Brightcove (BCOV) is a leading provider of cloud-based solutions for publishing and distributing digital video to internet-connected devices. The company was founded in 2004. It is based in Boston and operates globally, with offices in London, Tokyo, Paris, Barcelona, Singapore, Sydney, Seoul and most recently, Dubai. Jeremy Allaire, Chairman of the Board and a co-founder of the company, served as CEO until April 2013, when he handed the reigns over to David Mendels. Mr. Mendels had joined BCOV in 2010 as President and COO, after serving in executive positions at Macromedia and Adobe. Mr. Allaire was a principal at General Catalyst Partners (GCP), which along with Accel Partners, were the two main early stage investors in the company. Both GCP and Accel have since sold their stakes. However, David Orfao, a Managing Director and co-founder of GCP, still sits on Brightcove's board.
Brightcove's main product is Video Cloud, a service that allows customers to upload, encode, distribute and manage video content through a cloud-based application. Video Cloud improves video quality and minimizes file size. It provides customizable, full featured video players that support a wide array of operating systems, digital formats and devices. It also offers content management services that help users to analyze and monetize their video traffic. The finished product is usually distributed to users via content delivery networks, like Akamai and Limelight Networks.
Video Cloud also offers live streaming services. It employs a multi-tenant architecture that enables it to serve all of its customers from a single software framework (with versions targeted to certain customer segments). This facilitates scaling the application as demand for the service grows.
In August 2012, Brightcove acquired privately-held Zencoder, Inc. for $27.4 million in cash. Zencoder makes a highly-regarded cloud-based encoder (known as the Zencoder service) which prepares video content for distribution to a full array of viewing devices. At the time of acquisition, the Zencoder service had 1,000 paying customers, including PBS, Scripps Networks Interactive, IGN Entertainment and SmugMug. Zencoder is a scalable and secure platform with tools that allow customers to edit and manipulate a wide variety of video formats and generate very high quality video output. Zencoder has also developed an open source HTML5 video player, called HTML5.js, which is used by many websites, including Airbnb.com.
At the time of acquisition, Zencoder, was losing money. Brightcove allowed Zencoder to continue as a standalone service, but it also planned to use Zencoder to enhance Video Cloud's capabilities. The company recently announced a new version of Video Cloud, called Video Cloud Live, which uses Zencoder to process live video content.
On January 31, Brightcove completed the acquisition of substantially all of the assets of Unicorn Media for consideration totaling $49 million, including 2.85 million shares of BCOV valued at $14 per share plus $9 million in cash to cover transaction and other costs. Unicorn has developed a cloud-based service called Once, which allows content providers to dynamically insert both customized programming and targeted advertising into on-demand and live video streams. Unicorn has been awarded 14 patents and has 20 patent applications pending for the technologies that underpin Once and related products. ESPN, NBC News and the Weather Channel subscribe to the service. Following the acquisition, Once is now known as Brightcove Once.
Brightcove intends to integrate Once into its other service offerings. For example, it recently launched a targeted ad service for Google's Chromecast. Five executives of Unicorn have assumed key positions at Brightcove, including the heads of media marketing and technology. Brightcove is discontinuing most of its low-end Video Cloud Express offerings to concentrate on marketing to large media organizations in order to maximize the opportunity that it sees with the addition of Brightcove Once.
When it announced the Unicorn Media acquisition on January 6, Brightcove reaffirmed its fourth quarter outlook and provide preliminary guidance for 2014. The company said that it expected 2014 revenues of $126-$130 million and a non-GAAP loss from operations of $9-$12 million. That loss included a loss attributable to Unicorn of $11-$12 million.
The stock plunged 20% on the day of the announcement, closing at $11.59. It has since fallen another 19% and now stands at $9.37. Investors were disappointed for a number of reasons, as articulated in a Seeking Alpha article by Dan Rayburn on January 7. Besides the added dilution of the shares issued to Unicorn's owners - equal to an estimated 9% stake in BCOV - some investors have raised concerns about whether Unicorn can deliver. Mr. Rayburn pointed out that in the six years since its founding in 2007, Unicorn had only ramped up to $5 million in revenues. (On a conference call, Brightcove's management said that Unicorn did not pursue the opportunity to develop Once until recently.) Even so, Brightcove anticipates that Unicorn's revenues will rise 60%-80% to $8-$9 million in 2014.
The expected 2014 operating loss for Brightcove also did not sit well with investors. Management had asserted previously that Brightcove would be profitable in 2014. Now, it anticipates that Brightcove will not become profitable until the 2015 first quarter.
On top of this, the company's revenue growth is slowing. Total revenues increased by 45% in 2011, 38% in 2012, 25% in 2013 and management's guidance translates into expected 2014 growth of 15%-19% (or 6%-11%, excluding the Unicorn acquisition). Management said that the company faced some revenue headwinds in the 2014 first half, due to an expected decline in customer overage revenues and higher than anticipated professional services revenue in the last half of 2013. But it also indicated problems in sustaining demand in its 2013 third quarter 10-Q and slower industry growth than it originally anticipated. Given that online video still accounts for a small proportion of the total video market, we believe that this recent slowdown is temporary and that demand will pick-up over time, especially as new services like Brightcove Once are rolled out.
Except for the revenue headwinds, it does appear that management is achieving its prior guidance of core business profitability in 2014. Excluding the $11-$12 million non-GAAP loss from operations for Unicorn in 2014, management expects to deliver non-GAAP operating profit of $0-$3 million from the rest of its business. That may be only a negligible improvement over 2013, but it does look like management has set a low bar for 2014 and this is reflected in consensus estimates. Excluding Unicorn, guidance for the base business is below historical improvement trends.
Historical and Projected Financial Performance: 2010-2016
Our projections, given in the table above, provide a framework for the level of performance that we think will be necessary for BCOV's stock price to recover the ground that it has lost. Our projections for 2014 are consistent with management's published guidance of $126-$130 million in revenues, a non-GAAP operating loss of $9-$12 million and expected shares outstanding of 32.1 million. Assuming that consensus estimates are based upon non-GAAP EPS, they are also in line with consensus estimates.
Despite the first half revenue headwinds, Brightcove's 2014 guidance appears to be conservative. Excluding the negative initial impact of the Unicorn acquisition ($9 million in revenue and a non-GAAP operating loss of $11-$12 million), the guidance assumes net revenue growth of only 6%-11% for the full year and a slight improvement in profitability. Although revenue growth is slowing, the company has been making steady progress over the past few years in improving its operating efficiency.
If the company fails to beat guidance in 2014, we believe that it must show tangible progress in non-financial measures, such as signing up new customers, to provide support for improved financial performance in 2015. Otherwise, its stock price will remain vulnerable and the company may be faced with the prospect of having to make drastic expense cuts to attain profitability on a more modest revenue base.
Beyond 2014, our projection framework assumes a moderate pickup in revenue growth, to just below 20% in 2015 and 2016. Under our assumptions, higher gross margins and lower operating expenses would lead the way to non-GAAP earnings of $0.07 in 2015 and $0.48 in 2016. Our framework even shows Brightcove posting GAAP earnings of $0.14 per share in 2016.
This is would be an impressive achievement, but it reflects expense ratio targets that are less aggressive that those suggested by CFO Chris Menard in a recent investor presentation. There, he hinted at fairly aggressive long-term targets for certain key income statement line items, including r&d expense at 13% of revenues, sales and marketing costs in the mid-30s (contingent upon an acceleration in sales growth) and general and administrative costs at 11%-12% of revenues, all of which are well below current levels. Mr. Menard would also like to see gross margins well into the 70s, but acknowledges the significant challenges in getting there. If the company were to achieve Mr. Menard's targets on a sustainable basis, its common stock would trade at a multiple of the current price.
Valuation is always a challenge with early stage companies like Brightcove, especially in software. We think that BCOV fits the financial profile of a couple of software companies that we have looked at briefly: Salesforce.com (CRM) and Red Hat (RHT). Both of these companies are considered to have good growth rates and their stocks trade at very high forward P/E multiples. By our calculations, Salesforce trades at 125 times next year's consensus earnings, Red Hat at 36 times. Both are well above the broader market's forward P/E multiple and have been for quite some time.
In Brightcove's case, a near-term (i.e. 6-12 month) price target of $12 would equate to a forward P/E multiple of 170 times our 2015 non-GAAP estimate of $0.07 per share and 25 times our 2016 of $0.49 per share, as given in our earnings framework in Table 1 above. Under those performance objectives, a medium-term (12-24 month) target price of $15 is reasonable. This $15 2015 price target equates to a multiple of 31 times projected 2015 earnings. From the current price of $9.37, those two price targets would produce investment returns of 28% in 12 months and an additional 25% in 24 months for a two-year compounded annual return of 26.5%.
If Brightcove is to achieve our performance targets, it must handle the industry's competitive challenges successfully. Clearly, Brightcove faces tough competition. On the one hand, some big video users operate as do-it-yourselfers, processing and managing their video streams in-house. This reduces the potential size of the market. Convincing some of them to shift to the Brightcove platform would be a big plus. On the other hand, Brightcove must contend with a plethora of start-up companies all vying for that big brass ring.
As Mr. Rayburn pointed out in his SA article, Brightcove's competitors include Ooyala, mDialog, Yospace, Jivox, Blackarrow, Vubiquity and more than a few others. These are not shabby outfits. Blackarrow's backers include Comcast, Time Warner Cable, Cisco, Motorola Mobility and Intel. Vubiquity is backed by the Carlyle Group and four other venture capital firms. Many of them already claim to have the capability to do dynamic ad inserts, but it is unclear whether their services are as robust as Once and therefore ready for rollout.
Unlike some, we are not as troubled by the big price tags paid for Zencoder and Unicorn. It is obvious that the ability to do custom ad inserts in high quality live streaming video (or audio) for the broad universe of devices is the Holy Grail. We understand (from Brightcove management's presentations) that this is not an easy thing to do, especially in live video, where commercial breaks often occur randomly and at varying lengths. Logically, we think that it will not be easy for more than a few competitors to develop the same full-featured capabilities. If we are right, the patents should be valuable. If not, the services offered by Brightcove and its competitors will quickly become commoditized. First movers should have a big advantage. Brightcove's purchases of Zencoder and Unicorn are intended to keep the company at the front of the pack.
Because we are generalists with limited industry knowledge, it is difficult for us to assess accurately Brightcove's market position. We are not alone. But we have made a few observations that give us some confidence: First, Brightcove is one of the few pure-play publicly-traded companies in this business. Its IPO gave it a cash stockpile and strengthened its financial position, enhancing its competitive position. Brightcove also has an impressive list of clients, including broadcasters, newspaper and magazine publishers, music publishers, major retailers and other businesses. Its customer list is bigger than any of the other competitors that we have seen. It is significant, we think, that one of the industry's rag sheets, streamingmedia.com, uses Brightcove to manage its video content. This helps to confirm the quality and strong market position of Brightcove's Video Cloud. In 2012, ABI Research named Brightcove the leading online video platform, ahead of Akamai and Ooyala.
Still, there are signs that Brightcove's competitive position has been slipping. It is worrisome that Brightcove was not able to develop in-house offerings comparable in quality to Zencoder and Once, despite spending over $67 million on research & development over the past four years. The failure of Brightcove App Cloud, which was released in May 2011 and discontinued less than two years later, raises more questions about the effectiveness of its internal strategic planning, marketing and r&d efforts. To its credit, the company was able to spot both the deficiencies in its own offerings and the opportunities in the Zencoder and Once products, use its cash surplus to fill in its product line and add talent in key positions from these acquired companies; but this has come at a significant cost to shareholders.
The endgame for Brightcove and its competitors remains in question. Unless Brightcove is able to build a strong, defensible and profitable position in online video platforms, it will probably have to broaden its product and service offerings over time, if it is to remain independent. It is also possible that Brightcove will eventually be acquired. Potential acquirers might include Verizon, Comcast, Adobe, Yahoo, AOL, Microsoft and other companies who see the online video platform as a way to enhance their core product offerings, such as internet traffic, web services or advertising networks.
The stock is now below its February 2012 IPO price of $11 per share. From a technical perspective, it looks like it may be forming a base, after the big January sell-off, around the current level of $9.37. The stock has been able to hold this level recently, despite a modest amount of insider selling. The decline from the recent peak of $16.25 is within Fibonacci retracement parameters for the rally off of the stock's all-time low of $4.89 set in April 2013. This could turn out to be a successful retest of that low. If the stock stabilizes near current levels and eventually reclaims its 50-day (10-week) and 200-day (40-week) moving averages, it should begin to gain some momentum.
The charts do not provide a compelling case for a long position in BCOV at this time, but we think that it would still be prudent for investors who agree with our thesis to initiate a small position in BCOV and scale into a full position over time as opportunities arise or when its performance prospects become clearer.
With its forward guidance, Brightcove has bought some time - six months or so - to get its house in order. It has set expectations for an eventual return to modest growth. Sustainable profitability should follow soon thereafter. Once it gets its house in order and assuming that the economy remains in recovery mode, this should turn out to be a reasonably good investment.