Why Wall Street Hates Outerwall

Outerwall is among the most hated stocks on Wall Street. Almost 40% of its outstanding shares have been sold short, making it one of the most heavily bet against stocks in the market. This is not a recent phenomenon -- Outerwall has been a frequent target of short sellers for nearly five years.

But why is Outerwall so heavily doubted? Although it has a promising initiative, its core businesses appear to be in inexorable decline.

Coinstar and Redbox compose the overwhelming majority of Outerwall's businessThe bulk of Outerwall's business comes from two of its subsidiaries -- Coinstar and Redbox. Last quarter, for example, Redbox and Coinstar combined to generate roughly 95% of Outerwall's revenue, and 180% of its operating income (its other ventures lost money). Of this, the overwhelming majority came from Redbox -- its DVD rental service brought in more than 80% of its revenue and 140% of its operating income.

This is an obvious problem, as Outerwall's Redbox business may not be around for much longer. Notable short seller Jim Chanos has been predicting Redbox's imminent downfall since at least 2012. Outerwall has completely defied Chanos' predictions, but he appears to have been early rather than wrong.

Consumers are increasingly turning to online streaming services for their video rental needs. According to Consumer Intelligence Research Partners, Amazon Prime members buy or rent digital videos from Amazon, on average, more than five times a month. Other services, including Vudu, iTunes,and Google Play,have seen increasing popularity.

These services are helped by the proliferation of smart TVs, video game consoles, and set-top boxes that make accessing online video an ever-easier prospect. To date, Apple has sold more than 25 million Apple TVs, while smart TVs equipped with online rental services now represent about half of all television sales.

This year could mark an inflection point for Outerwall, as a wave of Google Play-equipped Android TVs (and possibly a more robust offering from Apple) hit the market. With so many Internet-equipped televisions, it's hard to imagine Redbox's business persisting for much longer.

Coinstar also appears challenged, though its demise may be less likely. The technology remains in its infancy, but advances in mobile payment solutions -- Apple Pay and other services -- will continue to encroach on the use of physical money.

Its new ventures have seen mixed successOuterwall's management is aware of the challenges it faces, but has argued that its expertise in vending machine technology will allow it to pivot and survive. In an attempt to stave off its decline, it has diversified into new ventures. Unfortunately, these ventures have been fairly lackluster, and have not contributed meaningfully to Outerwall's performance.

In 2012, Outerwall signed a deal with Starbucks to create a coffee vending machine. Outerwall's machine -- known as Rubi -- would've delivered high-quality coffee at a reasonable price (at least in theory). Yet it never caught on, and in late 2013, Outerwall announced that it was abandoning the Rubi venture. Other failed concepts include Crisp Market -- a fresh flood vending machine -- and Star Studio, a photo booth.

Outerwall's New Ventures segment is now composed almost entirely of ecoATM, a start-up it acquired nearly two years ago for $350 million.

ecoATM is similar to Coinstar, but instead of accepting coins, it takes old electronics -- primarily smartphones and tablets. It's a crowded space with many participants, but the buying of used electronics could prove a lucrative business in the long-run, as an ever increasing array of gadgets (smartwatches, fitness bands, etc) come to market.

ecoATM, however, remains unproven, generating less than 5% of Outerwall's revenue and operating at a loss. That may change one day, but for now, Outerwall remains dependent on what appears to be two doomed business models.

The article Why Wall Street Hates Outerwall originally appeared on Fool.com.

Sam Mattera has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Apple, Google (A shares), and Google (C shares). The Motley Fool owns shares of Amazon.com, Apple, Google (A shares), and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.