Turn Pennies and Nickels into Big Profits

Sitting in his college dorm room, a student stared at his jar of coins, wondering what to do with them.

Two years later, Jens Molbak started a company that allowed customers the convenience of pouring their change into a machine and getting dollars in return.

That was in 1991. The business that started out with three coin counting machines operating in a San Francisco supermarket is now offering its products and services in more than 90,000 locations in more than 140 countries. And in addition to getting your coins counted, you can rent a movie from this company, transfer money and make an e-payment.

Coinstar, Inc., (Nasdaq: CSTR), which went public in 1997, claims that 90% of the U.S. population lives within five miles of a Coinstar Center. And every time a customer empties a piggy bank into the machine, Coinstar collects 8.9% of the amount. The machine also offers customers the option of getting a gift card to retailers such as Lowe’s (NYSE: LOW), J.C. Penney (NYSE: JCP), or Eddie Bauer, just to name a few. Or they can opt for an e-certificate. There is no fee for this option.

Any way you count it, it all adds up to a nice chunk of change: Coinstar revenues of $192.4 million in the nine months ended Sept. 30, 2009 from that segment, down slightly from $194.8 million in the year-earlier period. And there’s no shortage of material: Coinstar estimates that Americans have more than $10.5 billion in loose change sitting idle in their homes.

#-ad_banner-#Collecting a fee from a bit of loose change is nice, but Coinstar has also ventured into other areas. The company offers money transfer and e-payment services to consumers as well. And in the wake of the recent disaster in Haiti, Coinstar responded by enabling 15,000 of its coin counters to accept donations to the U.S. fund for UNICEF.

Taking on major players such as Western Union (NYSE: WU) and MoneyGram (NYSE: MGI) has not been easy: Coinstar reported a loss in this segment for the nine months ended September 30, 2009.

But there’s a bright side to Coinstar’s other line of business. Its acquisition of Redbox, which provides one-dollar DVD movie rentals through its ubiquitous red kiosks, has the company seeing green.

The segment has proven to be a very smart investment — so much so, that the name Coinstar is a bit of a misnomer. The DVD segment comprised about 66% of the company’s revenue for the nine months ending Sept. 30, as shown by the chart below.

Coinstar expects to see even more growth from Redbox in the future. About 900 new Redbox kiosks are being installed in supermarkets, convenience stores, Wal-Marts, and McDonald’s locations each month. There are now more than 22,000 Redbox locations.

Looking at Coinstar’s third quarter 2009 revenue shows a sharp rise — up +45.5% — totaling $296.0 million, when compared to revenue of $203.5 million for the third quarter of 2008. Its 2009 first and second quarter revenues increased more than +40% year over year, as well. A large part of that growth was due to DVD rentals.

It’s quite telling that Coinstar has seen its revenue increase, even exclusive of its acquisition, when most companies are still feeling the effects of the financial crisis and recession. It leads to the obvious question: Is it because consumers are feeling pinched?

Not necessarily. Several surveys indicate that the self-service DVD rental service has the potential for more upside growth. Self-service automated kiosks are appealing more to the public than ever before. Interestingly, Redbox reported two million DVD rentals on New Year’s Eve, a record for the company.

One area of concern that could impact Redbox’s DVD service is litigation. It has filed lawsuits against three studios, claiming restrictions on DVD purchases. Some studios want Redbox to wait up to 30 days after a DVD is released to the public before it can offer it in kiosks.

There’s also the matter of other video rental companies pining for their share of the self-service market. Blockbuster (NYSE: BBI), for one, announced its plans to close stores through 2010 and expand its DVD rental kiosk business.

According to studies cited by management, kiosk DVD rentals should grow from 10% of the movie rental market to 16% by 2013. Redbox has already come close to that with a 14.6% market share, according to CEO Paul Davis in Coinstar’s most recent earnings conference call.

Coinstar’s management is also seeking future growth opportunities through avenues like video game rentals. Reuters reported that negotiations are underway between Redbox and video game developers, which could open up a new revenue stream. That could certainly make coin counting look like chump change.