Is DivX Just a Troubled Kid?

Did everyone see yesterday’s announcement from DivX (DIVX)? TVs that are DivX Certified, from HP and LG. Yawn. DivX has had an HP TV certified for some time, and the rest of this was distressingly devoid of details. (Nice to see the SKU count up, though.)

Particularly curious was the mention of internet video streaming capability on some models, but the wording suggests DivX isn’t involved in this part. If any of these SKUs incorporated DivX Connected technology I’m sure it would have been announced.

All in all quite a fluffy release, without much new in it. I wouldn’t have thought DivX was one to use puff pieces prior to earnings. But then…

Parents are always on the lookout for those telltale danger signs in their kids: falling grades, withdrawal from family involvement, strange friends, mood swings, glassy eyes, smoky odors clinging to clothes, etc.

I wonder. Is DivX a troubled kid?

First, there was the Stage6 imbroglio, with Jordan Greenhall and most of the founding team leaving for parts unknown. Stage6 was neither retained as an (expensive) venture investment nor spun off to others, but simply value destroyed - complete with swirling rumors of hot tempers and incompetence.

Then the departure of SVP Sales & Marketing Pamela Johnston early this month. These things are rarely explained adequately, or truthfully. Might be poor performance, might be strategic disagreement. But it could have been “time to get the hell out of Dodge”.

Third, sagging guidance for 2008, leading to a reduction in analyst estimates on the stock. The 2008 mean estimate has fallen 8% to $0.47, while the 2009 estimate dropped 15% to $0.55. The stock price followed. Everyone had been holding their collective breath for the end of the Stage6 drag on costs, but the MainConcept deal has brought unanticipated expenses and 2008 is now being billed as “an investment year”. I thought 2007 was the investment year.

Finally, I have heard rumblings lately about layoffs at DivX. If true, this could really hit the stock where it hurts, although any associated cost is almost certainly already in management–if not analyst–estimates.

DivX is cheap. It’s trading at about 15 times forward earnings, and has an enterprise value on the order of only $100M. This is simply nuts for a company with high gross margins and rapidly growing license revenue. It generated $13.3M in free cash flow last year, and that was when it was burdened to the tune of about $20M by Stage6. But some of the points above help explain why this thing has been so badly ostracized by the investment community, which is understandably nervous after a long roller coaster ride.

I like DivX. I use their tech and it’s excellent, especially DivX Connected. Their user base is rabid and involved. I like the management team. They’ve made impressive announcements recently about licensing and content deals which should prove lucrative. The DivX format will soon incorporate perhaps the best H.264 codec.

But like a good kid going through a rough patch, their potential always seems to be receding into the future. And like most teens, DivX can rightly complain that “nobody understands me.”

On the other hand, maybe it’s just puberty.

Disclosure: I hold no position in any of the stocks mentioned here.

Comments

[robert99]

Nice article; I think you're spot on with your analysis.

[jackson09]

I believe netflix ,apple or Microsoft will buy Divx before the end of the year or early 09. The one who does will be in a great position for streaming cost and licencing to the other two. Mainconcepts just released a new plugin for adobe and will cut bandwidth and boost quality. There may be more going here with the stock than meets the eye.

[Scott Berry]

I'm on record as suggesting Dolby is a perfect match as a buyer. But Microsoft is a definite possibility. As to the stock, if they don't disappoint over the next few quarters it should do quite nicely. I doubt they'd accept a bid anywhere near the current price.

[jackson09]

Also I believe stage6 is returning on the 29th if this is true,it was the plan all along:)
www.divxit.net/

[jackson09]

Update: They just changed it to Vreel ,opening may 6.
vreel.net/

[Tom B]

Apple gives away MPEG-4 (H.264) for free as part of Quicktime ( as small license fee for AUTHORING). H.264 is widely supported in devices, including every PC with Quicktime; every Mac, AppleTV, and newer CE devices. H.264 is every bit as good as DiVx. I don't understand how DiVX (the company) can even claim to have a business model, going forward. Geez. Remember Real Players? Can you say "scrap heap of history"?

[Scott Berry]

I just commented on Vreel this morning: scottjberry.com/2008/0.../

[Scott Berry]

Tom B: no time to explain DivX bus model to you, but a few points:

1. H.264 will be in DivX soon, their H.264 implementation is already in Flash.
2. Betamax was better than VHS, so what. More DivX users worldwide than Mac users. How many non-Apple CE devices play back quicktime files? DivX aiming to be the .mp3 of video.
3. To understand their bus model go look at Dolby Labs (DLB).

[Tom B]

"1. H.264 will be in DivX soon, their H.264 implementation is already in Flash. "

H.264 and DivX are "codecs"-- basically file formats-- in this case both based on the MP4 "spec". Quicktime and Flash are "containers" for Codecs-- sort of like you can save an MS-Word doc to WordPerfect format, should you so desire. Thus; I don't find your argument clear.

"2. Betamax was better than VHS, so what. More DivX users worldwide than Mac users. How many non-Apple CE devices play back quicktime files? DivX aiming to be the .mp3 of video."

I never said 264 was "better" than DivX-- they are in the same ballpark. FYI-- any PC with iTunes probably has Quicktime installed. Or any PC used for gaming.

[Davis Freeberg]

@Tom - I think that you are mistaken about H.264 being a "codec", it's really a format standard for high quality video that anyone can license and support. This difference is subtle, but important. H.264 would be comparable to Mpeg4. Even though anyone can support Mpeg4, DivX has was able to build a business around their certification because there is so much confusion over what Mpeg4 really is. By creating the DivX brand, they've made it easy for consumers to know that their files would play on a CE device without having to worry about the technical specifications. Moving forward, we'll see more devices support H.264, but because most consumers don't know anything about video formats, there is a need for a brand name to tie it all together. This is why Apple has used Quicktime as a wrapper around their H.264. They don't want consumers to be worried about whether or not the content will play, they want it to be seemless for them.

With so much confusion over H.264, DivX is in a great position to grow their brand around the format. As we move forward, I expect that DivX certification will eventually mean that both Mpeg4 and H.264 is supported and since Apple is a notoriously closed system, it creates an opportunity for independent companies like DivX to help fill this void. If Steve Jobs would open up his DRM to companies like Toshiba or Samsung, then h.264 Quicktime could be a threat to DivX, but somehow I don't see them allowing other gadget makers to muscle in on their monopoly over the content. In the past, better formats like Betamax did fail, but that was only because they were dependent upon the mainstream media's approval in order to get access to the content. Since the H.264 and Mpeg4 pirates don't seem too concerned about asking for permission, it allows DivX to continue to build their brand around these standards, even though Hollywood hasn't come to their senses yet.

[Scott Berry]

Yep. Saying H.264 is a standard is sort of like saying a three-pronged power plug is a standard. All well and good until you try to plug your American device into a (3-pronged) European outlet.

Not a perfect analogy, but I think it gets the point across.

[Tom B]

"All well and good until you try to plug your American device into a (3-pronged) European outlet."

I can get an adapter for about $0.25

[rach]

so what for the stock up or down

[Scott Berry]

@Tom B: Good point, but "adapter" in this case is a $200-300 set top box, and it only works for a few. What about other countries? Other formats?

@rach: I'm a bull on the stock, even after the post-earnings runup. Only a $200M EV, with $100M top line and 95% gross margins? What's not to get?