Digimarc Corporation (DMRC) provides media identification and management solutions to commercial entities and government customers in the United States and internationally.
More specifically, the company's patents relate to various methods for embedding and decoding digital information in video, audio, and images. These are often called "digital watermarks". Its solutions are used to identify, track, manage, and protect content, as well as to enable new consumer applications to access networks and information from personal computers and mobile devices (Source: Yahoo Finance).
Living in this ever increasing digital age that we live in, combined with the constant battle between media content creators and piracy, it should be immediately clear that there is an ever increasing market for these kind of technologies. As stated in the company's 10-K, the technology allows customers to do a variety of activities. some examples include:
- Quickly and reliably identify and effectively manage music, movies, television programming, digital images, documents and other printed materials, especially in light of new non-linear distribution over the internet;
- Deter counterfeiting of money, media and goods, and piracy of movies and music;
- Provide consumers with more choice and access to media content when, where and how they want it;
- Better secure identity documents to enhance national security and combat identity theft and fraud.
Digimarc has been a rapidly growing company during the past decade. The company went public in 2005, and has since increased sales from $11m annually to over $36m in 2011. Net Earnings have also increased at an impressive clip and reached nearly $4m last year.
This recent article from CNNMoney talks about the growth of counterfeit goods around the world continues to increase. The International Chamber of Commerce, ICC, estimated that in 2008 the value of counterfeited goods including digital pirated material was about $650 billion worldwide. Another $125 billion was lost in tax revenues in developed countries due to this, and several million jobs. By 2015, ICC expects the number to increase to a whopping $1.7 trillion. That is a CAGR of about 15%, which is quite in line with the recent growth as a company that Digimarc has seen. A lot of this growth comes from increased use of digital mediums where movies, music, and other content is routinely pirated. Also world governments, including the US, continue to spend a lot of resources in recent years to deter would be counterfeiters of paper money.
Digimarc's products are used for many other promising applications as well, besides just for law enforcement purposes. For example, digital watermarking technology is also used on images as a way for content owners to give permanent signatures to their work which might be widely distributed on the internet. The company also has the Digimarc Discover app for smartphones, which uses digital watermarking, audio fingerprinting and barcode detection in order to "see, hear, and engage" with all forms of media. Users can point their phone at advertisements, signs, product packages, and many other forms of content and the app will connect them to a menu of items where the user can decide to learn more, view videos, share via social media, etc.
Although some of the new technologies of Digimarc are still a small part of the business, it does show the small company has technical prowess to keep innovating and further grow their product lines.
Business Risks To Consider
As with any company, there are always some risks to consider.
One of the biggest risks with Digimarc is customer concentration. Not an uncommon occurrence with small caps companies, but always something to review closely. Digimarc relies on a whopping 94% of its revenue from only 5 customers:
- The Bank for International Settlements (which acts on behalf of the world's central banks) - Banknote counterfeit deterrence was the first widely used application of Digimarc's technology.
- Nielsen - The company formed 2 joint ventures recently with Nielsen to license its technology for copyright filtering solutions and certain enhanced television offerings.
- IV - Intellectual Ventures, which has agreements to sub-license up to 900 patents from the company.
- Civolution & Verance Companies which operate in a similar business but licenses the use of digimarc's digital watermarking.
One thing to note here as that the concentration risk is not as bad as it seems on the surface, as the company's technology is used in many central banks for example, and the BIS is used as a proxy to a number of customers. The same is true for the relationship with IV.
Other risks worth mentioning is just the shear amount of alternative technologies existing, and that longer term nobody really knows which technologies will definitely prove superior, depending on the application and context. Some other examples include: RFID tags, smart cards, digital fingerprints and signatures, image recognition, and containers. I won't go into each of these here in detail, but clearly there are many available options. I think Digimarc still is in a great position though, as the explosive growth of digitally stored data is continuing at such a rapid pace that many of these technologies collectively will continue to do well as the overall market expands.
The company maintains an impressive portfolio of 1200 patents related to its technologies. This is a significant amount of intellectual property for a company with a market cap of only $122m. In the 10-K the company states that no company dominates their market, but most of their competition is from other technologies besides digital watermarking, since their extensive patent portfolio gives them a big advantage here. I also like that the gross margin has increased from 67% to 81% in only 3 years.
Digimarc has several points with general positive trends for shareholders:
- The company recently started paying a quarterly dividend of $0.11/share. At current prices this is a respectable yield of 2.4%.
- The payout ratio is only 21%, and with no debt and more than $30m in cash the dividend seems well secured.
- Insiders do have some ownership stakes in the company, with a total around 10%.
- One negative point, is that earlier this year there has been some insider selling when the share price was between $23-26/share. Now at 52 week lows at $18/share, it will be interesting to watch insider action closely.
Earnings Growth Trend is Positive
One point I always check when research companies is how predictable their earnings have been in the past and what the trend is. Digimarc has been public since 2005, and has seen earnings grow from -0.68/share to 0.76/share in 2011. Earnings grew at a pretty impressive clip, with the exception of the recession in 2009.
There are only 3 analysts who cover the stock, but all have buy ratings on the company. The estimates are for $1.21 and $1.39/share for 2012 and 2013 respectively. The forward P/E on the stock is now less than 13, which is quite cheap considering the growth of the company.
Digimarc Has A Pristine Balance Sheet
The company has an excellent balance sheet. A few key points:
- Zero Debt. The company has grown without using any debt in its capital structure since going public in 2005.
- Over $30m in cash, which is roughly double the yearly FCF.
- Current Ratio over 9
- Price/Book about 2.4
Using a simple DCF method:
- EPS: $1.07
- 10-year growth: 10%
- Terminal Growth Rate: 3%
- Years of Terminal Growth: 10
- Discount Rate 6%
With these inputs, I arrive at an intrinsic value of $26.47/share. In my DCF method, I have used a fairly low discount rate, which is my normal practice as I look at this as the "risk free" return percentage that I feel confident I could get if I deployed my capital in alternative investments. I have also taken what I believe to be a conservative growth rate, as the company has grown much faster than this recently and at least in the coming few years is expected to maintain a higher growth rate. A popular alternative approach that some investors might use is to employ a higher discount rate instead. Although these methods are subjective, I feel regardless of the exact method chosen there is clear evidence of a margin of safety in the shares, especially now that the company is trading at the bottom of its 52 week range.
With a margin of safety somewhere in the 30-50% range, I think this hidden company is worthy of a deeper look for your portfolio. Over the past year the stock has drifted significantly lower in price, however the growth estimates for the coming 2 to 3 years remain quite strong, and the few analysts covering the company even have increased estimates slightly for the 2013 fiscal year in the past few months. With an EV/EBITDA of 6.23, (cash on cash yield of 16%), a protected dividend yield over 2%, and decent business prospects and growth expectations, I think the risk/reward ratio is quite good here and I recommend buying shares of the company.