Outerwall: A Stock Collapse In 7 Charts?
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It’s not every day that a company fires its CEO a day after hitting an all-time high, but Tuesday was such a day. Outerwall Inc (NASDAQ: OUTR) parted ways with CEO J. Scott Di Valerio, naming Nora M. Denzel interim CEO, despite a 51 percent run-up since a low of $51.37 back on October 10.
It’s not clear exactly what precipitated the move, but a close look at the company shows that despite the recent run-up in stock price, all was not well.
Let’s look at a time series of the past 10 years of Revenue and Gross Margin percentage for Outerwall. Revenue peaked at $2.33 billion in the first quarter of 2014. For the third quarter, revenue had dropped 1.6 percent to just under $2.30 billion.
Gross Margins had been flat in recent years, but declined from 31.7 percent to 30.5 percent over that time. While the top line had not deteriorated too badly yet for Outerwall, things were clearly headed in the wrong direction.
So, what can propel a stock to record highs while it is unable to grow revenue and maintain gross margins?
Stock buybacks. In the twelve months ending on September 30, Outerwall repurchased almost $650 million in stock.
That $650 million buyback is by far the largest among its specialty retail peers. In the scatter plot below, let's plot Cash from Operations on the x-axis and Common Stock Repurchases on the y-axis. Outerwall is the clear outlier and one of just three companies whose buybacks exceeded their cash from operations.
If a company spends more on stock buybacks than it actually generates in cash, it has to get the rest of the cash somewhere.
One option is to take the cash from existing reserves, which Outerwall seems to have done, as Cash and Equivalents declined nearly $200 million over the most recent twelve months.
Another option is to borrow the money, and as the next chart shows, Outerwall has done that as well, adding over $250 million in debt in the past twelve months.
In addition to plotting debt across time in the blue bars, the red line depicts equity across time.
This underscores an interesting thing about buybacks: They reduce assets, and therefore, equity. In the last twelve months, Outerwall has seen its equity decline 91 percent ($470.6 million).
When debt increases and equity declines, the debt to equity ratio goes through the roof. Outerwall has seen its debt to equity ratio skyrocket from 1.5 to 21.1 in the last twelve months.
The meteoric rise in Debt to Equity at Outerwall certainly looks troubling, but it's really an unpleasant side-effect of the recent stock buyback binge. By itself, it probably doesn’t warrant alarm.
However, in concert with a deterioration in financial performance, alarm bells should probably go off. In fact, Earnings from Continuing Operations Margin has declined nearly 50 percent in the past year, from 8.7 percent to 4.6 percent.
On the surface, Outerwall was on a roll.
Beneath the surface was a different story, though, as a stock buyback strategy has increased debt and reduced cash reserves, putting additional pressure on the company to perform operationally.
Yet, over the past few quarters Outerwall has not performed. Revenues have begun to decline, and along with it, margins. With an earnings report due in just two weeks, the latest news was shocking, and called attention to the risks of the very strategy the market had been celebrating.
Tom White can be found on Twitter @tbwhite67
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