DivX's Very Low Enterprise Value Should Interest Investors

| About: DivX, Inc. (DIVX)

We like DIVX, and it fits our model! Here is our review process, including support for why this is currently one of our top picks.

Step 1. Company with pristine balance sheet
Step 2. Extremely low enterprise value
Step 3. Operation or enterprise driving value to shareholders?
Step 4. Good business?
Step 5. Is the train wreck (and then, the fog from the wreck) clearing?

Company with Pristine Balance Sheets

DivX has roughly $143 million dollars in cash, or $4.38 per share, and no long term debt. DivX has a very strong balance sheet.

Extremely Low Enterprise Value

When you subtract the cash and debt out of the enterprise, DivX’s enterprise value, or the value of the ongoing operations of the company, is actually very small.

So if you buy the company for say about $5.25 dollars per share, or about $167 million dollars, then you remove the $4.38 of cash, or $143 million dollars, the remaining value of the company is only about $24 million dollars. For a very high margin licensing company that is trying to dominate high-quality digital video across any device, with a very nice established franchise, and a great ability to leverage off its large footprint and ecosystem, this appears to us to be extremely low.

Operation or Enterprise Driving Value to Shareholders?

DivX receives another yes. They had an outstanding quarter, as they lost 1 cent per share but they forecast profits of 1-3 cents and higher margins and revenues next quarter. With many people worried about the dollar, DivX gains most of its revenues, about 3/4 of their income, from outside of North America. So if the dollar declines it should be an added windfall for a US licensing company selling its intellectual properties abroad. This might be why DivX has a .74 beta, one of the lowest I could remember especially for a technology licensing company.

Good Business?

We believe this is a very good business with a chance for a monopolist standard setting returns. DivX today serves approximately 200 million devices throughout its total ecosystem. That allows for a large market for any upgrade and/or new service, knowing the world wants a seamless way to convert your favorite flick or video onto your desired device for the day. The value to leverage a new fee-based upgrade, or add on products and services to its already existing 200m installed base of clients, is quite attractive. Hopefully they can create new and innovative ways to monitor this over-sized footprint.

Train Wreck and Fog Clearing?

When finding companies around cash value, often there is what we call a Train Wreck. With DivX, I believe the biggest negative issue is as follows:

  • Will their technology become the true standard for engaging, creation, distribution and licensing of digital video technologies?

The roadblocks often seen to DivX’s success are:

  1. highly fractured industry
  2. a new wide open paradigm emerging
  3. not a proven profitable market for companies
  4. very large companies are trying to establish simulator or competitive standards
  5. top management is over compensated
  6. UMG lawsuit

I believe all these factors and more have been priced into this company’s current price, due to their small size and single products. Being seen as Swiss, they’re not seen as a threat to most companies, and industries often in hard times will let single companies establish a standard because uniting an industry on a single standard often can greatly enhance and grow the whole industry. With DivX’s large footprint, the new paradigm and the overall poor global economy, these factors could help DivX’s chances at becoming the de-facto standard, or (simply put) obtain a monopolist position with strong industry leverage.

DivX’s CEO, Kevin Hell, commented earlier, “I believe we are in a strong position to emerge as the de-facto standard for high-quality digital video across any device”. The value of DivX (which is just above cash) is priced as if it might not survive, but we believe that its large and increasing cash, forecast growth of profits, top line growth and focus to be the monopolist leader help DivX to be in a very strong position, being well placed to expand and profit plus possibly lead a revolution area of change.

DivX expect that its future success will depend upon their ability to successfully penetrate the existing markets of digital media technologies including:

Established Markets

  • DVD players
  • DVD recorders

New Markets

  • network connected DVD players
  • Blue Ray players
  • high definition DVD players
  • portable media players
  • digital still cameras
  • digital camcorders
  • mobile handsets
  • digital media software applications
  • digital TVs
  • home media centers
  • set-top boxes
  • video game consoles

To date, the DVD Markets have been the top revenue providers, but due to economic conditions, the DVD sales appear to have stalled, and this has been the reason for the DivX reduction of sales for year to date in 2009.

In the 3rd Quarter, 2009, DivX announced it had 16% of sales from the New Markets category, and DivX has forecasted that 24% of revenues will come from the New Markets in the next 4th Quarter, 2009. This large uptake is helping DivX to also forecast overall higher top line revenue growth, quarter to quarter. Since royalties and licensing revenues for DivX, and most companies along similar models, are posting a quarter in arrears, a very large amount of this current quarter should already be completed with profits and sales already booked. It appears this New Market has just started to prove a nice lift to sales, and the main reason for DivX's increased forecast. This also is a good time, since the often much larger Christmas quarter (again in arrears) will be forecasted at the end of this quarter. Christmas could provide a much bigger boost knowing the historical large increases in volume for both the New Market category and DVDs.

It’s my belief that the enterprise could achieve 4 times sales (given DivX’s industry average is 4.58), which is a valuation that could be low for a very high margin licensing firm. Four times revenues would put the enterprise value at around $8.12 a share, adding in the cash of $4.38 per share; this could have an upside of $12.50 per share and still be in parity with other technology firms. If DivX is able to gain a monopolist position and the corresponding advantages, this could put them in the 10 times revenues league.

Summary

DivX currently is in a position that we are trying to identify for our clients – a good business with operations showing many strong tangible signs of improvement, at a very low price, with the possibilities of great appreciation and/or possible buyouts, and hopefully limited downsize. Even if DivX isn’t able to achieve monopolistic appreciation in our best case scenario, DivX’s very low enterprise value alone could be the basis for a limited value increase.

Disclosure: Yes, and absolutely yes, I and related accounts own this company. We started buying around 5.07 per share. I just wish I could raise the money and buy the whole company. We like to invest in profitable business enterprises that have almost zero or, like in this case, a very small enterprise value. I’m sure other successful business persons would also like to do the same.