June 27, 2012
TiVo (TIVO) is one of the most enigmatic, misunderstood and complex investment stories across the entire technology/media/telecom universe. Part of the turn-off for investors is that it’s impossible to evaluate TiVo on a conventional basis. Its stock price has lost about 30% of its value over the past 90 days despite improving operating trends and a very significant contract win announced on June 25. The likely explanation for this disconnect is that investors have grown weary of the long sales cycle and slow rollout of its licensed product as well as the ongoing development costs and litigation expenses that have contributed greatly to the company’s continued unprofitability. To me, the recent selling pressure looks like a big investor or two simply ran out of patience with TiVo. For investors with a minimum one-year horizon, I believe TiVo offers a compelling opportunity here around $8 per share.
TiVo, as most people certainly know, pioneered the DVR in the late 1990s as an innovative consumer electronics product that allowed viewers to record television to a hard drive on a TiVo-branded set-top box for playback at their convenience. While the company continues to market its hardware and support its legacy DVR customers, this product line has been quietly de-emphasized as the company shifts away from branded DVR hardware and toward integration of its software with incumbent set-top box manufacturers and, increasingly, into the network architecture of its pay TV customers. The company now fashions itself as a technology partner facilitating “advanced television” for pay TV providers to multiple devices. So transformative has been the company’s evolution that the press release on June 25 announcing a wide-ranging and exclusive agreement with Sweden’s largest cable operator, Com Hem, contained not a single reference to its legacy DVR technology.
The contrast can be jarring. While CEO Tom Rogers is an evangelist for “new TiVo” – an intellectual property-based advanced television software provider - and speaks enthusiastically about TiVo’s future as a trusted partner to global pay TV operators, the company’s web site remains a relic of “old TiVo”, a consumer-facing retailer of new and refurbished DVRs much the same way it likely was a decade ago. It’s unfortunate that sharing of technology and IP between the old and new TiVos probably prohibits the ultimate separation of the two someday.
Communicating TiVo’s evolution to investors would be challenging enough even if it didn’t involve participation in such a complex, emerging business with developing standards and protocols and a notoriously demanding cable and telco customer base. Advanced television generally refers to the orderly presentation and availability to customers of video content from multiple sources (cable programming lineup, over-the-top providers, web content) to multiple connected devices (TV, tablet or smartphone). Locating, integrating and seamlessly facilitating delivery of these personalized content streams for customer navigation, managing and presenting the information load on any screen in an intelligent way and providing data analytics on is a useful way to describe TiVo’s advanced television product. The business mostly adheres to the established cable network “per subscriber” fee model, which is good, but the fact that the bulk of TiVo’s advanced television customers are in Europe makes it difficult for U.S. investors to evaluate the product up close.
Virgin Media, the UK’s largest cable operator, is TiVo’s best and most mature integration success story with a pay TV customer. Virgin noted in its Q1 earnings release that “the appeal of TiVo is driving strong pay TV performance” and that it had grown its TiVo subscribers by more than 50% in the quarter to a total of 677,100 at March 31, 2012. TiVo is delivering a similar product to ONO, the largest cable operator in Spain, and has emerging projects of varying scope with Charter and a handful of smaller operators in the U.S. Legacy license deals with Comcast and DirecTV encompass the DVR product only and are thought not to contribute much revenue, though Comcast is now integrating Xfinity On Demand programs with TiVo Premiere subscribers for the first time in San Francisco and Boston. TiVo’s recent announcement with Sweden’s Com Hem represents the most comprehensive advanced television license and integration deal to date and is a significant product validation for TiVo, yet the stock market failed to notice, perhaps because development work is required and revenue generation is still a year away.
One reason that pay TV partnerships in the U.S. have been slow to develop is TiVo’s aggressive patent litigation strategy versus prospective customers. The company settled litigation with DISH Network for $500 million in 2011 and AT&T in early 2012 for $215 million which grant DVR licenses to both companies. Litigation remains pending with Verizon, Time Warner Cable and Cisco and a court date in the Verizon case is scheduled for October. Given the circumstances, there is little likelihood that these litigation adversaries will want to partner with TiVo on a more robust advanced television offering, though TiVo argues that a broader arrangement with any of them wasn’t likely anyway. With a precedent for recovering significant proceeds in the DISH and AT&T settlements, a favorable outcome seems likely, at least in the Verizon case (the Cisco/TWC case is less developed and tougher to handicap) but legal expenses continue to mount for TiVo. One imprecise indicator: the company reported $567 million of cash on its balance sheet at April 30 (or $4.18 per diluted share), which was $51 million less than the January 31 cash balance.
Given all the moving pieces – “old TiVo”, “new TiVo”, litigation on multiple fronts, the complexity of and investor unfamiliarity with the emergin advanced television business – combined with its chronically unprofitable operations, it’s understandable that TiVo shares have been a poor investment in its 13-year history as a public company and a disaster over the past three months.
But I see a few catalysts that should generate interest in TiVo shares over the next year. First, simplifying the story should attract investors unwilling to dedicate countless hours to fully understand it and management must endeavor to this. Second, advanced television product sales cycles are compressing, due to increased industry awareness aided by the positive results from Virgin Media. Further, TiVo should begin to see engineering and development efficiencies as it rolls out similar products to multiple customers. Third, clarity on when TiVo will achieve positive operating cash flow should be evident by the next earnings release in August. Without this visibility, the stock is likely trapped in a trading range. Fourth, especially if the Verizon litigation concludes successfully, the company needs to begin returning capital to shareholders more aggressively. The fact that 52% of TiVo’s market value is in cash – a historical high – provides a backstop for investors and the company only began repurchasing stock in early June against a $100 million share buyback authorization from last August. The company’s market value, net of cash, is $500 million (assuming conversion of the convertible notes), not exceedingly cheap for a company that will generate only about $325 million of revenue this year but it ignores TiVo’s proven patent portfolio, litigation outcomes and its emerging leadership position in advanced television. Finally, as advanced television software becomes an attractive product line and should TiVo become litigation-free someday, it seems unlikely that it will remain an independent company forever.
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