You remember TiVo (TIVO, Financial), right?
Years ago, the company pioneered the digital video recorder (DVR), and forever changed the way people consume television. No longer did we have to make appointments to watch television, fiddle with VCR settings (yes, they still existed back then), or sit through boring and repetitive commercials to watch our favorite shows. Consumers loved their TiVos, and even though third-party DVRs soon found their way into the market, there was little question that TiVo's platform was far and away superior in quality.
However, TiVo never really came to dominate the market as some expected. The company for much of its history has been unprofitable, and cheap DVRs with far inferior software experiences proliferated through most of the major service providers. TiVo won a deal with DIRECTV many years ago that is still one of its major sources of revenue, but the other cable and satellite providers went in a different direction.
Over the last few years, though, TiVo has revamped its strategy and also won significant patent licensing settlements that have put this once unprofitable company back into the green. With the stock recently showing up in the Magic Formula� Investing (MFI) screens, now seems like a good time to take another look.
TiVo's Business Strategy
Today the company reports revenues in three "buckets": Services (33% of total 2014 revenues), Technology (45%), and Hardware (22%).
Let's start with Hardware. TiVo still sells its own DVRs and extension boxes, both directly to customers and through some of its cable/satellite/broadband partners, referred to as multiple-system operators or "MSOs" by the company. TiVo DVRs can be used for existing cable service via the CableCARD interface, or can be used to augment over-the-air service. Despite its meaningful revenue contribution, Hardware for TiVo is a very low-margin (3-5%) business and not a major contributor to profits.
Services is the company's future. We can break this down further into TiVo-owned, where consumers purchase a TiVo box and subscribe directly to the company's services, and MSO, where the service provider uses TiVo software and services on its own hardware. TiVo-owned subscriptions account for only 19.5% of total subs, but generate 59% of service revenues. The value-add for consumers is TiVo's ability to provide single search over both cable TV and video-on-demand from Netflix, Hulu, and other sources, as well as high-end features such as 4-6 tuner recording and mobile apps that turn your smartphone into a TV itself.
Also in the services segment are media services (12% of the segment), where TiVo provides advertisers with highly granular data on customer viewing patterns, as well as ad inventory designed to reach viewers who like to fast forward through ads. TiVo has some big customers here, including Interpublic and Omnicom.
Lastly, we come to Technology. This has been the company's saving grace as it has won over $1.6 billion in patent settlements from Motorola, Cisco, AT&T, DISH, and others since 2011. These are being amortized over several years and, along with ongoing licensing deals, make the technology line item both a very predictable and very profitable (nearly 90% margin) one for TiVo.
TiVo's Way Forward
TiVo's growth going forward will come from two places: increasing MSO subscriptions and, to a lesser extent, growth in their advertising services.
In 2014, TiVo's MSO subscriptions increased an impressive 46.4%, representing over 80% of all subscribers. These excellent results are set to continue, and possibly accelerate, due to 3 catalysts. In February, TiVo secured a deal with Frontier (FTR) to be their primary video solution. This is a big deal - Frontier has 2.7 million broadband customers and will nearly double in size as it recently acquired over 3 million Verizon subscribers.
A second catalyst for increasing MSO subscribers is TiVo's purchase of Digitalsmiths, a platform-agnostic, cloud-based search and recommendation service. Digitalsmiths revenue grew an impressive 25% just between Q3 and Q4 last year, and is set to be an important part of TiVo's international strategy. Speaking of international, that too will be an important source of new subscribers. A good chunk of the company's 324,000 MSO subscription additions in Q4 came from the roll-out of its service by Spain's ONO service provider. More deals are likely imminent - TiVo has tripled its MSO partners in the past 3 years alone.
Continued build-out of relatively recent deals is the third major catalyst. Most of TiVo's MSO deals are recent - subscriber count is up to 5.5 million from just 1.9 million 3 years ago. Management feels further penetration from still new partnerships should contribute to subscriber growth.
As subscriptions grow, TiVo should be able to further leverage its fixed costs to improve gross margins. It also makes the company less risky, as subscription revenues are relatively sticky and predictable. I believe the firm should be able to grow revenues at a respectable 7-10% rate over the next 3 years, with increasing margins.
My Concerns With The Stock
Despite the decent near-term prospects, as a value-based investor the stock does not look particularly interesting.
First of all, I'm not really sure how TiVo is even screened by MFI. By my calculations, its trailing 12 month earnings yield is about 6% - hardly value territory. Traditional metrics fare no better - P/E ratio is over 40, price-to-book exceeds 4 times, and even price-to-sales ratio is high at 2.8. I can't see any scenario where TiVo is a value stock.
Secondly, we have the matter of licensing and settlement revenues (e.g., the Technology segment). Guaranteed settlements and licensing will be steady through 2018 at a little over $170 million per year. After that, they fall to $89 million in 2019, and then become almost immaterial after that.
If Technology was just a contributor to TiVo's business, this wouldn't be a major issue given growth elsewhere. The problem is, these settlements comprise ALL of TiVo's profitability... and then some! Last year, the company earned over $200 million in Technology revenues at an 89% margin ($178 million profit). Compare this to the firm's reported $61 million operating profit, and you can see these settlements are covering up a services business still pretty solidly in the red. The growth ramp in services is nice, but TiVo will have to really scale that side to make up for the future losses in technology. This must be accounted for when coming up with a price for the company.
These factors, combined with the fact that (outside of licensing) TiVo has never generated any serious operating cash flows, lead me to pass on the stock outright. There are certainly scenarios where investors could win here (big new patent wins, an outright acquisition), but it seems unlikely in all but the rosiest scenarios that TiVo is worth more than $13/share.
