How many activists does it take to fix Outerwall?
Engaged Capital is pushing for a major overhaul of the down-and-out operator of Redbox DVD kiosks just a little more than two years after the $480 million company was targeted by another activist investor, Jana Partners. The changes encouraged by Jana -- including a large share buyback and ending cash-eating ventures such as Rubi coffee vending machines -- worked for a while. Jana exited in the second quarter of 2014 after a decent climb in the stock, and Outerwall shares went on to hit a record this past July. And then reality sank back in.
There's little reason to believe physical DVD rentals are going to have a massive rebound any time soon in this age of Netflix and streaming services. Many of Outerwall's attempts to find new ways to make money have done more harm than good -- including Rubi coffee and the money-losing EcoATM kiosks for recycling consumer electronics. Things have gotten so rough that Outerwall decided it won't provide revenue guidance for 2016. After three quarters of disappointing earnings reports, the stock fell to a six-year low last week. What makes Engaged Capital think it will have more luck with a revamp this time around?
The activist investor has some changes in mind, including outsourcing maintenance services to cut costs and essentially admitting defeat on the 2013 acquisition of EcoATM. Some of its suggestions may work for a while, but they come across as mere Band-Aids for a company in need of a much bigger shakeup. The true end game here is a sale to private equity and a cash payout for shareholders.
On this front, Engaged Capital may have some luck. While there's no clear strategy for a private-equity firm to restart growth, Outerwall does throw off a lot of cash. A private-equity firm betting the business can keep on chugging long enough to make its money back, and then some, could see value here. Indeed, at least three firms have approached Outerwall about buyout talks in the past two years and been rebuffed, people familiar with the matter told Bloomberg's Beth Jinks.
I can't think any Outerwall shareholders are too happy to hear the board didn't engage with offers as high as $90 a share, as reported by Jinks. That's higher than the stock has ever traded. Even after a pop Monday on news of Engaged's involvement, the shares were going for less than $30 apiece. But if Engaged can put enough pressure on the board and Chairman Nelson Chan to sell, then perhaps it can recoup some value for investors.
Some buyout firms may be willing to pay more of a premium for Outerwall's logistics expertise and relationships with the large network of stores in which its kiosks reside, said Larry Berlin, an analyst at First Analysis. There's a lot that goes into maintaining each kiosk -- keeping it clean, keeping it working and staying on good terms with the store owners -- and those management skills could be applied to other businesses. The company also operates the Coinstar money-counting business, a relatively stable division that could be sold for a decent chunk of change.
There are signs that Outerwall isn't getting as much juice from activist attention as it once did. The stock closed up more than 9 percent on the news of Jana Partners' involvement in 2013. In contrast, at midday in New York on Monday, Outerwall shares were up about 7 percent, down from an earlier climb of as much as 11 percent. That's not a huge gain for a company that had about half its free float sold short -- a greater percentage than all but a few handfuls of companies on the Russell 2000 Index.
And Engaged faces a tough market for financing larger buyout deals. Carlyle Group had to slash its purchase price for a takeover of Symantec's data storage business, as Wall Street banks struggled to offload the debt committed for the deal. At $7.4 billion, that purchase was much bigger than an Outerwall takeover would be, but banks are wary to take on riskier deals until the market shows sign of improvement. Outerwall is already saddled with a debt load roughly twice its market value. Adding much more could be challenging.
Buyers will need to be convinced Outerwall is a risk worth taking. Engaged seems to think there's still something to it. At the very least, it's cheap enough.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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