Coinstar Burns Short Sellers

Jim Chanos, Kynikos Associates founder and CEO, appeared on CNBC’s Squawk Box early Thursday and discussed shorting stocks. He explained that the least important determinant when deciding ideas on the short side was valuation. “We’re looking for flawed businesses, we’re looking for flawed accounting and technological changes,” Chanos said. One of the flawed businesses he found was Coinstar Inc. (NASDAQ:CSTR), which is well-known for its Redbox self-service movie and video game rental brand. However, investors that followed Chanos and shorted shares quickly found themselves on the wrong side of the trade.

Chanos found Coinstar to be a compelling short because total digital entertainment spending in the U.S. is decreasing. DVDs, which are at the core of Redbox’s business model, are starting to go the way of VHS cassettes. Chanos explained, “DVDs as a percent are now beginning to do what VHS cassettes did ten years ago, they’re beginning their decline.” He later added that unlike Netflix Inc. (NASDAQ:NFLX), Coinstar has not transitioned away from hard DVD copies.

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Although Coinstar still relies heavily on hard copy DVD rentals, business is booming. After the closing bell on Thursday, Coinstar announced certain preliminary financial results for the first quarter. The Washington-based company said revenue came in between $567 million and $569.2 million, while earnings for the first quarter were $1.62 to $1.66 per share. Analysts expected profit of only 89 cents per share on revenue of $538.6 million. The company said titles like Moneyball, Puss in Boots and 50/50 boosted results. Earnings also benefited from lower than expected card processing fees from a lower mix of regulated debit card transactions, a special rate extension for the first quarter and the roll-out of single billing during March.

The strong first quarter preliminary results also caused Coinstar to raise guidance for the full year. The company now expects revenue to come in between $2.155 billion and $2.280 billion, with earnings between $4.40 and $4.80 per share. Although Coinstar closed 2.9 percent lower during regular trading hours on Thursday, shares surged 16 percent after the late preliminary financial results were released. Shares climbed as high as $69.80 in extended trading, above its all-time closing high of $66.98.

While Chanos is probably not pleased with the surprising good results from Coinstar, he also explained in his interview that his typical holding period for shorts is one year. In some cases, he has had shorts on for three, four or even five years. There is still plenty of time for his short trade to payoff. Chanos is hardly the only investor to be negative on Coinstar. Last month, Bespoke Investment Group, a money management and research firm, listed Coinstar as one of the most heavily shorted stocks in the S&P 500 based on short interest as a percentage of floating shares. Other stocks on the list included GameStop Corp. (NYSE:GME) and RadioShack Corp. (NYSE:RSH).

Even though streaming video is becoming more popular among consumers, Coinstar is not exactly becoming a couch potato in the media industry. In February, the company formed a joint venture with Verizon Communications Inc. (NYSE:VZ) to sell streaming video services, including mobile offerings. Little details have been released, but the service is expected to launch in the second half of 2012.

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