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Rovi Corp: Profitability in Times of Change
Posted by: Damian Illia (IP Logged)
Date: February 19, 2014 02:48PM

Rovi Corp (ROVI) has had several ups and downs in the technology market over the past few years. However, the last quarter showed positive financial results, and the new management team has taken upon itself the task of breathing fresh air into the firm. Therefore, the company is now undergoing a rebuilding period to improve its complex structure, which could put a temporary strain on operating margins.

Nevertheless, Rovi’s 5300 issued and pending patents worldwide, in addition to its two- to five-year licensing contracts makes this business highly profitable, yet riskier. Furthermore, the firm’s intellectual property portfolio is its backbone and will be the key growth driver in the future as well. However, the current solid shareholder returns of 48% could suffer if the company’s Rovi Entertainment Store and DivX restructuring initiatives are unsuccessful.

So, given the complexity of Rovi Corp’s business model, I will analyze its past profitability, debt, capital and operating efficiency, apart from looking at which institutional investors have recently bought this company’s shares. Based on this information, we will get an understanding of the company´s revenues, operating metrics and quality of earnings, establishing whether or not this tech giant is worth investing in.

Profitability Analysis

In this section I will study several profitability metrics, such as return on assets, quality of earnings, cash flows and revenues. By analyzing these four metrics, we will be able to elucidate if the company is really making money. In addition, I always compare a company's revenue growth and operating cash flow growth, which reflects how much of total revenue is being redirected to cover operating expenses.

On top of growing revenues, a company should generate improving cash flows. This was not the case for ROVI. Over the past three years, the company's operating cash flow has decreased by -0.21%, with cash flows plummeting from $247 to $195. However, fourth quarter fiscal 2013 showed a year-over-year revenue growth of 14.9%, with 3.10% annual growth, due mainly to the firm’s new licensing deals with Samsung, Google Inc. (GOOG) and Sony Corporation (ADR) (SNE).

ROA - Return On Assets = Net Income/Total Assets

ROA gives an idea as to how efficient management is at using its assets to generate earnings. In simple terms, this metric tells you what earnings were generated from the company’s invested capital (assets).

The fact, that Rovi Corp's ROA decreased from -1.53% in 2010 to a current -5.73% is somewhat unsettling. However, Rovi Corp's ratio is evidence that the company is generating less from its assets than it did in 2010.

Quality of Earnings

This metric establishes the amount of earnings attributable to higher sales or lower costs, rather than artificial profits created by accounting anomalies — such as inflation of inventory. In order to assess Rovi Corp's quality of earnings we will compare the level of income with operating cash flows.

The firm augmented its profits at a rate of 3.19%, but the growth of cash flows was higher, which shows that profits are not being created through anomalies such as inventory or accounting practices.

Working Capital

This ratio indicates whether a company has enough short term assets to cover its short term debt, reflecting the company’s efficiency as well as its short-term financial health. Anything below 1 indicates negative W/C (working capital), while anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.

In Rovi Corp´s case, the current ratio (working capital measurement) increased from 4.0 in 2010 to 7.0 in 2012, so we can safely assume that the company has a strong balance sheet and can pay off its obligations. When looking for long-term investments, a company with ratios above 1 is a must.

Common Shares Outstanding

I like companies that buy back their own shares, diminishing the number of outstanding shares. Although ROVI Corp.’s buy-back ratio marked 113.13 million shares in 2011, compared to 99.1 million in 2013, this ratio is still strong enough to benefit investors.

Broad Competitive Portfolio

When it comes to evaluation a company’s future profitability, it’s always a good idea to look at its product portfolio, as well as its clients. As a digital entertainment company, Rovi provides a vast stream of services, ranging from media guides, cloud services and video streaming to entertainment metadata or advertising. Also, the firm’s 5,300 patents, mainly linked to IPG businesses, have long-term expiration dates running into 2031, giving the company a sense of future stability and earnings.

However, Rovi is still a medium sized company when compared to competitors like Cisco Systems Inc. (CSCO) or ARRIS Group Inc. (ARRS), which makes raises the risk of investment. Although the firm enjoys solid relationships with its many licensing partners, it has yet to grow in terms of financial, technical, and marketing resources.

Gross Margin: Gross Income/Sales

Gross profit margins measure a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor what percentage of revenue/sales is left after subtracting the cost of goods sold. Thus, a company that boasts a higher gross profit margin than its competitors -and overall industry- is more efficient, leading investors to pay more for these businesses, as they should be able to make a decent profit as long as overhead costs are controlled.

Over the past three years, ROVI Corp.’s gross margin has decreased from 84.4% in 2010 to 82.8% in 2012. A decreasing margin indicates that the company has been becoming slightly less efficient year-after-year.

Asset Turnover

Asset turnover measures a firm's efficiency in using its assets to generate sales or revenue - the higher the number the better. It also indicates pricing strategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover. The fact that the revenue growth has outpaced the assets growth (-0.30% growth) on a percentage basis, indicates that the company is making money on its assets.

Institutional Sponsorship

I assume that if a prominent institutional investor put money into Rovi Corp, the stock will pass strict fundamental standards. As such, in the recent quarter, both George Soros (Trades, Portfolio) and David Dreman (Trades, Portfolio) among other prominent investors bought the company’s stock at an average price of $18.13.

Analyst Outlook

Currently, many analysts have a good outlook for Rovi Corp. Analysts at MSN money, for example, are predicting that the company will retrieve EPS of $1.73 for FY 2013 and EPS of $1.90 for FY 2014. Analysts at Bloomberg are estimating Rovi Corp's revenue to be at $532.76M for FY 2013 and $557.17M for FY 2014. And on 12/11/2013, Pacific Crest gave the technology firm a rating of "Sector Perform" with a target price of $24.17, which means significant upside potential from this point.

Bottom Line

Although Rovi Corp is still a relatively small company, compared to its industry peers, its financial balance sheet is quite convincing. 2011 brought on many changes in terms of management renewal (Tom Carson assumed position as the new CEO) and infrastructural modifications, putting a dent in operating cash flow and driving debt levels up. However, the company’s solid clientele base and vast intellectual property portfolio, with distant future expiration dates, are sure to drive growth further over the next few years. So, for investors willing to take a risk in an industry with high growth figures, Rovi might be the right investment.

Disclosure: Damian Illia holds no position in any stocks mentioned.




Guru Discussed: David Dreman: Current Portfolio, Stock Picks
Stocks Discussed: ROVI, GOOG, SNE, CSCO, ARRS,
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