit Intermediation” establishments.

In the 1997 Economic Census, an economic accounting of the United States done every five years by the Census Bureau of the Department of Commerce counts over 100,000 banks, savings institutions, credit unions and thrifts, which it refers to as a group as “Depository Credit Intermediation” institutions (from now on to be referred to as banks). This huge installed base of banks means that even adding the number of supermarkets to department stores in the United States barely equals half the number of banks, by my calculations. Although I have not been able to secure any scientific counts, an educated guess on the number of banks with coin counting equipment is about a third (although many of these banks do not offer free or cheap coin counting).

Although Coinstar did fill a niche being abandoned by banks over the last decade, there is a burgeoning corporate and individual counter movement to fee-for-everything banking. The best example of this, I believe, is Commerce Bank in New Jersey. While most banks maintain bankers hours, Commerce adds hours, including Sunday hours. As other banks begin to charge you for teller transactions, Commerce makes sure that there are not only tellers but also banking representatives available if you are interested in adding new services and options. And instead of charging for coin counting, Commerce adds a free, self-service coin counting machine to every branch, almost 200 at last count. Apparently, customer service pays, as indicated by their more than doubled share price over the past two years and robust branch additions.

In addition, with the creation of and grassroots support for the Coin Counting Home Page, at www.TheUnderstory.com, a single source of non-Coinstar coin counting locations exist. Both corporate and grassroots efforts may threaten Coinstar's coin counting business, through which it currently earns all of its revenue and will earn for probably the next three quarters.

Relationships & Partnerships

Perhaps one of Coinstar's biggest hurdles, is the pending banks/card companies versus retailers battle which will be a drag on further development of debit card commerce.

Retailers are battling Visa and Mastercard over the demise of flat fee transaction cards, which the credit card companies and their bank partners have nearly killed and replaced with their percent based transaction cards. This battle is probably affecting Coinstar because it has impacts on who gets what share of credit/debit transactions, and is a sensitive issue to its retail partners. Coinstar's recently added bank-experienced board members are surely related to figuring out this new terrain.

What about the broader field of free standing kiosk competition? I am not prepared to say which way the field will go, such as which type of partnering will succeed, what types of locations will these systems work in, and other business model nuances. But a “competitor” in the loose sense of the word is Radiant Systems, and it is an almost eerie doppelganger to Coinstar.

Radiant Systems (www.RadiantSystems.com) develops and consults on commerce systems for gas stations; grocery and drug stores; food service companies; hotel and lodging companies; theaters; general and specialty retailers; telecom companies and automotive companies. Radiant, as of last year, had over 55,000 sites where its products were used. This is where it gets interesting. Radiant already has thousands of self service credit card enabled e-commerce kiosk systems set up and running at movie theatres, gas stations and other retailers. Go to the movies at a Loews or Cineplex and you can buy your tickets at a Radiant kiosk (and print them out if you already ordered them, I believe). Financially, Radiant has very similar revenue figures, gross profit numbers, net margins, etc. They are like financial fraternal twins in many ways. They both have a few patents, partner with retailers, and have big goals.

There are two reasons I bring up Radiant. First, Radiant is already doing much of what Coinstar hopes to do; enable self-service credit card operations. Second, Radiant is trading at about half the value Coinstar. I suspect either Radiant is too cheap, Coinstar too expensive, or a little of both.

Coinstar's Value

What is Coinstar worth? Using Yahoo data, because everyone has access to it, current market capitalization (total shares times share price) is about 580 million dollars based on Tuesday, June 18, 2002's close. Its book value is just over 40 million dollars, probably based on mostly depreciated Coinstar units, some of its goodwill, and its few patents. Coinstar rose to a high of just over 750 million dollars in April 2002 for a while, which was extraordinary. Using a common generic benchmark valuation of 20 times earnings gets us an 86 million dollar market cap, based on trailing twelve months (ttm).

I would be tempted to discount the promise of Coinstar more than the existing market is doing. The penny stocks my dad let me buy when I was young and the more recent Dot-Com bubble taught me that the potential for earnings and real earnings are different enough that valuation should be done differently for each. Coinstar has already delayed, most recently in its May conference call, its highly touted “new services” debit card system, and will not launch this year at all. Only when they give hard schedules and full system financial cost and benefit launch should any significant bonus be added, I believe.

A fair value for Coinstar, given a clever, somewhat protected niche business with promise is, I believe, more closely aligned to existing income than future promise. After all debt expenses are paid off, Coinstar's value could rise to 320 million dollars, based on 4 million dollars a quarter earnings and valuing the company at 20 times earnings. Thus, if the company never develops a card system, pays off its debts (which it still has approximately 50 million dollars worth), it could be a self sustaining coin counting company. This value gives it the benefit of the doubt that its revenues will not drop due to coin counting competition (very generous on my part), that it will pay off its debts (which it is, slowly), but doesn't give it any additional value until the company is truly able to introduce a profit making debit card product.

Stock Price Postscript

How did Coinstar's stock start its recent rise from its much lower level of just last November? A convenient starting point for any stock picker is the bottom, and the weeks following September 11, 2001 was an easy starting point for anyone. Even in the absence of any news or commentary, Coinstar would have “recovered” from late September. Helped along on its “recovery” was Chris Edmond's November 7, 2001 “Bottom of the Barrel” Column for TheStreet.com, Jim Cramers stock information web site creation. The media fueled boost continued with Business 2.0's March 2002 short article and recently by Standard & Poors positive mention of Coinstar in an April.
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