Evaluating TiVO: Why It's Worth $10 a Share

Dec.11.06 | About: TiVo Inc. (TIVO)
Financial analysis isn’t something I’m prepared to tackle publicly, so I’ve brought in some muscle for a multi-part series on TiVo’s (NASDAQ:TIVO) numbers. Obviously this is speculative in nature and just one stockholder’s interpretation of the limited information TiVo chooses to disclose. Your mileage may vary. -DZ

In Part 1 and Part 2 we focused on TiVo’s biggest business: their subscription recording service. But TiVo has other irons in the fire, and to get a value for the company, we need to consider those items, as well. But first, we’ll finalize our look at subscribers.

In Part 1, we found the NPV of TiVo’s current subscriber base [including a conservative estimate of the value of the DirecTiVo subscribers], but we have since discovered a flaw in our calculation of TiVo’s advertising revenue [that has also led us to some new insights – but we’ll get to those another day], which we have recomputed as an average $0.47 per month per subscriber for the past twelve months – less that we originally estimated. But we were also able to get a more accurate estimate of the cash flow of monthly and lifetime subscribers, and so we will use those numbers, too. These improvements have caused us to revise our estimate of the NPV of TiVo’s subscriber base to $407 million – somewhat higher than the $388 million we found before.

Lifetime Cash

Earlier, we hinted that there was a “hidden” value to the lifetime subscribers that we had not included. To understand this value, one needs to understand how TiVo accounts for lifetime subscriptions. When TiVo sold a lifetime subscription, they put an amount on the “cash” line of their balance sheet for the full amount of the subscription, and offset it with a “deferred revenue” liability of the same amount. The cash would then amortize over the expected lifetime of the subscription. TiVo picked 48 months as the lifetime of the subscription, so for a $299 lifetime subscription, that amounts to $6.23 per month. Then, each quarter, TiVo takes the appropriate amount of cash from the cash line and puts it on the revenue line of the income statement, where it then makes its way through the financials like normal revenue. But, to make the balance sheet balance, TiVo also removes an amount from the deferred revenue line equal to the amount of cash shifted to the income statement.

*Quarterly Lifetime Cash = $6.23 * [lifetime subs - fully-amortized lifetime subs] * 3 months

In other words, there is a certain amount of cash on the balance sheet that is spoken for, and as it is used for its intended purpose, an offsetting liability disappears. It may seem a bit complicated, but is a normal way to account for an upfront payment against which products or services are delivered at a later date.

So what does this mean for our valuation of TiVo’s subscribers? It means that when we did an NPV calculation for the lifetime subscribers that looked only at their net cash flow, we ignored that they represented a lot of liabilities on the balance sheet. Think about it this way: the NPV we found for these subs was about negative $40 million, but if you were to sell them for this amount [i.e., pay someone this amount to take them off your hands] the “deferred revenue” liability would disappear from the balance sheet, freeing up exactly the same amount of cash.

By going back through the last four years of subscription numbers [anything beyond that is now fully amortized and therefore will no longer be represented in the deferred revenue], we have found the amount of deferred revenue attributable to the lifetime subs is $82 million [of about $108 million in total deferred revenues]. This brings the value of TiVo’s subscribers to $489 million, or $5.31 per share.

Balance Sheet and Fourth Quarter Subscriptions

TiVo’s shareholder’s equity at the end of the third quarter was about $30 million, but TiVo announced plans to burn through $30+ million in 4Q [which is now more than a month underway], so we won’t count that. But in burning through that money, the company will acquire about 200,000 new subscribers, and retire about 49,000 old ones through churn. Since the SAC is included in the quarter’s net loss, we will only consider the cash flow of the subs:

* NPV4Q SUBS = 200,000 * $545 – 49,000 * $216 = $98 million

[We must admit, part of our motivation for doing this calculation was to demonstrate the incredible value-building power of the new subscription system. Even if we have overestimated the NPV of the subscribers, the new model is so much better than the old that it is hard to understand why no one has noticed it.] Adding this number to the previous one, we get a sub value at the end of this quarter of $587 million, or $6.38 per share. We note that this number is now in excess of the stock’s closing price on 12/7/2006. Remember, our number represents only the projected NPV of the sub base and does not factor any of the other value that Tivo has. This means the market is completely ignoring Tivo’s considerable ability to grow the value of its subscriber base and assigns no value to any other asset.

What other value does TiVo offer? There are several significant items:

Comcast (CSMCA)/Cox

TiVo and Comcast are a month or so away from the public rollout of their digital video recorder [DVR] offering, dubbed the “TiVo Experience” in the contract. Built upon the Motorola (MOT) DVR hardware, the Comcast/TiVo service is a premium offering that Comcast will market to draw subscribers from DirecTV (DTV) [who no longer has a TiVo offering] and Echostar (NASDAQ:DISH), as well as to motivate DVR and digital upgrades from their own customers. Cox has signed a similar contract with TiVo, with an expected product rollout in mid-CY2007. Comcast, the nation’s largest cable operator, boasts over 24 million subscribers, with over 12 million of those taking digital services. Of those, approximately 4 million take “advanced” services [defined as high-definition television [HDTV] and/or DVR service]. Digital subs and subscribers taking advanced services are growing steadily. Cox is privately held, so they do not release financial or operational data. But the company has 5.4 million subscribers, and one can expect similar averages of digital and advanced subscribers.

Most analysts put TiVo’s share of the revenue for the subscribers opting for the Comcast/TiVo option at about $1/month. While we think the number is probably somewhat larger than this, we will use it to be conservative. Similarly, we will make a fairly weak assumption that the Comcast/Cox-TiVo sub base grows to one million over the next two years, and then stays there for five more years, then disappears completely. This gives us an NPV of $46 million for these relationships.

In addition to subscribers who upgrade to the “TiVo Experience” DVR software, TiVo is developing an advertising software platform for essentially all of Comcast’s and Cox’s DVRs, whether the consumer elects the TiVo Experience or not. TiVo will be allowed to sell national advertising on these DVRs, greatly increasing their inventory, and providing the potential for ad growth across the entire subscriber base. If we assume this platform goes live in June, 2007, onto 1.5 million Comcast boxes, growing to 4 million over then next two years, then remains flat for the next five years, and we assume only an average of $0.20 per sub per month, we get an NPV of $36 million.

This give us an NPV of these deals of about $82 million. We note here the possibility of additional MSOs signing on with TiVo, but we do not assign a value to such possibility [as will be our practice when a business opportunity is merely speculative]. We also believe that our take-up rates, cumulative subscribers, life-of-contract, and ARPU estimates for these deals are extremely conservative.

Echostar Litigation

We will not rehash the entire litigation process with Echostar. TiVo has been awarded $89.7 million dollars in damages and interest, and an injunction that orders all of Echostar’s infringing DVRs [over 4 million at last count] have their ability to record television disabled. Echostar has appealed the decision, and the injunction has been stayed pending the appeal. Echostar, in their most recent 10-Q said:

If the verdict is upheld on appeal, we would be required to pay additional amounts from August 1, 2006 until such time, if ever, as we successfully implement alternative technology. Those amounts would be approximately $5.7 million, $5.9 million and $6.0 million for August, September and October 2006, respectively, and would increase each month as the number of our DVR customers increases and as interest compounds.

There are numerous possible outcomes to the case. TiVo could lose the appeal, have the case go back to the Texas Circuit court under such restrictions that they could not win, and the case is dismissed with TiVo getting nothing. On the flip side, TiVo has also appealed, seeking triple damages among other things. TiVo could win the appeal, the case could go back to Texas under such restrictions that TiVo is awarded triple damages and the injunction. In this event, the value of the case to TiVo could exceed $750 million dollars [an amount on par with the total paid-in capital over the company’s entire history]. In between these extremes are much more probable outcomes, including a settlement that gives TiVo the damages it has won plus a monthly licensing fee, or a court ruling that awards TiVo its damages, but strikes down the injunction in favor of ongoing damages payments. We find the NPV of these types of arrangements to be around $300 million. Using a Bayesian approach to the various outcomes and their probabilities of occurrence, we find the value of this lawsuit at about $275 million.

TiVo has filed no additional suits to date, however the patent in question is currently under review by the United States Patent and Trademark Office [USPTO]. Should the patent be validated, one could expect to see additional lawsuits filed. Cisco’s (NASDAQ:CSCO) Scientific Atlanta [makers of DVR hardware for cable companies] and Time-Warner Cable seem likely next targets.

Tax Assets

At the end of FY06, TiVo had accumulated tax assets worth approximately $260 million. These assets have accrued from TiVo’s accumulated losses over its years of operations. Were TiVo to become profitable, these assets could be used to offset a like amount in taxes, greatly improving TiVo’s profitability and cash flow. In the event of a “change of control” there are restrictions on how these assets could be used, so their value to an acquiring party is unknown. Because there is no guarantee that TiVo will ever become profitable or profitable enough to use all of these assets, TiVo assigns a 100% valuation allowance to them, essentially giving them a value of $0. We will do the same, and simply note that the value is there if it can be extracted. NPV = $0.

Other Assets

There are a number of other assets for which it is hard to obtain a value:

* TiVo has launched an audience metrics business. Through their subscribers DVRs, TiVo can determine which advertisements are being watched, which are skipped, what catches a viewer’s eye, etc., all on a second-by-second basis. It is unclear how much revenue this business can generate, but in the face of $60 billion in annual TV ad spending, even small improvements in customer responsiveness are worth tens or hundreds of millions of dollars to advertisers.

* TiVo owns a 49% stake [and the option to purchase controlling interest] in TiVo Greater China [TGC]. TGC markets DVR services in Taiwan and intends to expand into other Asian markets. TGC also supplies low-cost engineering services to TiVo. The value of this company is unknown, but could be significant if its distribution is successful.

* Aside from the Barton “Time Warp” patent, TiVo owns a considerable IP portfolio of over 80 patents. These patents may represent considerable potential licensing revenue.

* TiVo’s brand name is one of the most widely-known and most favorably viewed in the industry. The value of such a brand in marketing efforts [such as will soon be made by Comcast and Cox] is significant, and could also be significant to organizations looking to penetrate the home media space with other products and services.

* TiVo has begun rolling out interactive features to subscribers of broadband-connected DVRs. These features include content download, games, news and information sources and podcasts. If TiVo is able to monetize any of these features [consider things like ordering a pizza, renting a movie, purchasing a product, etc.], the value of their subscribers could increase dramatically.

We assign a value of $0 to these items simply because they are hard to value. But together they represent a not-insignificant group of assets to which even the most cynical analyst should assign some value.

The Bottom Line

We have found the following:

Tivo Assets

[Per share calculation assumes 92 million outstanding shares.]

This is my conservative estimate of where TiVo stands today, and disregards the value of TiVo’s growth prospects and the value of many as-yet unrealized assets.

Disclosure: Author is long TIVO