Rovi: Compelling Reward To Risk
ROVI Corp. ( ROVI ) is a compelling long trading at about 11x forward EPS. This valuation is very attractive relative to management's guidance for 20% long-term operating profit growth. ROVI has dominant market positions and a relatively high mix of high margin, recurring revenue. The company's growth is tied to several secular trends including growing media consumption on mobile devices such as tablets, smart-phones and laptops and the growth of Over-The-Top ("OTT") video services such as those offered by Netflix ( NFLX ), Amazon ( AMZN ) and Hulu.
ROVI is a technology company focused on the discovery, delivery, display and monetization of digital entertainment. It is best known for its discovery intellectual property which almost all North American pay TV service providers such as Comcast ( CMCSA ), DirecTV ( DTV ), EchoStar (DISH) and Time Warner Cable (TWC) license in order to offer their customers an interactive programming guide ("IPG"). Licensing agreements vary but several sell-side analysts estimate that ROVI receives at least about 20c per month per subscriber for its IPG patents. The company also sells advertising inventory within these guides and its "metadata" which allows its customers to include cover art and information such as a short blurb about what a specific show is about. ROVI also does business with consumer electronics companies. These customers also license ROVI's IPGs as well as several other technologies such as DivX, a high quality video compression-decompression software library.
- Increased number of use-cases will drive higher licensing revenue from new and existing customers. ROVI licenses its technology by use-case. Pay TV service providers have historically paid ROVI for the TV use-case. Now that consumers have a desire to be able to watch TV from any device that has a screen, service providers are being forced to pay ROVI more for the "TV Everywhere" use-case. The increased range of devices for video consumption has also increased the potential number of consumer electronics customers for ROVI. For example, Apple (AAPL) signed a licensing deal in 2010. Time Warner Cable has recently been advertising "In any room on any screen." In case you missed their Super Bowl advertisement, you can see it here .
- OTT is a great opportunity. ROVI recently signed a licensing deal with Hulu. While Hulu is a relatively small service provider with only about 3 million subscribers, the deal shows the strength of ROVI's patents and increases the probability of a favorable outcome for the company's litigation with Netflix and Amazon. ROVI also has developed new IPGs that incorporate OTT that it is up-selling to its existing customers. It calls this "TotalGuide." For example, with TotalGuide, you can search for a specific show and get back not only when Comcast may be airing it, but also if it is currently available through your subscription with Hulu.
- Recent licensing agreements with LG and Hulu in Q1 de-risk 2013 estimates. When it gave 2013 guidance, the company was not counting on any revenue from Hulu. Management also guided for the LG licensing agreement to happen in the 2nd half. Bears are quick to point out the fact that management reiterated 2013 guidance following the LG deal. The company also reiterated the fact that 53% of the 2013 revenue will be recognized in the 2nd half. While it is possible that there is some deal slippage, I hypothesize that management reiterated guidance in order to have maximum negotiating leverage with customers for upcoming contract renewals and new licensing agreements. I find it very surprising that Street revenue estimates for Q1 at $152 million have been left unchanged when the LG agreement will likely represent close to $20 million of sales (since it includes a catch-up payment from previous shipments).
- Comcast and EchoStar agreements not currently being captured in earnings. Before it was acquired by ROVI, Gemstar signed a very large 12-year licensing agreement with Comcast and EchoStar for a total of $440 million. Since Gemstar was desperate for the cash, this was paid up-front and was supposed to be recognized as revenue over 12 years. However, when Gemstar was acquired, all this deferred revenue was written off. Consequently, ROVI currently has very large contracts with two large customers that it is not recognizing in its income statement. These deals are up for renewal in 2016 and should be renewed at much higher values because ((I)) ROVI will not be as financially desperate as Gemstar was in 2004 and will therefore likely not push for an upfront payment, (ii) the ARPU and number of digital subscribers at these customers is up significantly since 2004, and ((III)) ROVI's patent portfolio is stronger. I estimate that EPS is currently effectively understated by anywhere from 30c to $1 and it is only a matter of time until the earnings from these two important contracts get reflected in ROVI's price.
- New management and improved capital allocation. At the end of 2011, the company replaced its CEO. A new CFO came on board in Q2 2012. Previous management significantly overpaid for an acquisition which was one of the main reasons the stock did so poorly in 2011 and 2012. While the company is still looking for acquisitions, the company appears to be being much more selective and focused. ROVI is actually in the process of divesting a small, money-losing business. Management took advantage of the weakness in the stock last year to accelerate a buyback and reduced the share-count by 5%. The CEO also bought stock in September of 2012.
- International service provider opportunity. The company has relatively lower penetration into the international service provider market. As ROVI increasingly goes after monetizing its patents internationally, its penetration in these markets should increase. Moreover, cross-border mergers can help ROVI's business. For example, Liberty Global's (LBTYA) recently announced acquisition of Virgin Media (VMED) will likely bring in a new customer if Virgin opts-in to Liberty's existing agreement with ROVI.
- Growth set to accelerate. The company has a couple of declining legacy businesses that are offsetting growth in other areas. The good news is that these legacy businesses are going to be very small this year just in time for revenue from new OTT customers and increased revenue from new products, increased international penetration and new use cases to accelerate growth. Management is guiding for 2014 revenue growth of 7 to 12%, with the Street at the low end of this range.
A dream but not unreasonable scenario is that the stock's forward EPS multiple rises 50-100% to 15-20x and EPS also grows 60-100% over the next few years for a potential 200-400% return. At the same time, risk appears relatively limited given the company's low multiple on EPS that is arguably not even including revenue from 2 of the company's large customers and (ii) the fact that the LG and Hulu deals were signed earlier than expected.
Disclosure: I am long [[ROVI]], [[AMZN]]. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author may make trades in securities mentioned without notification. The information contained in this article is impersonal and not tailored to the investment needs of any specific person. You should consult with a professional where appropriate. The author shall not be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
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