By Pete Gallo
It may turn out to be the stealth tech play of the year, but one of the largest investments to make an appearance in Kingdon Capital Management’s portfolio of late has a decidedly low-tech–sounding name: Coinstar.
It’s also the newest, though less than obvious, piece of the puzzle to fall into place as the hedge fund plays an investment theme aimed at generating returns in companies focused on the digital distribution of movies, television shows and video games—a roster that already includes sizable stakes in all-star app makers such as Activision Blizzard, Apple and rising star Rovi Corp.
In late October Mark Kingdon’s portfolio took a hefty stake in Coinstar, best known for its coin-counting machines at supermarkets and Redbox–branded DVD rental kiosks. Kingdon purchased some 1.6 million shares of Coinstar on October 29, making it one of the Bellevue, Wash.–based company’s largest shareholders with a 5.5% stake, filings with Securities and Exchange Commission show. (BlackRock holds a smaller 1.3 million–share investment, a 4% stake.)
On the surface, it was a good tactical play for Kingdon. Coinstar has developed a healthy habit of beating Wall Street earnings estimates, doing so for seven consecutive quarters, including its latest October surprise, where revenues spiked thanks to higher DVD rentals.
The stock reached $61.41 on November 12, up from $27.78 at the start of the year.
Momentum aside, the hedge fund portfolio team should be credited for its timing. Kingdon picked up the stock at about $46.26, purchasing shares just before the company’s most recent Street-beating earnings report, as SEC filings show. On October 29 the stock spiked by more than $11.30 per share, its largest single-day gain ever—roughly 24.4%.
With 1.6 million shares, Kingdon stood to see its stake grow to $98.3 million, a gain of some $24.2 million in less than two weeks.
Strategically, it might seem Kingdon arrived late to the Coinstar party, considering the stock had already more than doubled in value between the start of the year and the time the hedge fund purchased its stake. But what Mark Kingdon’s portfolio team recognized that other investors may have missed is that this otherwise low-tech vending machine business is planning to make a leap online in 2011, bringing it into head-to-head competition in the digital movie rental business with the likes of Netflix and Apple’s iTunes.
The bankruptcy of rival Blockbuster and relentless rumors of its impending demise have already helped such digital players as Netflix and Apple in the eyes of investors. And Coinstar’s Redbox unit, which physically distributes films via more than 23,000 vending machines nationwide, has been the biggest gainer. The company’s DVD revenues grew in excess of 50% in the last quarter. Operating profits are also on the right trajectory, hitting $21.4 million (66 cents per share) last quarter, up from $11.6 million (38 cents per share) for the same period last year.
While it’s hard to imagine that Hollywood producers are happy seeing big-budget bonanzas like “Avatar” renting for $1, Coinstar’s Redbox remains poised to make the most of the recessionary trend of consumers keeping themselves entertained on a pocket-change budget.
As a major stakeholder, Kingdon must also be highly cognizant that some 4,500 of the company’s vending machines recently began offering video game rentals for $2 a pop, further capitalizing on rival Blockbuster’s decline. Higher price points for new video game releases (relative to DVD releases) bodes well for generating volume at Redbox–branded kiosks as cash-strapped consumers are less likely to shell out $60 for new titles.
It will be interesting to see if Kingdon opts to take on an atypical role of activist investor. The hedge fund has a long history of success in the sector and currently runs a tech-heavy portfolio that includes some prospective partners for Coinstar’s digital distribution push.
Kingdon also owns 2.5 million shares of Santa Clara, Calif.–based Rovi Corp., a maker of products for managing interactive online content such as movies, games and music that allow users to transfer between devices while making sure digital and licensing rights are not violated.
With Coinstar planning to compete with Netflix and iTunes in 2011 for a foothold in the video-on-demand business, it will be hard for the company to ignore Rovi’s products unless executives align with a deep-pocketed partner like Amazon.com.
Either way, Coinstar will have to move quickly. Earlier this year Rovi licensed its interactive program guide product to Apple and is rumored to be considering a similar deal with Google.
