It is not easy for a mature established company to successfully pivot and change business models. When they do however, it takes a long time for the stock market to reflect the change in their model and re-price it accordingly. This tends to create opportunities for patient investors.
I believe $TIVO fits this bill.
$TIVO has gone through two main stages in the last decade, first as a hardware company, selling actual TiVo boxes, and later as a litigation company, battling the likes of $DISH, $T, $VZ, $GOOG, & $CSCO in courts. The first stage has been a declining business for many years. As more and more cable and satellite companies or Multiple Service Operators (MSOs) have incorporated most of the TiVo benefits directly into their own boxes, fewer and fewer people found the need to pony up and pay for another box and additional monthly fees. The second stage is also done for the most part, but the benefits of all the settlements and licensing deals will run through the company’s balance sheet and income statements for years to come. The company received or is guaranteed to receive close to $2 billion in total payments from all of these settlements.
Over the last couple of years, the company has been transitioning to a third stage. While they are still committed to maintaining their high-end hardware business (evident in Roamio’s success), their primary focus is now gaining subscribers through relationships with MSOs.
Two years ago, $TIVO’s hardware – TiVo-owned – business generated approximately 2/3rds of the company’s non-litigation revenues vs. less than 44% this past quarter – and that number is falling. The company once known for their hardware has increasingly become a software and cloud based solutions company.
The battle for the living room is still up for grabs, but if one thing is certain, it is that internet TV / smart TVs / IPTV – whatever you choose to call them – will all have to include powerful operating systems. It is safe to assume that $TIVO will play major role in this evolution. Unless you are the size of a $DTV or $CMCSA et al, you can’t expect many of the MSOs to be able to afford the R&D to build powerful systems that can operate in today’s cutting-edge world. The OS will need to be able to suggest to users what they should watch, it needs a powerful DVR that has cloud storage capabilities, it needs to have access to over-the-top providers like $NFLX & YouTube etc.
$TIVO has targeted and achieved to sign on many of the tier 2 MSOs in the US (companies that have several hundred thousand to a million subscribers on average, e.g. Suddenlink, Mediacom, RCN, and Atlantic Broadband). These companies compete directly with the tier 1 MSOs who spend lots of money in building out their box capabilities. They also won huge contracts internationally and signed up hundreds of thousands of subscribers through deals with Virgin Media and ONO.
It is true that ARPU per MSO subscriber is a fraction of a TiVo-owned subscriber (~$1 vs. ~$8), but it does come with higher margins. It only costs $TIVO several hundred thousand dollars to set up a US MSO. Also, the potential subscriber base – from a realistic perspective – is so much larger than what the retail business would be otherwise. So far, the company has only signed up 5% of the subscribers signed with current partnering MSOs. (MSO ARPU will also increase (closer to $2) the more the business shifts to the US from international.)
I think this thesis is great, it is so easy to see why people overlook $TIVO, but what about valuations?
This is where so many people go wrong. You cannot count $TIVO’s cash receivables from past settlements both as a current asset on their balance sheet – providing a margin of safety, as well as a revenues in the income statement – helping show positive cash flows and EBITDA. You have to choose one or the other.
When $TIVO settled these law-suits, they received a majority of the money up-front, but the remainder of it they received, and will receive, in installments paid out over several years.
Many look at this money – $365.5M due as of the end of last quarter – and add it to $TIVO’s already huge net cash balance of $569.6M or $4.96 per share, and declare that $TIVO has almost $8 per share in net cash. That’s fine (setting aside not discounting the cash) as long as you don’t also bring in those cash payments when looking at the income statement – as management does – and also declare that $TIVO is going to do > $100M EBITDA this year.
If you could double count those cash flows, you have a slam dunk. $TIVO’s “net enterprise value” is only $558M, they are also growing nicely, they are “extremely profitable”, and yet they only trade at ~5.5X EBITDA! Let alone the margin of safety purchasing it with all of that cash/future cash/patents/NOLs etc.
You have to pick one side and stick with it.
What would the business look like without these promised funds (which comprises most of the company’s “technology revenues”)?
Not that pretty. By my calculations, TTM Adjusted EBITDA would go from a positive $92.4M to a negative $67.3M!
How about the other way around?
These receivables are going to stay solid through at least 2018. Is it fair to look at the income statement and derive a conclusion/value of the business based on numbers from ’14-’18? Not unless you give the entire business after that a zero terminal value. In which case you have 4 years of $100M+ EBITDA, falling to zero after that, is such a business worth more than $558M? – and actually, since we are looking at these receivables in the income statement, we cannot use it again on the balance sheet, so their real enterprise value is $877.5M. Are 4-5 years of $100M+ EBITDA worth that much if after that the business is worthless?
So why am I bullish on the company?
First off, you have to look at the company’s cost structure. While operating expenses as a percentage of revenues have consistently declined in past quarters/years, there is still so much more room to go. Said differently, if another (larger) company were to purchase $TIVO, the profitability would look a lot different.
More importantly, I believe that the company will become profitable – very profitable – even without the litigation revenues.
From a subscriber metric standpoint, it costs $TIVO $186 to acquire a TiVo-owned subscriber vs. close to $8 in monthly revenues. That converts into a now all time low of 16.6 months to break-even. With churn down at only 1.42%, that’s a nice business model.
The MSO business is worth even more. This is a business that has gone from almost nothing a few years ago to 3.6M subscribers. With only 50% tier 2 MSO penetration, and of the existing MSO deals they are only 5% penetrated, there is obviously tons of room to grow.
The company also has patents, and unlike many of the multi-hundred million dollar patent deals in the past ($INTC, $GOOG, $MSFT all come to mind), $TIVO’s patents have been tried, proven, and utilized in court to the tune of ~$2 billion! Keep in mind, they operate in the living room – an area that has yet to declare a winner. $TIVO’s IP can become a huge asset for a larger player.
Also, the fact that the next several years are going to show hugely positive results, even if it might be priced-in, it does help the actual balance sheet of the company. This will enable $TIVO to continue to buyback stock (the company recently increased their share buyback from $200M to $300M), as well as enable the company to do further tuck-in acquisitions. They purchased digitalsmiths earlier this year which helped the company expand vertically – digitalsmiths is the tech engine behind most of even the larger MSOs search and predictive engine. When including digitalsmiths’s customers, $TIVO now counts 18 of the largest 25 MSO’s as clients.
In conclusion, while $TIVO is not the “no-brainer” as some make it sound, they are wisely shifting their business model, they do have lots of takeover appeal, and a nice margin of safety to boot. If you overlooked it in the past, rewind, and have another look