Envivio (ENVI): Poor IPO Represents a Buying Opportunity

On Friday May 18, while the media and many stock market participants were endlessly fascinated by the Facebook IPO (which displaced the immediately prior obsession with the JP Morgan trading loss), I took the opportunity to buy shares for client accounts of an all-but-forgotten company called Envivio (ENVI) that had a much less celebrated IPO just three weeks ago.  Like FB, ENVI experienced a disappointing first day of trading on April 25.  But unlike FB’s underwriters, led by Morgan Stanley, which stoutly supported the stock on the first day to prevent an embarrassing breach of the issue price, ENVI’s underwriters, led by Goldman Sachs, apparently declined to support the ENVI stock in the aftermarket.  ENVI’s IPO came at $9 per share, down from the stated range on its S-1 filing of $10-$12 and has only briefly traded above the issue price in the ensuing three weeks.  It closed down 5% on its first day and after 18 trading days as a public company, ENVI closed today at $7.71 per share.  Down 14% in three weeks is not exactly the trading performance that the company, its pre-IPO investors, its post-IPO investors or Goldman wanted.  ENVI’s trading volume is low, buyers are scarce and it certainly appears that it is being tossed out by uncommitted sellers who received incomplete positions on the IPO and don’t care to understand the company.  All of which is understandable in a market that’s down nearly every day, it seems.

ENVI operates in a space that I find interesting so I’ve been keeping an eye on it since the IPO and, in fact, nibbled on shares in early May after it broke the $9 offering price.  So while it’s not exactly the trading performance I wanted, either, I’ve bought more shares on the way down and now own it at a blended price of just above $8.  Despite very poor market conditions, especially for Nasdaq names, I think ENVI has hit bottom and may represent an excellent investment opportunity here. 

First, a little background on the company and its industry.  ENVI’s business is creating video encoding software that enables cable, satellite and phone companies to deliver, and end users to view, video (and advertising) on “second screen” devices in the home.  ENVI’s largest customer, according to the S-1, is Time Warner Cable, which deploys its software to allow authenticated customers to stream linear and VOD IP programming to iPads and other second screens in the home.  Think of ENVI’s software as empowering the iPad or smartphone to add “set top box” to its array of functionality.  Enabling video compatibility between devices is at the core of ENVI’s product suite. 

The multi-screen video service provided by pay TV operators to its customers is known as TV Everywhere, is in the early stages of customer adaption and is growing rapidly.  Perhaps only 5% of the 100 million pay TV household universe currently streams live TV to iPads and smartphones in the U.S.  (The number is higher Over-The-Top services like Netflix and Hulu, also potential or existing ENVI customers.).  Needham & Co. estimates that 30% of households will be TV Everywhere users by 2016.  If you’re not one of them, let me tell you: it’s a terrific user experience and a compelling value-add for the pay TV providers.  I use my iPad to view linear cable programming from Cablevision’s Optimum nearly every day and I prefer the HD video quality, portability, navigation, channel guide and user interface to the conventional video product on the TV.  In my opinion, having the iPad in your hands delivering ultra-crisp live television is simply a better viewing experience than watching the same program with a clumsy remote control and a TV from across the room, even if that TV is a wide flat screen.  I can’t speak for the OTT experience on the iPad or laptop, as I am not a Netflix or Hulu customer, but reviews are similarly positive.

As noted, ENVI’s software enables virtual set-top box functionality on the tablet or smartphone.  Until now, customer premise equipment has always included intelligence and functionality in the hardware itself.  Now, much like other computing applications, it’s moving into the network and the cloud and the hardware isn’t provided by the pay TV provider but by the customer.  It wasn’t that long ago that Motorola bought General Instrument and Cisco bought Scientific-Atlanta, the cable set-top box duopoly.  Set-box vendors now must scramble to retain relevance (and profitability) as second screens and smart TVs emerge and the value moves back upstream.  

Technological risk in this space is high, of course, and non-programming vendors to the cable television industry have a lousy track record of creating value for shareholders.  The reasons, historically, have been many:  a lack of industry standards and protocols, the “closed” cable network infrastructure discouraged innovation, an undercapitalized cable industry for much of its history kept spending tight – all of which probably conspired to send the brightest technologists to design products and services for other industries, most notably the Internet.  But this trend could finally be shifting as there are a number of interesting young companies now serving the cable industry with infrastructure innovations.  A few of them, like ENVI, are now publicly traded.

ENVI is still in its post-IPO quiet period, which means that the S-1 is the investor’s sole guide until the company releases Q1 earnings on May 30.  ENVI generated approximately $51 million of revenue and $1 million of operating income in the 12 months ended January 31, 2012, both significantly higher than in fiscal 2011.  I’m looking for $80 million of revenue and $7 million of operating income in fiscal 2013 ending January and for the OI number to nearly double on improving margins to $14 million in fiscal 2014.  That puts ENVI’s valuation multiple at about 11x OI (ENVI shouldn’t be a significant tax payer for several years) using 30 million diluted shares and $76 million of IPO cash proceeds on the balance sheet.  That’s not wildly inexpensive on a pure valuation basis, but the calculation overlooks ENVI’s intellectual property portfolio and its scarcity value in a burgeoning new industry.

Here are the reasons why I think the downside risk is limited for ENVI shares:

·         The Second Screen is Exploding

As noted above, the second screen is a win-win for pay TV customers and providers, who often avoid the capex burden of additional set-top boxes and deliver a value-add service at no additional charge.  It is here now and it is an excellent consumer experience, even in this first generation of commercial deployment.  Given the penetration rates of tablets, consumer adaption rates for TV Everywhere should be steep, even despite the lackluster marketing and awareness efforts of the pay TV providers.

·         Poor IPO and Aftermarket Execution

The ENVI stock price has badly broken the issue price and many buyers on the deal have exited with few interested buyers.  The bid/ask is often wide and it sometimes feels like I’m the only prospective buyer out there.  I’ve been promptly filled a few times with bids considerably below the existing bid, probably from the market maker.  The buyers on the IPO must be furious that Goldman allowed a deal with less than $70 million of float to break the issue price so quickly and deeply.  Goldman and co-manager Deutsche Bank could have supported the stock at $9 and taken all unwanted shares on their balance sheets as a rounding error and disposed of them when market conditions improve.  The trading psychology of ENVI shares would be much better had Goldman stepped up but herein lies an opportunity for investors.  All this is a roundabout way of saying that I believe the stock is way oversold, in no small part due to the lack of IPO execution and aftermarket support.

·         First Reporting Quarters of Newly Public Companies Don’t Often Disappoint

ENVI reports its first quarterly results as a public company on May 30.  It’s unlikely that Goldman would have allowed the IPO to proceed if the results were looking weak.  And given that the IPO was on April 25, ENVI and Goldman had nearly a full quarter of visibility. 

·         The NCTA Effect

The cable industry holds its annual NCTA gathering in Boston this week (May 21-23) for 12,000 attendees.  It’s purely anecdotal but cable-related stocks tend to get a boost from the enthusiasm and press releases that tend to proliferate from the NCTA.

·         The SYNC Effect

Synacor (SYNC) came public on February 11, 2012 with a very similar profile to ENVI.  SYNC is also a TV Everywhere solutions provider, providing pay TV providers with an online, customized user interface, authentication gateway and billing solution, among other features.  SYNC’s brief trading history may be instructive (or merely hopeful) for ENVI.  Like ENVI, SNYC came public below the range on its S-1, in its case at $5 per share – a drastic price cut from the $10-$12 range on the S-1, suggesting the deal barely got done.  Both SYNC and ENVI had selling shareholders in the IPO and were similarly sized in terms of revenue (though SYNC is more profitable). 

Aftermarket trading was light and disinterested for a month as the stock languished around and a bit below the issue price (likely supported by BofA Merrill, its lead underwriter).  But then, during the second week of March the stock began moving up on increased volume to around $7 where it sat for another month.  Then, suddenly, beginning around the day ENVI came public, SYNC shares took off, nearly doubling in price on heavy volume before settling back around $10.  The net effect: despite a tough recent market, SYNC shares have doubled since the February IPO.  I’m certainly not betting on a SYNC-like trading performance from ENVI but the parallels are interesting.