On last night’s Mad Money with Jim Cramer, he discussed his investment thesis as it pertains to the home entertainment business. On a show known for the “Lightening round” and fielding questions on the fly, he devoted about as much time to this topic as he will allot to anything he does. Utilizing our RazorWire tool, we have collected almost the entire discussion and provided it here for our readers because we think he has an interesting perspective. Essentially, Coinstar’s (CSTR) Redbox kiosks are where the growth is, but the market still has the company valued similarly to the more established business Netflix (NFLX). Cramer alluded to a paired trade strategy to hedge this theory, which he said he would use were he still at his hedge fund today.

“The home video rental interest has a non-bricks and mortar and mortar variety. There’s two ways to go. There’s Netflix and now a new one, Coinstar, that’s Redbox. You may have seen their DVD rental kiosks in the supermarkets, drugstores, mass retailers like Walmart and convenience stores that rent DVDs for just $1 each. So you could say it’s Netflix here, okay, and Redbox. These are both good companies. This is a great growth industry. But back to my hedge fund, I do what we’d call a paired trade…

CSTR I never recommend shorting stocks on this show. It’s too dangerous for most non-professional investors. That said, I do want to go through this educational exercise because with these two stocks, Netflix and Coinstar, this is a great way to get rid of the risk. By betting against another company in the industry, what you’re doing is hedging out the risk that home entertainment will turn out to be a flop. Because you’re buying the best company in the industry, the two trades shouldn’t cancel each other out. You may not make as much as you would like if they both go up, but I believe, here it is, Coinstar, that’s Redbox, should go up more than Netflix. I think it’s the better story. And Netflix, I believe, will go down more than Coinstar if the whole DVD rental industry goes south. That’s how hedges work. Hedge funds, they hedge. That’s a hedge.

So why do I think that Netflix isn’t as good as Coinstar? First of all, you can like both. I know I do. But in a paired trade, you only buy the best and sell the not as good in case your thesis turns out to be wrong. I think Coinstar is the one to I’m going to give you. Why? Even though Coinstar isn’t a pure play on home entertainment, its namesake business is self-service coin-counting kiosks. Redbox makes up 59% of sales. More importantly, it’s growing like crazy. Redbox is the new blockbuster, and I mean that in a good way. Even though Coinstar stock looks expensive, 23 times expected 2010 earnings, I think it’s a bargain given that those earnings could grow by 61% between 2009 and 2010. Hey, that’s huge. The coin-counting business, you know the one where you put in the quarter and try and, of course fail, to grab the stuff those are all sluggish. None of these are really core.

NFLX Netflix trades at 21 times earnings, but it’s not much cheaper even though its growth doesn’t even come close to Coinstar’s. Netflix does deserve to be there, it’s never really screwed up. Its model works great. It’s just that with Redbox, Coinstar deserves to be much, much, much more expensive. The Redbox model is brilliant. Coinstar has 18,000 Redbox DVD kiosks installed across the country. It plans to have 21,200 by the end of the year, five months. They’re in McDonald’s, they’re in Walmart. The company has just starting rolling out the kiosks which costs them $15,000 to install a it only takes three to six months to become operating cash flow positive. I wish i’d thought of this idea.

Coinstar does have to share the revenue with the retailers where it puts its kiosks. Still, these things are like ATMs for coin. Redbox has already taken 14% of the video rental market. I think it could get much bigger; you can’t compete with a dollar DVD rental on costs. And other than Blockbuster, there is no one else significant in this space. Right now, you can buy Coinstar at a big discount. Why it’s being knocked down by ongoing lawsuits with the movie the lawsuits with Universal, remember that’s GE. That’s part of who I work for. Fox and Warner Brothers are about content access, who Coinstar is allowed to buy DVDs there is some worry here, no but there’s no doubt that Coinstar, they might not be able to sell all studios’ videos. I’m willing to take that risk. I think they’re much less threatening than they appear.

With Coinstar poised to grow earnings at 61% next year and over 24% annually for the next five years, you know I love growth. Netflix has 16% long-term growth and that seems paltry. You might think that streaming online video replacing DVDs would make Netflix the better buy. But that’s a long way from being a real reality as most people don’t have the bandwidth to watch movies over the web. And we don’t know that Netflix will be the winner in that market, where the Redbox is the champion of DVD kiosks.

You could just buy Coinstar. I’d do that if I’m not in the hedge fund business. I’m not saying that Netflix belongs in the sell block, but I’d bet against Netflix as a hedge of the consumer rolling the bottom line, I think Coinstar, which is the owner of Redbox, is the best home entertainment play out there. If you want insurance, if you want Mad-Money_8-20 to hedge the major risk, you should sell Netflix at the same time you buy Coinstar, in what you now understand to be a paired trade.”

At Ockham, we too believe that Coinstar offers the better value for the time being, and the growth factor is impressive. Also, like Cramer, we are not claiming that Netflix is a sell, rather that it just is less attractive in comparison.

For a complete recap of Mad Money, please visit our Mad Money recap page. The chart to the right lists each stock that was discussed on Cramer’s show last night.

Cramer’s Two Cents on Coinstar and Netflix