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Digital Domain Media Group (DDMG) holds meaningful intellectual property for 2D-3D conversion. Meaningful enough that Samsung called them to protect itself against infringement liability.

We ourselves were contacted by Samsung over the summer, and we hadn't written a letter to them or threatened them, we didn't even know them, and they paid us $3.5 million to not sue them when we had never called them.

(quote from Q4 earnings, transcript available here)

But unlike some, Digital Domain is not using its IP to sue the leaders in their industry -- instead, they're partnering with leaders from several industries, and leading their own industry, which is digital visual effects. What "visuals" means for DDMG is the task of translating ideas into data, and data into images. Images can be manipulated as images, video, 3D imagery, or interactive media like games or robots.

The technical terms to describe this are "digital visual effects" (VFX) and computer-generated (CG) animation. I like to think of them as imaging engineers, analogous to software engineers, who not only create products, but develop the best practices for advancing the profession. The business model analogy to describe this company is: quants moving out of the back offices at hedge funds and starting up their own firms. Many saw the role of quants as purely technical, but quants knew better: they were creating value worthy of a creator's premium. DDMG is a pioneer in recognizing this in terms of visual modeling and effects.

The stock shot up yesterday, as Wall Street learned that DDMG helped bring Tupac back from the grave. This happened at a popular music/art festival called Coachella. It is a big deal. Musical/cultural thought leader Questlove had this to say:

(click to enlarge)

The stock was also resurrected.

(click to enlarge)

I predicted this a couple weeks ago:

[...]we see a digital domain overlapping with physical. That's bullish for DDMG, whose private-placement investors paid more for shares prior to IPO in a bearish 2011 season than the current price.

If you didn't buy yet, don't flinch. The stock has retraced. And sub $21, there's still more than considerable immediate potential upside. Here's what you need to know:

  • They're the best at what they do: Visuals in Titanic, Avatar, and 2013 hit "Ender's Game" which will be their first ownership project. (My editor asks "how can something due in 2013 be called a hit?" I, Modernist, am "calling" it.)
  • They've very recently transitioned from a flat work-for-hire model into a diversified pipeline of ownership ventures; this was the earnings hiccup which is allowing the current discount.
  • A comparable but inferior company (The Mill) was bought out for 190MM, implying a margin of safety.
  • They've got their hands in military simulations, surgical simulations, for-profit education domestically and abroad, movies, television, advertising, video games, holograms, and who knows what else.

If you read through my prior articles, you'll see that I very rarely make an explicit prediction along the lines of a stock moving from $200MM to $1BB in a year. But for DDMG I made an exception several weeks ago. This is the kind of stock that will freak you out. In a good way.

I suggest to investors that they do not wait for a pullback in the stock because there is substantial upside and negligible downside. There could be a pullback, but now is the time to be greedy, not fearful. Investors should realize the market is unpredictable and may take some months to appreciate this stock. However, events such as the Tupac hologram will continue to illustrate to the unimaginative market what my readers already can see. Don't procrastinate; don't chase alpha.

The stock itself is suffering from a lack of coverage. Stocks at this level are too small for institutional investors to participate in and are thus neglected by financial media, because financial media is built around institutional investment. Also, this stock is volatile, so hedge fund managers with one-year watermarks are presented an additional barrier to entry beyond instrument size.

Frankly I think the stock does not have sufficient data to incorporate a fundamental analysis of the trading of shares themselves, and should instead be valued as a venture capitalist would value a maturing startup. Instagram, admittedly a social network but based on visual technology, sold to Facebook for $1BB. I am quite comfortable imagining that in the years ahead Digital Domain will generate a diverse stream of high-margin revenues from its leveraged status as an industry leader, so I am not shy in saying the current market cap should be $1BB. Each of these 4 businesses alone is worth 250MM: movies/TV/advertising, education/software, holograms/simulations, intellectual property.

This is a leading media stock that should have a Facebook (NASDAQ:FB) type of premium but instead has an old-media multiple. They've got their heads down generating value and they don't have time to cater to Wall Street accountants. See past the stock and look at the company. They have been involved in the most profitable visual media projects of all time, and have only recently decided to command ownership stakes. It really is a startup.

You can wait for the stock market's optimism to catch up with the company's strategic position, and do the fundamental analysis then, or you can buy now and profit from it.

If you like, you can print out the stock chart and draw some lines through it and imagine a predictable upswing. I prefer to connect the dots of the future, not of a chart.

Or maybe you can read the other financial media's opinion about this stock. You know, the other guys who predicted the hologram. Let me know when you find them.

One of my media colleagues at Seeking Alpha who also likes to look forward instead of backward is Chris Katje, who provides further details on DDMG general operations here with his price target of $14. Mine is closer to $20 and both are on a scale of one year.

Source: You Need To Know About Digital Domain