Sonic Foundry: Mediasite Franchise Value Remains Unrecognized by Market

Since our initial post regarding Sonic Foundry's Mediasite franchise on 5/1/09, shares have traded slightly lower despite the expanding franchise and positive financial progress. In our view, the Market remains irrational. At some point, value should track fundamentals -- it always does (over time). Consider this quote included at the beginning of Chapter 8 in More than You Know by Michael J. Mauboussin (shared with us by another investor - thank you):

click to enlarge

Key point: patience can bring great rewards as the Market comes to recognize value, so long as the initial assessment is correct. Although SOFO resides in a speculative category, we believe nothing has changed since our initial analysis, which pegged fair value per share at $1.95 to $2.72 ($2.34 midpoint) based on reproduction cost.

Recent event: Sonic Foundry completed its 1 for 10 reverse split last week and SOFO is trading as SOFOD ($5.11, or $0.51 pre-split) for 20 trading days before reverting back to SOFO. We previously commented on why we think the company effected the reverse split. Aside from removing delisting risk at year-end and enabling more institutional investors to purchase the stock, we think a significant reason for the move was so existing and/or potential customers are not scared by a sub-$1 share price. The very low prior share price gave the impression that Sonic was distressed and may not be around in 2, 3, 4, 5 years (i.e. if I'm a customer, why buy/install Mediasite if the company won't be around?). However, per our prior posts, we believe such a view couldn't be further from the truth. And, we're not drinking Kool-Aid either.

Why? The balance sheet is not distressed: the company has limited debt, retains borrowing capacity, and should generate excess cash over the next year (assuming growth remains consistent with >20% expected for fiscal 2009). Importantly, we don't expect F4Q09 results next Monday to change this reality (guidance is key question). Further, favorable working capital swings in the seasonally weak December quarter should buffer a potential operating loss for the period.

Recall progress over the past year:

click to enlarge

Next, we come back to the Mediasite franchise. While the economy remains weak and many tech companies are shrinking this year, evidence suggests the franchise continues to grow -- see customer commentary in press releases, Sonic's blog, awards, Webinars, etc. For example, Mediasite again won the Streaming Media Readers' Choice Award for best Webcasting platform (announced last Wednesday):

Webcasting/Presentations Solutions
Winner:
Sonic Foundry Mediasite 5.1 (36%)

Finalists:
Accordent Technologies Capture Station (18%)
ON24 Webcast Center (11%)

Other evidence: recent commentary in a Streaming Media article, The Government Video Boom, suggests Sonic Foundry is adding an average of 75 government customers each quarter versus perhaps 15 per quarter for competitor Accordent -- that's five times more new government customers for Sonic, revealing clear market leadership (emphasis added below):

• Within the past year, a growing number of government agencies in the U.S. and Canada have made that jump, according to several providers of online streaming technology. Sean Brown, vice president of education at Sonic Foundry, Inc., says that about 50–100 agencies become customers every 90 days, while Jereme Pitts, senior vice president of sales and marketing and co-founder of Accordent Technologies, Inc., says his company has welcomed about 50–75 new government customers in the past year.

Thus, we think Mediasite's economic goodwill continues to increase. How best to measure such goodwill? As noted in our original post, Mediasite customers are diehard about how Mediasite is improving productivity within their organizations. As a result, customers become voluntary evangelists on behalf of Sonic Foundry and, therefore, drive incremental penetration. These intangibles are extremely difficult for new entrants or even large players such as Cisco (CSCO) or Adobe (ADBE) to replicate by simply spending millions of dollars in marketing and selling, not to mention R&D to establish a competitive solution.

Sonic is building the franchise through an array of products and services around Mediasite - slides sourced from this August 2008 presentation (worth watching for "rewind" purposes; captured with Mediasite):


And, Mediasite economically addresses an important market need:

Here's what management said at the time (again, August 2008) about the outlook:

More:

Where do we stand today? Fiscal 2009 growth is now forecast at >20% Y/Y with more recurring license and services revenue -- below slides sourced from this September 2009 conference presentation (unfortunately, NOT captured with Mediasite so no integrated video -- Wall Street Webcasting needs to get with the program):

Most recent outlook (early September):

Sonic is expected to report fiscal 2009 results Monday 11/30/09, providing another update on business progress. Our analysis suggests that fundamentals are as sound as can be in a recession: growth with margin expansion. As for valuation, we still believe our reproduction analysis holds (i.e. $20 - $27), supported by the probable valuation that would be awarded by strategic buyer. On a forward basis, the valuation expands, particularly if Sonic closes additional campus-wide deployments and revenue scales further with positive earnings and cash flow generation. We're not hanging our hat on a buyout, yet more M&A deals are happening and, as noted, the Mediasite franchise appears difficult to replicate.

Finally, just for fun, let's compare the valuation of Ener1 (HEV) and A123 Systems (AONE) to Sonic Foundry. We expressed caution for both HEV and AONE in our October post, Wall St. Speculation Alive and Well in Clean Tech -- Risky Business. Since that time, shares retreated, but valuation remains rich:

• Ener1 trades at 21 times trailing twelve month (TTM) revenue and 6 times consensus 2010E revenue.
• A123 trades at 17 times TTM revenue and 11 times consensus 2010E revenue.

The Market is infatuated with rosy growth prospects and the "clean tech" sector. Meanwhile, both companies are bleeding cash. Sonic Foundry isn't growing top-line as fast, but should be profitable over the next year. If we apply the same 6 to 11 times forward revenue multiples to estimated fiscal 2010 revenue of $22 million (+13% Y/Y growth - conservative), the implied market capitalization would be $132 million to $242 million, or $31 to $56 per share (assuming fully diluted shares outstanding of 4.3 million). We're not justifying the multiples, simply pointing out how the Market can value different assets when it is in love with an idea/trend. Note that we prefer price to earnings and price to free cash flow multiples, not price to sales multiples.

Disclosure: Long SOFO

Comments

[j_remington]

You cannot realistically compare valuation of companies like HEV($600M) and AONE($1.5B) to Sonosite ($17M) due to their difference in size(market cap).

2009 Nov 24 11:27 AM

[Jeffrey Walkenhorst]

Hello, Sonosite (SONO) actually has a $402M MC with a TTM P/S of 1.8x. But, yes, Sonic Foundry's (SOFOD) MC of ~$20M (1x TTM sales) is small and, indeed AONE and HEV are larger companies in terms of MC. Yet, that's really the point: the Market can award wildly different valuations based on current perception and/or infatuation with various trends. In this case, we have very high FORWARD P/S multiples for AONE and HEV (which leads to large MCs). Actually, on a TTM basis, HEV's revenue of $30M is only 1.6x larger than Sonic's TTM revenue, but the company trades at 20x TTM sales versus Sonic at approximately 1x TTM sales. While HEV's high valuation is awarded on a massive, expected revenue ramp, the risk of potential disappointment is elevated given such high multiples (expectations) and ongoing operating losses (cash burn). I see lower risk with SOFOD.

2009 Nov 24 02:14 PM

[bouncingcat]

I looked at the Streaming Media Reader's Choice awards link you have above and it appears Accordent won in the more profitable Enterprise Video Platform technology section for its Accordent Technologies Rich Media Communications Suite. Sonic Foundry was not even a finalist. The product that they won their section with is the Mediasite hardware platform.

Since Accordent is private, I'm not certain you can make a case that number of Government clients loosely quoted by each company represents some significant piece of information for investors. This is especially the case when Accordent is winning praise for an enterprise software suite that is substantially more expensive than commoditized pc broadcasting device.

The horrible operating margins and return on equity is also something that the private companies could not afford to tolerate to the extent that SOFOD has punished its investors.

Ideally the sector as a whole does well and SOFOD investors are rewarded. However I fail to see how the 1 for 10 reverse split rewarded investors. Beyond exposing the shares to more pressure from shorts (which under ideal circumstances might someday generate a short squeeze but is unlikely to have positive impact now); it is highly dubious to claim this opened the shares up for institutional investors. If that were the objective SOFOD should have completed a 1 for 20 reverse split.

Again, the sector as a whole is undervalued and investors in SOFOD may get lucky. However, part of the reason the sector as a whole has been ignored is poor actual performance by companies such as SOFOD in comparison with what is expected from such opportunity.

2009 Nov 24 11:47 PM

[Jeffrey Walkenhorst]

Hi bouncingcat,
Thanks for your comments -- appears you know the space and may even work for one of the companies....

You're right that Accordent won the Enterprise Video Platform award, which is a positive for that company and indicates favorable traction. However, Sonic also plays in that arena and has solid mind-share. For reference, please see this Streaming Media article, "Navigating the Enterprise Video Workflow", which highlights four major companies: Computer Associates (CA), Lockheed Martin, Merck, and QAD. Of the four, three use Mediasite and only Merck uses Accordent.
www.streamingmedia.com...

Mediasite is far more than simply hardware - there is a major software element, along with service/support. Combined, it's far from commoditized as indicated by gross margins in the mid to high 70% range. Personally, I'm focused on buying franchise type companies that have multiple competitive advantages and are inherently NOT commodity businesses. Technology companies are notoriously bad investments because of change/competition, yet Sonic Foundry's large and growing installed customer base suggests Mediasite isn't going anywhere anytime soon.

Importantly, operating margins and ROE are poised to move from "not meaningful" to "meaningful" as the business crosses a cash flow inflection point and generates positive net income. Acknowledging that the business (and sector) is (are) nascent with sometimes "lumpy" revenue, forecasting can be a challenge. Assuming forward net income of only $2 million would yield an ROE of approximately 20%.

The split had nothing to do with shareholders - likely reasons were detailed in my prior posts, with customer perception no doubt very high on the list. Note that shorts can still easily get squeezed since volume is so light (short ratio same pre/post split). If Sonic puts up good numbers Monday, the stock could "gap" higher and others should take notice. Expectations are extremely low.

Growing top-line ~20% in a recession isn't too bad. Otherwise, we'd probably be seeing 30-40% Y/Y.

All investments carry risk and SOFOD is an illiquid microcap, which carries even more risk. The key is to mitigate risk factors and not bet on "luck". If I'm wrong and positive free cash flow doesn't arrive as expected, I will change my tune.

2009 Nov 26 12:13 AM

[Jeffrey Walkenhorst]

PS - better phrasing re: split is this:
IN A SENSE, the split had nothing to do with shareholders.... some reasons do hold, such as investor perception and attracting potential institutional interest. Perhaps call/put options could even be introduced.... But, I think a major reason is customer perception.

2009 Nov 26 12:47 AM

[bouncingcat]

Certainly SOFOD has opportunity to become a very good investment as economic conditions should demand that government and corporate sectors finally leverage distance based learning and communications to what most in that industry would have assumed should have been done already. Monday's financials should be very interesting however SOFOD (and all others in this space) have a history of little correlation between forecasts and actual results. This is troublesome for investing as just when you think a company has broken out it often turns out to be the case that a few big contracts don't tell the future as much as hoped. Again, I'm not claiming SOFOD won't buck this trend, just that I need to see a few Q's in a row before getting in it. Sure that will make me late to the game but SOFOD, OBAS, VCST.OB, RNWK, and some now deceased companies continually make me question the sector.

SOFOD has all the potential to break out but as the stock symbol suggests it is best suited for those with disposable amount to bet on it.

Your stuff is very well done though. I hope I didn't come across as too dismissive about the quality of the work. I also understand that Mediasite is more than a hardware platform but in my opinion the larger business will be won on the Content and Viewer management side. If any of the offerings in this space become sufficiently well done I assume some ERP vendor with strong skills on the HR side might become interested in acquisition.

2009 Nov 28 06:14 PM

[Jhbeck]

Jeffrey,

Quick question for you....Is there any particular reason why SOFOD's volume is so low? I have not been following this stock very long and am new to the market so I assume it would have been much higher before the reverse split. Thanks,

Justin

2009 Dec 01 12:40 PM

[bouncingcat]

SOFOD confuses me a bit as an investor. The lack of licensing revenue bugs me a bit but service revenue seems strong and should make for some security in upcoming quarterly forecasts. I am curious if Jeffrey thinks this is the right time to invest as it appears their guidance is for somewhat flat revenue over the next few quarters but strong growth after that. Does that suggest most of the upside in the stock can still be captured if you wait at least another 90 days to get in?

2009 Dec 02 08:38 AM

[Tim Siglin]

Jeffrey, thanks for the plug for my article "Navigating the Enterprise Video Workflow", from the most recent Streaming Media magazine, which highlights four major companies: Computer Associates, Lockheed Martin, Merck, and QAD.

While you are correct that three of the companies mentioned in the article use MediaSite, I don't think you'd want to use that as a litmus test for how Accordent and SonicFoundry fare in the enterprise space, for three reasons:

First, choosing enterprise companies to talk to on record is completely different than companies that are willing to talk off-the-record, which in itself is different from companies who are willing to give a sentence or two but no more. In my twenty years in integration design and consulting, I've done work for multiple enterprise clients who won't allow a press release or use of their logo on a client sheet, but it doesn't negate the fact that I've done work for them (and that they'll provide private references when asked). Part of the equation has to do with the PR/marketing department finding companies willing to speak on the record and get approval in a limited timeframe, so I would equate it to the analogy of figuring out which cars are selling best by standing on the sidewalk and sampling the first ten cars that go by . . .

Second, you'll may have also seen that one of the three MediaSite-centric enterprises uses the product within a particular division of the company, adding that other solutions are used in other divisions. That's a key point that I did not stress in the article, but I often find a large enterprise using several solutions, including competing and/or homegrown solutions, across the various divisions or business units.

Third, and I touched on this briefly in the article, the solutions that are in place today in some of these enterprise customers have, for the most part, been in place for five-eight years. They work, they don't break and they could probably keep working for the next decade. There are impending inflection points that will re-open the market to further re-assessment of total solutions, which may benefit Sonic, Accordent and others.

To use one example, the fact Windows Media encoding / decoding solutions form the core of the early solutions has been a non-issue until Microsoft's recent more toward Silverlight. The ability of Silverlight (or of Flash, for that matter) to yield a more flexible player / multi-pane viewing solution versus the relatively static options available a few years ago may be compelling enough to force enterprise managers to relook more than just the format that they've used in the past.

Hope that's helpful clarification to my article, without disparaging any vendor or end-user company that was part of the interview process and subsequent write-up. Thanks again for the plug for the article.

Tim

2009 Dec 02 09:16 AM

[Tim Siglin]

I have to agree with BouncingCat about the ability to compare Accordent, a private company, with Sonic Foundry, a public company.

While I had the pleasure of knowing Krishna and James for several years before Sonic Foundry acquired MediaSite, and also have known the Accordent co-founders since the company's inception, the fact that Accordent is private means that the information on their sales is disclosed only at their discretion. I've never been privy to Accordent's sales figures yet I don't think one has to work in the space (or for a company, as you allude that BouncingCat may) to understand why there will never be a comparison.

BouncingCat's comments remind me of the issue that has been faced by several writers, including Dan Rayburn who also has blog posts on Seeking Alpha, with regards to On2's licensing versus H.264 licensing.

In an article I wrote on the On2-H.264 licensing topic after being challenged by an On2 shareholder to show how H.264 was more expensive than On2's licensing - since On2 didn't charge for decoding - it boiled down to an ability to deconstruct MPEG-LA's licensing documentation (hard, but not impossible) versus an inability to know what On2 charged for encoding (half, twice, ten times MPEG-LA's H.264 encoding charges?)

From that article (www.streamingmedia.com...):

"Given the known cost of a standards-based codec, unlike the unknown cost of a proprietary codec, it appears that many of the criticisms leveled at H.264 licensing are based on critics being upset about paying a known amount for something they equate to open source. Mistaking standards-based for open source, they act on the first part of a famous quote ('data wants to be free'), forgetting the second part of the same quote: 'and data wants to be very expensive.' In the end, for a fair comparison of licensing fees, it is up to the proprietary codec creators to lay the licensing cards on the table."

In the twelve years of writing articles in high-tech companies, I think I've only had pricing and revenue information on ten startups, and then only during their initial 18 months of business. There's just no compelling reason for them to broadcast that information once they've established a firm footing in the marketplace.

2009 Dec 02 09:37 AM

[Jeffrey Walkenhorst]

Hello Tim, thank you for your insightful comments, feedback, and article(s) -- much appreciated. You raise very good points.

I always try to be balanced in my research and should have mentioned potential sampling bias in my "three to one" comparison. You are correct that many companies don't talk publicly about internal IT solutions/apps, so the fact that three raised their hand and happened to use Mediasite may not be illustrative of overall market share. In this case, I was simply highlighting that Sonic Foundry also has "solid mind-share" in the enterprise realm alongside Accordent (which clearly has a following given the Enterprise Video Platform award).

Each solution has different merits and, as you point out, many organizations may use different products in different business units. Of course, over time, my expectation is that more organizations will move to a central IT video platform, much as we've seen in other areas of IT (e.g. business units moving from "silo" servers to shared servers for an entire enterprise = more efficient, lower total cost of ownership, etc.).

That said, when it comes to rich media webcasting and lecture/conference capture, my ongoing research implies that Sonic Foundry remains the market leader with a robust offering and road-map.

Thanks again and I look forward to following your work.

Jeff


On Dec 02 09:16 AM Tim Siglin wrote:

> Jeffrey, thanks for the plug for my article "Navigating the Enterprise
> Video Workflow", from the most recent Streaming Media magazine, which
> highlights four major companies: Computer Associates, Lockheed Martin,
> Merck, and QAD.
>
> While you are correct that three of the companies mentioned in the
> article use MediaSite, I don't think you'd want to use that as a
> litmus test for how Accordent and SonicFoundry fare in the enterprise
> space, for three reasons:
>
> First, choosing enterprise companies to talk to on record is completely
> different than companies that are willing to talk off-the-record,
> which in itself is different from companies who are willing to give
> a sentence or two but no more. In my twenty years in integration
> design and consulting, I've done work for multiple enterprise clients
> who won't allow a press release or use of their logo on a client
> sheet, but it doesn't negate the fact that I've done work for them
> (and that they'll provide private references when asked). Part of
> the equation has to do with the PR/marketing department finding companies
> willing to speak on the record and get approval in a limited timeframe,
> so I would equate it to the analogy of figuring out which cars are
> selling best by standing on the sidewalk and sampling the first ten
> cars that go by . . .
>
> Second, you'll may have also seen that one of the three MediaSite-centric
> enterprises uses the product within a particular division of the
> company, adding that other solutions are used in other divisions.
> That's a key point that I did not stress in the article, but I often
> find a large enterprise using several solutions, including competing
> and/or homegrown solutions, across the various divisions or business
> units.
>
> Third, and I touched on this briefly in the article, the solutions
> that are in place today in some of these enterprise customers have,
> for the most part, been in place for five-eight years. They work,
> they don't break and they could probably keep working for the next
> decade. There are impending inflection points that will re-open the
> market to further re-assessment of total solutions, which may benefit
> Sonic, Accordent and others.
>
> To use one example, the fact Windows Media encoding / decoding solutions
> form the core of the early solutions has been a non-issue until Microsoft's
> recent more toward Silverlight. The ability of Silverlight (or of
> Flash, for that matter) to yield a more flexible player / multi-pane
> viewing solution versus the relatively static options available a
> few years ago may be compelling enough to force enterprise managers
> to relook more than just the format that they've used in the past.
>
>
> Hope that's helpful clarification to my article, without disparaging
> any vendor or end-user company that was part of the interview process
> and subsequent write-up. Thanks again for the plug for the article.
>
>
> Tim

2009 Dec 02 11:06 PM

[Jeffrey Walkenhorst]

Hi Justin, share count was reduced by factor of 10, so trading volume is now reduced by factor of 10. Thus, the stock is now less liquid than previously. Buying/selling shares with limit orders (rather than market orders) makes most sense, especially in this case.
Jeff


On Dec 01 12:40 PM Jhbeck wrote:

> Jeffrey,
>
> Quick question for you....Is there any particular reason why SOFOD's
> volume is so low? I have not been following this stock very long
> and am new to the market so I assume it would have been much higher
> before the reverse split. Thanks,
>
> Justin

2009 Dec 02 11:11 PM

[Jeffrey Walkenhorst]

bouncingcat:

"SOFOD, OBAS, VCST.OB, RNWK, and some now deceased companies continually make me question the sector."

Fair point -- we should absolutely question the sector as "makers" of technology often underperform "users" of technology. The critical factor is to distinguish between companies offering true "platform" technologies and those where obsolescence is a real risk. In my view, platform technologies are comprehensive, "living" (i.e. evolving over time to match customer needs) solutions that efficiently address a clearly defined market need and can scale into a large global market. I believe Mediasite is in this category. The outlook provided Monday suggests the company may finally be at the "tipping point".

On Nov 28 06:14 PM bouncingcat wrote:

> Certainly SOFOD has opportunity to become a very good investment
> as economic conditions should demand that government and corporate
> sectors finally leverage distance based learning and communications
> to what most in that industry would have assumed should have been
> done already. Monday's financials should be very interesting however
> SOFOD (and all others in this space) have a history of little correlation
> between forecasts and actual results. This is troublesome for investing
> as just when you think a company has broken out it often turns out
> to be the case that a few big contracts don't tell the future as
> much as hoped. Again, I'm not claiming SOFOD won't buck this trend,
> just that I need to see a few Q's in a row before getting in it.
> Sure that will make me late to the game but SOFOD, OBAS, VCST.OB,
> RNWK, and some now deceased companies continually make me question
> the sector.
>
> SOFOD has all the potential to break out but as the stock symbol
> suggests it is best suited for those with disposable amount to bet
> on it.
>
> Your stuff is very well done though. I hope I didn't come across
> as too dismissive about the quality of the work. I also understand
> that Mediasite is more than a hardware platform but in my opinion
> the larger business will be won on the Content and Viewer management
> side. If any of the offerings in this space become sufficiently well
> done I assume some ERP vendor with strong skills on the HR side might
> become interested in acquisition.

2009 Dec 02 11:34 PM