Redbox Owner Pits Jana Against Skeptical Shorts: Real M&A

Activist investor Jana Partners LLC is betting it can spin one of America’s most shorted stocks into gold.

Jana last week disclosed a 13.5 percent stake in Outerwall Inc., the owner of the Redbox DVD kiosks that has a higher level of short interest than 99 percent of the Russell 2000 Index, according to data compiled by Bloomberg. Jana, now the $1.7 billion company’s biggest shareholder, is defying skeptics who expect the main DVD business to become obsolete as viewers move to digital content.

Outerwall has been trying to build Redbox into a stronger competitor to Netflix Inc. while also investing in coffee-vending machines and kiosks for trading in mobile phones, new ventures that B. Riley & Co. says are masking the company’s attractive cash flow. Wedbush Inc. values Outerwall at $78 a shares, 31 percent more than yesterday, and said it could sell the Coinstar money-counting business and buy back stock. Outerwall may even lure private-equity bids, Gabelli & Co. said.

“They have to explore all of their options and see which one makes the most sense for shareholders,” Larry Berlin, a Chicago-based analyst at First Analysis Securities Corp., said in a phone interview. “Jana’s very good at doing that and will help Outerwall to do something. The outcome is still open to be decided, but I think there’s upside to the stock.”

Bearish Bets

About 30 percent of Outerwall’s shares outstanding were sold short as of Oct. 3, while the index’s average short interest was just 3.9 percent, according to the latest data compiled by Markit. In a short sale, traders sell borrowed stock on the assumption the price will decline, allowing them to make money by buying it back at a lower price.

Marci Maule, a spokeswoman for Bellevue, Washington-based Outerwall, said by phone that the company’s recently increased share buyback program “underscores our confidence in Outerwall and the upside we expect as a result of the actions we’re taking to improve Redbox, control costs and direct capital toward their highest return opportunities.” She declined to comment on additional moves the company might make.

Jana said in a regulatory filing Oct. 4 that Outerwall is undervalued and that it intends to hold discussions with the company’s board and management about ways to boost value.

Meeting Management

Executives of Jana met last week with Outerwall management to discuss options including a breakup, according to a person with knowledge of the matter, who asked not to be named because the talks are private. Cost cuts and buybacks were also discussed, the person said.

Charles Penner, a partner at Jana, declined to comment beyond the filing.

Today, TPG-Axon Management LP, the hedge-fund manager founded in partnership with private-equity firm TPG Capital, reported a 5.1 percent stake in Outerwall.

For $1.20 a day, customers can rent a movie from a Redbox kiosk, found inside grocery stores and other retailers, and return the DVD to any location. Redbox accounted for almost 87 percent of Outerwall’s $2.2 billion of revenue in the 12 months through June, while Coinstar made up 13 percent and new ventures generated less than 1 percent, data compiled by Bloomberg show.

New ventures, the side that’s trying to create new kiosk ideas, had an operating loss of about $35 million over that span, the data show. Redbox and Coinstar were profitable.

In July, Outerwall announced its $350 million acquisition of EcoATM, a kiosk business that lets consumers trade in smartphones, tablets and MP3 players for cash. The electronics are then sold to other companies for refurbishment or recycling.

Value Estimates

Analysts have wide-ranging estimates for Outerwall’s value. Andy Hargreaves, a Portland, Oregon-based analyst at Pacific Crest Securities, doesn’t see any upside, with his sum-of-the-parts analysis yielding about $32 a share, 46 percent lower than the stock’s closing price yesterday of $59.36.

Outerwall’s stock climbed 6.2 percent today to $63.04, making it the fourth-biggest gainer in the Russell 2000.

“I don’t believe there is significant value to be unlocked in Outerwall through a breakup or sale,” Hargreaves wrote in an e-mail yesterday. “Redbox has a demand and leverage problem, not a capital allocation or value-recognition problem.”

On the other hand, Eric Wold, a San Francisco-based analyst at B. Riley, yesterday raised his share-price estimate to $95 from $75. He said the new ventures are draining Outerwall’s cash flow.

Jana is likely to ask Outerwall to shutter that unit and instead use the cash to buy back shares, according to Brett Harriss, a Rye, New York-based analyst at Gabelli.

Cash Generator

“We can argue about how long it’s going to take the DVD business to decline, but the company generates a ton of cash now,” Harriss said in a phone interview. “Rather than taking that cash and wasting it by trying to create new ventures, they can give it back to shareholders.”

Outerwall may appeal to private-equity buyers because Redbox and Coinstar don’t require much capital and throw off a lot of cash, Harriss said. Suitors also could include movie studios and other types of content providers, Berlin of First Analysis said.

Next year, Outerwall may generate about $225 million of free cash flow, or cash from operations after deducting capital expenses, according to analysts’ projections compiled by Bloomberg. That would be up from $140 million in the past 12 months.

There’s room to cut costs and Outerwall could sell Coinstar for a “significant sum,” Wedbush’s Michael Pachter wrote in an Oct. 6 report. The Los Angeles-based analyst sees the stock climbing 31 percent to $78 in the next 12 months.

Value Opportunity

Shares of Outerwall have gained more than 18 percent since Jana announced its plans Oct. 4. Up until that day, the stock returned just 0.3 percent this year.

“It’s a company where there’s opportunity to make some strategic changes to unlock more shareholder value,” Michael Olson, a Minneapolis-based analyst at Piper Jaffray Cos., said in a phone interview. “The stock would suggest that investors have been hoping for something like this to transpire, and now that it has, there’s certainly a lot of optimism around what the outcome could be.”

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