December 17 2012
Because we’ve viewed it as a misunderstood category at a key inflection point, a core Twinleaf investment theme in 2012 has been advanced television. And while we’ve been disappointed with the performance of one of our smaller positions in the space, Envivio (ENVI), we’ve been rewarded with significant gains at two of our largest portfolio companies, SeaChange (SEAC +35%) and TiVo (TIVO +30%), as investors have only recently come to better appreciate the industry dynamics and the individual appeal of SEAC and TIVO.
Advanced television is a broad, emerging, complex category. For our purposes, the term refers to:
Cable operators are being forced to adapt TV Anywhere as a customer retention tool, to fend off over-the-top web video alternatives and to satisfy increasingly tech-savvy consumers. But given the complexities involved in advanced television transitions, only the largest cable operators have the internal capabilities to do it in-house. Further complicating TV Anywhere initiatives is that they currently do not generate much, if any, incremental revenue for cable operators. The expenses involved in providing an enhanced user experience across multiple screens are being absorbed without corresponding revenue gains, further compressing cable video margins already stressed by soaring programming costs, especially from sports networks.
Far from the DVR-centric company that it was only a year or two ago, TIVO has emerged as an important vendor to the cable industry. Much as IBM transitioned its business almost entirely to higher-margin services from commoditized hardware in the 1990s, TIVO has quietly become a trusted partner to the cable industry as a full-service provider of advanced television software and solutions. In addition to its multi-screen DVR capabilities, TIVO licenses its on-screen user interface and provides technology integration, all aimed at adding value for cable operators and, ultimately, enabling incremental video revenue.
The TIVO investment story is shifting from intellectual property enforcement (current litigation scorecard: $1 billion in proceeds from settlements with DISH, AT&T and Verizon since 2010 and one case outstanding versus Time Warner Cable, Cisco and Motorola that could yield another $800 million in 2013) to an operating one. While TIVO continues to support a consumer product at retail, its business model now more resembles that of a pay TV network, with per-subscriber monthly fees in the $1.50 range and favorable scalability characteristics in which every incremental revenue dollar now drives margins and profitability higher. TIVO’s largest customers are Virgin Media (VMED) in the UK and Ono in Spain with a combined 1.5 million subscribing households; a handful of other customers should begin adding TIVO homes in early 2013, including mid-sized operators Mediacom, Midcontinent and CableONE in the US.
Now that TIVO’s licensing and services business has turned profitable, its balance sheet is flush with cash ($4+ per share) and its litigation expenses declining, we believe that a sale of the company within the next 24 months is probable. Indeed, there is speculation that Cisco or Google may elect to acquire TIVO in conjunction with a settlement of pending litigation or perhaps Microsoft or even Apple may become a suitor. The company continues to rise in value and thus, we are content to patiently wait for an M&A event, should it occur.
The investment thesis for SEAC is strikingly similar to that of TIVO: improving operating momentum and customer wins in the advanced television space, a cash-rich balance sheet and the prospect of a sale of the company in the next 12-18 months. New management spent 2012 reorganizing the company around a suite of software solutions aimed at helping cable operators navigate the complexities of advanced television transitions, principally in billing, VOD, DRM, back office and dynamic advertising insertion.
We are encouraged that SEAC’s largest shareholder, Starboard Value, has been deftly steering the company’s reorganization by virtue of its board representation and installation of a hand-picked CEO in early 2012. Starboard has a very successful history of activist investing, often realizing value through a sale of its target companies. Its 9% stake in SEAC is probably too large to unwind in the absence of an outright sale of the company. As such, we believe a sale of the company in 2013 is likely, perhaps at a $12-$13 per share valuation, and that possible suitors could include Adobe, Arris or Ericsson.
As for ENVI, its ten months as a public company have been disastrous, its share price dropping from $9 to below $2 due to money-losing financial performance and poor internal forecasting that has caused investors to question management competency. We are sharply underwater on our ENVI position and not happy about it. But the shares now trade well below balance sheet cash, valuing the company’s video encoding business at less than zero. While ENVI’s niche in advanced television (video encoding and transcoding) is crowded, we don’t believe that its business is worth nothing so while we are not buying more ENVI shares, neither are we sellers at this hugely depressed valuation.
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