Outerwall's Fair Value Is Just $26 Per Share, Says Pacific Crest

Outerwall Inc OUTR rental volume is likely to continue declining, which may derive an increased evidence of negative operating leverage, according to analysts at Pacific Crest. Pacific Crest issued an Underweight rating with an estimated current fair value at just $26 per share for Outerwall Tuesday. "We see fair value at $26. We estimate current fair value at $26 based on a cash flow model that assumes 15 percent annual declines through 2017 followed by accelerated declines in 2018. Given how far we are into the secular decline of DVDs, we see few reasonable scenarios that could justify Outerwall's current valuation.," analysts commented in a research note on Tuesday. With negative operating leverage viewed as increasingly likely, Pacific Crest believes Redbox content commitments could have a growing impact on decisions regarding kiosk removals and the mix of content purchases. The firm believes if rental volume continues to decline in 2016, such commitments are "likely to drive negative operating leverage or a more rapid pace of kiosk removals." Pressure from the rental declines are expected to mount in 2016. "We have not found a physical media format that stabilizes after several years of declines, which strongly suggests DVD rentals will decline at a rapid rate. However, this is weak, in our view, as it ignores the convenience of connected devices and the incremental cost of entertainment on those devices, which is often near zero" the firm noted. Looking ahead, Pacific Crest sees Redbox's average rentals per kiosk declining at an accelerating rate. As a result, this declining rental volume drives negative leverage. "Outerwall continues to use near-term free cash flow to repurchase shares, leaving the company highly levered with rapidly deteriorating cash flow," the firm commented.