Investment Analysis and Stock Valuation on REDBOX company - Term Paper Example

 Investment Analysis and Stock Valuation Company: REDBOX Automated Retail LLC Redbox Automated Retail, LLC Redbox is an American company that has its scope of business in the rental of DVDs, Blu-Ray Discs, and also video games using fully automated retail kiosks. Redbox possessed over 33,000 kiosks in over 27,800 locations. Redbox, as a subsidiary of Coinstar Inc., constituted 34.5% market share of discs rented, as of the second quarter 2011. As per Coinstar Inc.’s Annual Report for the year 2010, the company increased its ownership proportion of Redbox from 51% to 100%. Three Step Valuation a. General Economic Influence: At a time when a sluggish and struggling economy prevails in the United States, interest rate being stagnant at 0.25% since January 2009 as an example, the rental kiosk service of DVDs, Redbox has been identified as enormously successful in its operations. The economic influence has not hit the company on a tough scale. The simplicity and value of the company’s product and its pricing has made Redbox manage inflation adjustments in the form of rises in its product prices easily as compared to its competitors. To offset rising costs especially increasing debit card fees, started from the 31st of October, 2011, a standard Redbox rental costs $1.20 rather than $1.00 which depicts an escalation of 20%; this is in clear contrast with the huge 60% rise in prices by NetFlix, one of Redbox’s competitors. b. Industry Influences: Redbox faces one of the biggest pressures from Blockbuster, the leader in rental home entertainment which has vast market coverage and possesses a strong brand image. Blockbuster’s retail store model at first appeared to be a threat for Redbox’s rental model but due to Redbox’s futurist strategies, now Redbox is bullish pertaining to the growth opportunities for its $1 rental model. There are a number of industry pressures creating obstacles for Redbox’s growth but it’s simple pricing and product value has made Blockbuster and almost all other competitors subservient to Redbox (Jim Muehlhausen, 2011). c. Company Analysis: Operating in an industry subjugated by Netflix and GameFly, Redbox rents out DVDs using its signature red color and arched top surface automated kiosks. They are situated across the United States at various grocery stores, supermarkets, discount stores, pharmacies, fast food restaurants such as McDonald’s etc. The company wants to bolster its way into the hearts and minds of movie and game renters. As mentioned previously, Redbox is a futurist and so the fast-growing firm, which brags around 33,000 kiosk nationwide, plans to proffer web or internet streaming by the end of 2011 and also feels that it can double the current number of rental outlets considering its bullish trend and prospective growth opportunities (Brad Tuttle, 2011). I. Stream of Expected Returns (Cash Flows) a. Form of returns: Due to non-availability of Redbox’s financial statements, its parent company, Coinstar Inc.’s financial data is being considered. Examining the years ended December 31, 2008, 2009 and 2010, the cash flows from operating activities reduced by 35.42% to $123.89 million in 2009 and escalated by a massive 154.76% mainly due to increase in liabilities. The cash flows from investing activities were negative in all three years analyzed; however, there was an increase of $37.13 million and $5.02 million in 2009 and 2010. Due to heavy repayment of borrowings and purchase of stock in 2010, the financing activities came about again as a negative figure (-$122.046 million) after a meager one in 2008 (-$602,000). b. Time pattern and growth rate of returns: As mentioned in the previous part, a yearly time pattern has been considered. The growth rate of return is known as the Sustainable Growth Rate and is computed as follows: g = RR (Retention Ratio) * ROE (Return on Equity). As there are no dividend streams being paid by the company, RR will be equal to 100% and as ROE = 22.47% (according to Yahoo Finance, Coinstar Inc. Key Financials as of December 31, 2010), the growth rate will also come about to be 22.47%. II. Investment Decision Process: A comparison of Estimated Values and Market Prices To consider investment decisions in a particular stock, its estimated or fair value and market price comparison should be carried out. This will tell investors whether the stock is undervalued (decision: buy or hold the stock) or overvalued (decision: sell the stock). The estimated value is computed using two main head of techniques: Discounted Cash Flow (DCF) and Relative Valuation techniques. III. Discounted Cash Flow (DCF) Techniques a. Present Value of Dividends (DDM): As Coinstar Inc. / Redbox LLC is not currently paying out dividends to its shareholders; this DCF technique cannot be applied (Coinstar Inc., 2011). b. Present Value of Operating Free Cash Flow: The formula for calculating Operating Free Cash Flow or Free Cash Flow to the Firm (FCFF) is as follows (Knol Google, 2011): FCFF = EBIT (1 – Tax) + Depreciation Expense – Capital Expenditures – Change in Working Capital – Change in other assets As per the 2010 Annual Report, the Free Cash Flow from continuing operations is $144.772 million Value = FCFF1 / (1 + WACC) FCFF1 = FCFF0 * (1+g) = $144.772 * (1.2247) = $177.30 million WACC = [wd*kd*(1 – T) + we*ke] Wd = 200 / (200 + 434.169) = 31.54%, we = 68.46% Ke using CAPM = RFR + Beta (Rm - RFR) RFR (according to 2010 Annual Report) = 2.4% Beta = 0.57 (Yahoo Finance, 2011) Rm = ? Rm0 = Market Index of NASDAQ before 1 year = 2,578.78 points Rm1 = Market Index of NASDAQ today = 2,697.97 points Rm = (Rm1 / Rm0) – 1, Rm = 1.0462 – 1 = 4.62% Ke = Cost of Equity = 2.4% + 0.57 (4.62% - 2.4%) = 3.6654% WACC = 3.266% V = 177.30 / 1.03266 = $171.69 million Value per share = 171.69 / 30.78 = $5.58 c. Present Value of Free Cash Flow to Equity: FCFE = Net Income + Depreciation Expense – Capital Expenditures – Change in Working Capital + New Debt – Debt Repayment FCFE = 51.008 + 129.025 – 170.847 – (-115960) +0 FCFE = $115.969 million, FCFE1 = $142.03 million V = FCFE1 / (1 + ke) V = 142.03 / (1.036654) = $137.005 million Value per share = $4.45 IV. Relative Valuation Methods a. Price / Earning Ratio (P/E) P/E = $47.85 / $2.6 (Diluted EPS) = 18.4x The P/E ratio of 18.4 means that the share of Redbox or Coinstar (as assumed here) is trading at 18.4 times its earnings. b. Price / Cash Flow Ratio (P/CF) P/CF = $47.85 / (37,559/30.78) = 39.21x This ratio shows that the stock is trading at a price that is 39.21 times the company’s cash flow per share (as of November 07, 2011). c. Price / Book Value Ratio (P/BV) P/BV = $47.85 / 16.06 = 2.98x The share of Redbox is trading at only 2.98 times its Book Value which is not a much favorable ratio. d. Price / Sales Ratio (P/S) P/S = $47.85 / 56.29 = 0.85x This shows that the market price is only 85% of the sales of Coinstar as of November 07, 2011. V. Risk Premium Risk Premium is incorporated according to a number of factors such as currency risk, country risk, business risk, firm-specific risk. This premium is added to the cost of financing so as to cover up uncertainty in any aspect of risk. Taking into mind the risk factors discussed in the 2010 annual report of Coinstar Inc., the risk premium should be kept comparatively at a higher level, a percentage more than 2% so as to be higher than the interest rate as well and to cover other risk factors as well including leverage, scope of business etc. References Brad Tuttle, 2011. Redbox Raises DVD Rental Price, But Doesn’t Go ‘Full Netflix’. Retrieved November 06, 2011, from < http://moneyland.time.com/2011/10/28/redbox-raises-dvd-rental-price-but-doesnt-go-full-netflix/> Coinstar Inc., 2011. Annual Report 2010. Retrieved November 06, 2011, from Jim Muehlhausen, 2011. Blockbuster vs. Redbox Business Model. Retrieved November 06, 2011, from Knol Google, 2011. Operating Free Cash Flow Discounting Model. Retrieved November 06, 2011, from Yahoo Finance, 2011. Coinstar Inc., Income Statement. Retrieved November 06, 2011, from < http://finance.yahoo.com/q/is?s=CSTR+Income+Statement&annual> Read More