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Summary

  • 12% fall on April 8th has created a buying opportunity.
  • Loss of patent lawsuit is less meaningful than the six new licensing deals and renewals announced in January.
  • A reasonable valuation framework shows that the intrinsic value is close to $30 (46% upside).

Based in Santa Clara, CA, Rovi (NASDAQ:ROVI) licenses its patents and technology to TV manufacturers and cable/ satellite operators. It was founded in 1983 as Macrovision and later changed its name to Rovi (macROVIsion) in 2009. Its origins are in video copy protection and rights management. Through a series of acquisitions, notably of Gemstar-TV Guide in 2008 and Sonic Solutions in 2011, ROVI transitioned from a legacy content protection business to a digital media solutions provider: ROVI's portfolio now consists of an array of digital media content solutions - a set of technologies that can be embedded within its customers products and services as a means of adding value.

It has 5,000+ issued (2K) & pending (3K) patents worldwide related to the digital media ecosystem and it has 1,500 employees.

Vast majority of licensing agreements are concluded without the need for litigation however, litigation is a normal part of Rovi's licensing business.

The company gets 73% of its revenues from service providers (AT&T, Charter, Comcast, Cox, DishTV, TimeWarner etc) and 25% from consumer electronics manufacturers (Apple, Samsung, Sony, LG etc).

Amazon (AMZN) litigation news on April 8th and overreaction by the stock market

Yesterday the company announced that the United States Court of Appeals for the Federal Circuit has issued its decision in Rovi's patent infringement litigation against Amazon Inc. Rovi had sued Amazon in United States District Court for the District of Delaware in 2011 for infringing the two patents at issue in today's decision. The appeals court sided with Amazon and found that the District Court's interpretation of the claims of the patents was correct and therefore Amazon did not infringe these patents.

The stock fell 12% on this news and is now down 17% over the lat few days. The stock is trading at a price-earnings ratio of 11.9 and 10.9 based on current year and next year estimates, respectively. As detailed in the valuation section below, the intrinsic value of the stock is close to $30 (46% upside).

The stock market reaction to the news is excessive since

  • Earnings estimates did not incorporate any revenues from potential licensing in connection with the Amazon litigation
  • This decision relates to only two patents in its extensive portfolio and since its patent portfolio is even more relevant to Amazon today and going-forward than when the present litigation began in early 2011
  • As illustrated by various recent agreements, Rovi's patent portfolio continues to be recognized by leading companies looking to deliver compelling video experiences across multiple screens. So far this year, the company has announced new licensing deals or renewal of licensing deals with Google, Samsung, LG, Sharp, MStar, America Movil, Pegasis and Sony
  • Underlying business is doing well and earnings estimates will not be affected by the Amazon lawsuit ruling. In February, it announced better than expected earnings - stock up 5.11% in reaction to the earnings release.

Since the stock market reaction yesterday, multiple sell side analysts (JP Morgan, Piper Jaffray, B.Riley have said that this is a buying opportunity.

Valuation

DCF - $29.9

Assumptions:

  • Revenue growth of 7% per annum. This is towards the low end of the 5%-15% company guidance (Jan 2014 presentation)
  • Margin improve from 40% to 44% over six years. Incremental margins on additional licenses have low marginal cost. The company has guided to 44% -47% margins
  • Terminal price earnings ratio of 15
  • 12% discount rate. This accounts for the risk of longer than expected licensing negotiations and litigation risk
  • Using the $1.5 billion federal tax loss carry forwards.

Other positives (not in the DCF above)

  • Several large multi-year US service provider licensing renewals (2015-2016) related to its Gemstar acquisition. Two of these are currently not flowing through its income statement. The license fee was paid as a lump sum upfront and the deferred revenue was written off at the time of the acquisition
  • History of share buybacks. Planning to repurchase a minimum of 5 million shares (5% of outstanding) in FY14. The company recently sold its DivX and MainConcept business and will receive up to $75 million (approximately 76 cents per share)
  • No concerns with leverage ratio or debt repayment schedules due to significant free cash flow. Largest debt maturity is in 2019

Conclusion

Overreaction to the Amazon litigation news has created a buying opportunity since the loss of the patent lawsuit is less meaningful than the six new licensing deals and renewals announced in January. A reasonable valuation framework shows that the intrinsic value is close to $30 (46% upside).

Source: Rovi: Overreaction Has Created An Opportunity - 46% Upside

Additional disclosure: KL Investment Partners may change or exit my position without updating this article and without informing the Seeking Alpha community