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IP Video Industry is Hot

One of the hottest growth areas in technology is the video distributed over the internet to computers, mobile phones and IPTV to your set top box (3 screens). From 2007 to 2012, "traffic will increase sixfold," Robert Pepper, a vice president of Cisco (NASDAQ:CSCO), told the Internet Governance Forum ((IGF)) in Egypt's Red Sea resort of Sharm el-Sheikh. "It's growing at a compound annual growth rate (CAGR) of 46 percent and this is being driven by video," he said. "Video is the driver. Make no question about that." Moreover, the New York Times ran an article entitled, ”Online Ads Are Booming, if They’re Attached to a Video."

Analysts say they expect the flow of online advertising dollars to video to continue as the research firm eMarketer projects 35 to 45 percent growth for the segment for each of the next five years, topping out at $5.2 billion in 2014. In the five-year outlook it released last month, eMarketer said that video ads would be the “main channel” for major advertisers seeking to increase their online spending. Already, ads for companies like Johnson & Johnson (NYSE:JNJ) and Unilever (NYSE:UN) pop up often on sites like MSNBC.com. According to other industry analysts, spending related to online video infrastructure (excluding streaming costs) was $2.7 billion in 2008 and is expected to increase to $10 billion (38% CAGR) by 2012. Ad spending was estimated at $1.2 billion in 2008, and is expected to rise to $4.5 billion by 2012. KIT is in the ‘sweet spot’ to benefit from this growth.

KITD's recurring revenue model is primed to bring strong returns

Nasdaq listed Kit Digital (OTC:KITD) sits in the middle of this massive growth trend and is on the precipice of significant attention and stock price gains in my opinion. KIT Digital is a leading, global provider of on-demand, Internet Protocol (IP)-based video asset management solutions. KIT VX, the company's end-to-end software platform, enables enterprise clients to acquire, manage and distribute video assets across the three screens of today's world: the personal computer, mobile device, and IPTV-enabled television set. The application of VX ranges from commercial video distribution to internal corporate deployments, including corporate communications, human resources, training, security and surveillance. KIT Digital's client base includes more than 600 enterprise customers across 30+ countries, including The Associated Press, Best Buy (NYSE:BBY), Bristol-Myers Squibb (NYSE:BMY), Disney-ABC (NYSE:DIS), General Motors (NYSE:GM), Google (NASDAQ:GOOG), IMG Worldwide, Intel (NASDAQ:INTC), McDonald's (NYSE:MCD), News Corp (NASDAQ:NWS), Telefonica (NYSE:TEF), the U.S. Department of Defense, Verizon (NYSE:VZ) and Vodafone (NASDAQ:VOD).

What I like best about KIT Digital is that it is a company that provides the necessary “plumbing” of IP video—as management describes it—and is not betting on any one particular end-business model for IP video deployments. A classic “selling jeans to miners” approach. I also like the company’s international presence, and particularly its focus on high-growth IP video markets in Europe, Southeast Asia and the BRIC countries. Some real-world VX deployments include GM, which uses KIT Digital to communicate with staff and stakeholders through video-messaging; Citadel/ABC Radio uses KIT VX to display video content across 200+ radio station websites as well as mobile handsets; Telefónica 02 utilizes KIT VX to acquire IP-based video content at sports venues in Central Europe, then edit and distribute to online, mobile and other IP-enabled points of delivery; the Associated Press uses KIT VX to acquire, edit, localize and monetize its premium video content for global commercial consumption.

KIT’s long term, enterprise-level client engagements (i.e., over 2 year average initial contract length, with automatic renewals) provide a steady and predictable “recurring” revenue stream. KIT generates its revenue consistent with a traditional SaaS model, which is very efficient and cost-effective. Clients license the company’s VX platform and compensate KIT digital through modest up-front setup fees, followed by monthly maintenance and usage fees. Professional and creative services are usually at the core the com­pany’s upfront setup work for a client, and KIT can also be engaged on a project-by-project or on­going consultative basis to integrate with existing CMS and ERP platforms. Once the company’s “VX” product is embedded with a client, switching costs are high (data loss, re-training needs, end-customer annoyance, etc.), so client attrition rates are very low.

KITD has also been growing ARPU for its software solution, from less than $5k/month in the beginning of 2008 to over $8k/month today, according to management’s last investor call. So growth is both internally and externally driven.

Recent Financial Results Have Been Strong

Formerly Roo TV, KITD was taken over in early 2008 by CEO Kaleil Isaza Tuzman (38 yr old Harvard undergrad, Goldman Sachs alum, serial software entrepreneur) who vowed to cut its bloated cost structure and reposition the company ahead of the video tidal wave of growth. The management team also consists of 5 former CEOs (of Factory 212, Narrowstep, Juzou, Visual Connection, and Nunet) of the 8 senior executives. Management is significantly invested in the success of KITD as well, having invested over $10 million personally in the company. This all-star team has delivered. Quarterly revenues announced last Thursday November 19th soared 104% year on year to $11 million, and up 300% from the the Q1 2008 $3.5 million in quarterly revenues when he took over the company. More importantly, cost cutting discipline and inherent operating leverage in the business model have driven EBITDA from (3.8) million to $0.9 million over the 7 quarters since acquired as shown in the table below (remember this was during one doozy of a global recession):

1Q08

2Q08

3Q08

4Q08

FYE 2008

1Q09

2Q09

3Q09

Revenue

$3,502

$5,485

$5,381

$9,033

$23,401

$9,624

$10,494

$11,036

EBITDA

$(3,751)

$(2,238)

$(1,569)

$(4,542)

$(12,100)

$198

$671

$927

EBITDA Margin

-107%

-41%

-29%

-50%

-52%

2%

6%

8%

With organic growth of more than 50%, KITD also benefits from recently announced (October) synergistic acquisitions of competitors NuNet and Feedroom at modest cash flow multiples of just north of 4x EBITDA. NuNet, growing at 30%-40% annually strengthens KITD's focus on mobile video while Feedroom brings stable and growing corporate video business along with a new roster of global enterprise clients to cross-sell other KITD wares to. Proforma for these acquisitions, I project revenues to grow from approximately $60 million in 2009 to $90 million in 2010 while EBITDA grows from approximately $9 million to $18 million. That's 50% Revenue Growth and 100% EBITDA growth. Best of all, 75% of KITD's revenues are contract based (read - highly visible), recurring revenue streams that growth as the company's clients increase their video usage/traffic (client retention has been 98% in recent years). According to management, operating margins have expanded every month for the last 23 months. And remember - Venture capitalists involved in the Feedroom invested into KITD at $11.0 (higher than the current price) when the acquisitions were made just over 1 month ago. What is such a visible, quickly growing cash-stream worth?

Strategic Value, Valuation and Catalysts

The company’s competition are almost exclusively private companies today—although one which is public is On2 Technologies (ONT), does around 25% of KITD’s revenues and operates at a loss, and got bought for over 6x revenues by Google (GOOG) two months ago! The meaningful companies that compete which I could find through my discussions with management and my independent research include Multicast, thePlatform, Brightcove, Ooyala and Digitalsmiths. But none of these companies seem to be strong in mobile video management & distribution (over 25% of KITD’s revenues) or IPTV cable systems, and all are focused on the U.S. marketplace (less than 10% of the overall global IP video marketplace). Except for Brightcove, which may have comparable revenues, all these companies seem to be substantially smaller than KITD, and all are probably still losing money. Last month, it was rumored Google was buying Brightcove for $500-700 million (6-9x) of revenues, and the industry scuttlebutt indicates that Brightcove has been working on a planned IPO with Goldman Sachs for a while—with a $400 million pre-money valuation. Either of these outcomes would be outrageously positive on a comparative basis for KITD—which is of comparable size, profitable, and with more entrenched client relationships than Brightcove.

Google has been an active acquirer in the IP video market recently (and is a substantial client of KITD), as has Cisco, Comcast (NASDAQ:CMCSA) and WPP (NASDAQ:WPPGY). From my viewpoint, there are more than a dozen major potential acquirers for KITD who have a reason to buy into the “plumbing” of IP video management and delivery.

Mr. market currently values this undiscovered gem at just about $100 million or a 5.4x 2010 EBITDA. Remember that's EBITDA growing 100%! By comparison, peer Akamai (AKAM - an imperfect as a peer since AKAM faces declining pricing unlike KITD) is valued at 8.9x EBITDA with EBITDA projected to grow at just 5.6%. Moreover, Google is in the process of buying more direct peer On2 Technologies at 6.0x trailing sales (versus KITD at a current 1.6x) Also it has been rumored recently that Google is in talks to acquire direct private peer Brigthcover at 6-9x revenues. Other rumors have it that Brightcove is preparing an IPO through Goldman (with a premoney valuation of $400 million on approximately the same revenues as KITD) that should bring much attention (and valuation jump) to KITD stock. Just for fun, at 6x KITD's 2010 projected revenues of $90 million would value the stock north of $50.0 per share vs. the current price of $10.4.

Many catalysts exist to drive this stock higher. First the upcoming Q4 report is the company's seasonally strongest quarter and will be the first integrating recent acquisitions NuNet and Feedroom. This meaningful jump in revenue and EBITDA to what I think could be as much as $17.5 in revenues and $3.0 million in EBITDA should grab attention. Moreover, on last Thursday's call several sell-side analysts not covering the company asked questions, hinting that perhaps several are preparing initiation reports. Roth Capital and Maxim Group (the banks which co-led KITD’s Nasdaq offering) should be initiating analyst coverage quite soon. Furthermore, Kaleil mentioned on the call that he intended to pick up the marketing/exposure going forward for the company. I expect additional conference attendances and contract win press releases, along with positive earnings surprises to drive this stock significantly higher in coming months.

Disclosure: Long KITD

Source: Kit Digital: Riding the Online Video Wave