Here's Why Redbox Digital Won't Save Outerwall

Shares of Redbox owner Outerwall Inc

gained last week after Variety reported that Redbox plans to launch a new video streaming service called Redbox Digital. However, Darren Aftahi of Roth Capital sees the strategy as "frankly too little, too late," given the commoditization of video on demand market. Read more: http://www.benzinga.com/news/16/03/7757559/outerwall-shares-pop-following-report-redbox-will-unveil-new-streaming-service#ixzz44CXcMXC0 "While shares were up over 4% on the news, we believe the optimism overshadows continued troubling trends in its physical rental business, which we estimate is tracking down ~20%+ in 1Q. We see the move as a last ditch effort to be relevant in digital streaming," Aftahi wrote in a note to clients. The analyst sees several issues with this strategy. First, he sees the potential product as being little differentiated on either content or price (new release digital movie content is typically ~$4.99 for standard definition and $5.99 for high-definition, regardless of platform). Aftahi noted that it will be extremely hard for Redbox Digital to have storefront placement like that of Vudu, Amazon Instant Video, etc. on IPTVs, Roku, Apple TV, among others, without a material marketing spend. He is concerned it will have challenges with backward compatibility with older IPTVs, an issue that surfaced with its Redbox Instant platform. "While we understand the need for a digital platform, we believe this is a case of throwing good money at bad," the analyst highlighted. Based on Proprietary analysis, the brokerage estimate DVD rentals are down about 20%+ y/y, quarter-to-date. If the analysis is directionally accurate, this would mark the third quarter in a row of rentals being down at least 20% y/y. In addition, the analyst warned over how a continual slide in the Redbox business could potentially impact OUTR's financial standing, namely its net leverage ratio. Currently its notes carry a 2.5x net-debt-to-LTM core adj. EBITDA ratio. "While we don't have this ratio being breached in our current model, we would note that if we assumed 20% declines in rentals in 2017, rather than our ~16% assumption, we estimate this covenant would be breached sometime in 1H'17," the note added. A breach in this covenant, per its terms, would have very restrictive measures on two of its largest capital allocation policies, namely dividends and share repurchases. Shares of Outerwall closed Thursday's regular trading session at $37.22.