|Shares Out. (in M):||39||P/E||0.0x||0.0x|
|Market Cap (in $M):||234||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||-48||EBIT||0||0|
Every single time I have bought a security on panicked sell-offs due to non-fundamental reasons, I have done very well. Whether it’s a bankruptcy filing or a stock delisting or an FTC merger block, it doesn’t matter. (Don’t worry, I manage to screw up just about everything else in my life.) Let’s get this out of the way now: Avid has not reported financial results since 2012 and trades otc. If this is a non-starter for you, it won’t hurt my feelings. Sadomasochistically, I like any situation that causes the vast majority of investors to not bother. It keeps competition modest.
Avid is an application software company that makes non-linear editors (NLE’s) for professional audio and visual editing. The company has been around for over 20 years and is considered a leader in the niche space. Their products are needed for editing TV shows, newscasts, movies, commercials, music, etc, and they have an especially strong foothold among the really high-end users. For example, every Academy Award Best Picture nominee film last year was edited on Avid’s software. It’s a company that easily passes the “would it be missed?” test, even if most people have never heard of Avid or used its products.
Software is sold as a perpetual license, and customers typically sign maintenance contracts worth 10-20% of the total contract value. Avid continually updates its software with new features in the hopes that existing customers will upgrade. Avid also makes specialized hardware for high-end users who are running massive workloads and need a customized product that can handle their performance and collaboration needs. This is a nice differentiator for Avid and it helps entrench them at the high end, providing reliability and performance that most competitors can’t match. It also highlights that NLE’s can’t get disrupted by SaaS because they’re too data-intensive.
Avid’s reputation is generally very good on both the audio and video sides, although the industry is highly competitive. There are competing products by Adobe, Autodesk, Green Valley, Miranda, Apple, Harris, Harmonic, and a few others. Apple had been particularly troublesome for Avid since their Final Cut Pro product had taken share on the low end and moved up the value chain. Luckily for Avid, Apple had some recent stumbles with an update to Final Cut Pro, and customers have really soured on it. Avid actually sold their consumer business in 2012, whose performance was materially worse than the rest of the company. Proformas are available on their IR site which break out historical results adjusted for the divestment. Switching costs can be high because studios, post-production houses, and newsrooms have large teams, plus the software is fairly complex. People who get trained on a given product generally like to keep that product, as long as it’s doing a good enough job.
Apart from the competitive environment and losing share on the low end, since 2006 Avid has seen its revenue decline almost every year from the waning HD adoption cycle. Around 2001, plasma screen TV’s and HD started to become very popular. There was a virtuous circle effect as TV prices declined, more consumers bought them which further lowered costs. The more people bought HD-enabled sets, the more they demanded HD content, and the more HD content was produced, the more incentive OEM’s had to make TV’s and consumers to buy them. On and on it went.
As the market became saturated, Avid’s (and many others’) fortunes reversed. This decline has been evident in many businesses that touch TV sales. Chip companies focusing on HD processing, such as Trident Microsystems and Genesis Microchip blew up. Japanese TV OEM’s have had some notorious struggles in recent years. Best Buy’s TV sales have been terrible. You get the idea...after the whole world upgraded and got their new toys, the growth reversed. It turns out the industry is cyclical.
I see a reason to be excited about this industry, a reason to believe we are at the beginning of a new cycle, and it’s in the form of what’s known as 4k (or UltraHD). Basically, this is HD on steroids. It’s called 4k because that’s the resolution, since it’s quadruple the current standard of 1080. It looks fantastic, and I encourage anyone still reading to google around for more information. Best Buy sells 4k TV’s today and you can buy a Vizio 50” set for $1,000 or a Dell monitor for $700. I reckon there are a lot of couch potatoes, sports junkies, and Netflix addicts out there for whom 4k would be a worthwhile upgrade.
I was especially encouraged by what I saw at CES last month. I had been a bit worried that people might think of 4k as another 3D, which is to say a fad that fell flat. After CES, I don’t have any such fears. TV OEM’s focused on 4k sets, and why shouldn’t they? They want another upgrade cycle as much as Avid and other industry players do. But what really encouraged me was the content availability. For example, Reed Hastings said that Netflix was going to make all of its original programming in 4k, as well as its most popular streamed shows like Breaking Bad. Hearing Netflix commit to the 4k format was extremely encouraging.
Or what if Apple comes out with their long-rumored iTV and it supports 4k? I have no idea if that’ll happen, but I do know that Apple is getting deeper into the video delivery business one way or another, and given their commitment to quality I believe they’ll want to offer 4k content. At some point, I believe investors will start looking for ways to play the upgrade cycle.
While the competitive landscape among NLE’s remains tough, the upgrade cycle is the proverbial rising tide. Competitors may (or may not) take share from Avid, but I believe the magnitude of the upgrade cycle will offset any share loss and enable Avid to grow regardless. During the last go-around, Avid’s revenue grew organically by about 50%. The cycle is in the first inning.
Accounting Restatement and Financials
In late 2012, Avid discovered they had been accounting for certain software components incorrectly, booking some revenue upfront when it should’ve been amortized over time. The reason for the mistake? Pure carelessness, I suppose. There’s no excuse.
Accounting restatements are ridiculously tedious, time-consuming, and expensive, and unfortunately it’s shareholders who underwrite them. Avid has had to rebook over five million revenue transactions spanning eight years, 20,000 contracts, and 700 software upgrades. It’s an overwhelming amount of work, so much that they had to buy and install entirely new accounting software just to re-crunch everything. According to the company, they are now mostly through this process. The next step will be auditing those results, which should take another 4-6 months.
Avid last reported financial results in Q3 2012, and it was a truly horrible quarter. I believe this has amplified Avid’s perception problem since this was the last actual quarterly report people think of. Anyway, we can roughly estimate Avid financial results since going dark based on the restatement costs and the cash balance. Avid went dark with $72m in cash, reported having $52m in cash at 9/30/13 and $48m at 12/31/13. So let’s estimate what the restatement costs, then solve for underlying cash flow.
First thing I would point to is management’s recent estimate that they would have to spend $25-34m in 2014 related to the restatement. Combined with their estimate that it should conclude “mid year”, this means the restatement is costing them something like $12m/quarter.
Second thing is highlighting what Volt Information Sciences, a similarly-sized company, spent on their own restatement. Volt disclosed the expenses every quarter, and they spent about $10m per quarter on theirs.
With these two data points, I think a reasonable estimate of the quarterly restatement expense is about $10-12m. Avid has burned about $22-24m in cash over the past year, which means the underlying business is actually generating something like $16-26m in fcf, or about $.40-.65/share. Not only has this business not collapsed, it appears to be doing quite well and suggests that the stock is trading for less than 10x ev/fcf. Bottom line is that I think there is strong evidence to suggest that the business is doing just fine.
Nevertheless, the stock has been a disaster in 2014. On 1/7/14, management put out a press release that sent the stock down sharply. They disclosed (i) they were switching auditors from E&Y to Deloitte, (ii) they wouldn’t be able to complete the restatement by their original 3/31/14 deadline, (iii) they were adopting a poison pill, (iv) they were almost certain to get delisted by NASDAQ, and (v) management was working on providing investors with a strategic update.
It was mostly the auditor change which was not taken kindly, nor should it have. The issue was that E&Y has been named in various shareholder lawsuits. Because of their role in the original screw-up, they had shifted to full-on CYA-mode and management said that they were being counterproductive, taking too long and costing too much money. For better or worse (they insist better in the long-run), the decision was made to switch firms, and E&Y confirmed that they did not leave as the result of any dispute. But the whole situation was viewed as another slap in the face of shareholders and further evidence that Avid is mismanaged.
This past Monday was the really big puke. On 2/24/14, Avid confirmed that the NASDAQ was delisting them the following day, although they stated that they anticipated having the restatement complete by “mid year”. I was actually relieved to see this since it meant the end of the process was within sight and wouldn’t drag into 2015. The stock was sent down 30% on news that it would be delisted from the NASDAQ. Despite not being current in its financial reporting for almost 18 months and saying a month before that it was certain to be delisted, this revelation evidently came as news to many, many shareholders. Avid has 39m shares outstanding, while it’s float is 32m. I further know of another 6m shares that were either buyers or not-sellers, which means the effective float on the offer yesterday was 26m shares. Incredibly, 13m shares traded on Monday while another 7m traded on Tuesday. Impressive for a stock whose ADV was 130k and hadn’t traded more than 2m shares in a single day during the previous five years. Abrupt shareholder rotation is a great place to look for things to buy.
(A good friend of mine told me something very interesting which could explain the extraordinarily volatile trading on Monday. Evidently, many mutual funds frequently engage in a type of market manipulation of stocks the day before they are punted from indexes. Say you manage a mutual fund and your benchmark is the NASDAQ Composite. You own 1m shares of Stock ABC and know that today is its final day of listing. You wait until five minutes before the close, then you put in a 200k market-sell order. The stock gets destroyed and your benchmark gets dragged down with it. But you know that the closing mark isn’t “real” and expect it to pop the next day. When it does, your fund gets the performance on your remaining 800k shares, but your benchmark doesn’t participate. I suppose if you can pull this off enough times in a year, it might give you a modest advantage in beating your benchmark, which is the only thing that matters in that world. Diabolical. If you look at the intraday trading in Avid on Monday, it certainly seems consistent with this tactic. Aside from thinking this was interesting as hell, it helps show that the big sell-off was stupid.)
When I look at past examples of “real” companies going dark on financials or delisted (or both) for reasons other than insolvency, history suggests they are usually great buying opportunities. Volt’s stock fell from $8.50 to $6 on their delisting (juuust about the low) then rose to $11 four months later...today it’s at $10. Globalstar was delisted in December 2012, falling from $.42 to $.30 on the day it got delisted. That day was the low, and today the stock is at $2.30. Comverse’s stock was flat on its delisting day in 2007 despite 43% of the shares outstanding trading. The stock actually climbed for a few months until the mayhem of the financial crisis rolled around. Navistar’s stock did nothing, then it doubled four months later.
Other situations seem similar to me. Olympus was accused of being a fraud and having the Yakuza running the company in 2011, and everyone panicked that the stock would get delisted, quickly sending the stock from Y2500 to Y500. It had almost tripled two months later, and today it’s at Y3300. Diligent Board Member Services trades in New Zealand (although oddly it’s registered with the SEC and files K’s and Q’s) and went dark last year for almost identical reasons as Avid. In December they warned that their own restatement would take an extra couple months and that delisting from the NZX was possible. The stock gapped down from $4 to $3 on the news, yet today it’s almost at $5.
It’s good to be buying stuff from guys who Just Need Out.
What Is Avid Worth?
I’m not a fan of the ev/sales multiple, but it has its use and it’s made me money in the past. It can be imprecise and misleading, but it can also be helpful in pointing you in the right direction. Avid trades at .5x ev/sales while competitors average 4.3x. The second lowest multiple I can find is 1x, and for that I have to go to France for a company that sells software/hardware to the textile industry (Lectra, I’m looking in your direction).
Another clue that Avid is probably significantly undervalued is the multiple it trades on of its maintenance revenue. Avid is generating ~$160m in service revenue, the majority of which is maintenance and therefore more-or-less recurring. I’ve looked at acquisitions in the application and enterprise software space over the past few years, and the average multiple (excluding the high outliers) is 7.4x. The lowest multiple was 4.9x. Avid is trading at 1.1x. There has got to be a way to monetize this.
Grass Valley is a strong competitor to Avid and they were acquired by Belden (NYSE: BDC) on 2/6/14 for $220m while generating $290m in revenue and $24m in ebitda. That ev/sales multiple today on Avid would make it worth $9.30/share, so about 60% upside. It also shows that a ~10% operating margin should be achievable for this business. If Avid could muster a 10% operating margin, the deal implies a $13/share valuation for Avid, or about 120% upside. Keep in mind this is just on what I believe are today’s numbers. Also, a 10% operating margin at Avid currently would produce $1.30-1.40/share in fcf, so I think the shares would likely be worth more than $13. Also remember that the 4K cycle should help tremendously over the next couple years, so there could be a lot of upside from here anyway.
Belden also bought another NLE company called Miranda Technologies on 6/5/12 for $345m while it was generating $185-200m in revenue and $36-40m in ebitda (another 9x multiple). This deal would value Avid anywhere between $11-23/share.
The timing of the Grass Valley deal was interesting when you consider Avid adopted a poison pill just a month before and Belden appears interested in gobbling up NLE firms. A little consolidation could do some good. I think it’s reasonable to assume that Belden approached Avid about a deal. While the poison pill is in some ways frustrating (especially when management credibility is as poor as Avid’s), it’s reassuring to know that someone out there wants to buy this company. The new CEO of Avid sold his previous company to Fiserv a year ago, by the way.
I can’t figure out any reason why Avid shouldn’t be fixable even with stagnant revenue. Just some revenue stabilization should help achieve this and based on my estimates of their financials, I think we’ve got that today. When the restatement concludes, I believe management will focus on profitability and generating acceptable returns for shareholders. If they could simply eke out a 5-6% operating margin, it would generate about $.65 in eps and fcf. I think this is conservative, and a more likely goal is a 10% operating margin (I have relied on some old anecdotes from other shareholders and industry folks for this target).
The 4k cycle is where the numbers could get silly. Could Avid grow revenues to $600-750m? Yes, if the cycle ramps up, this is perfectly reasonable. What if they could do a 10% operating margin? Again, this is an achievable target for a company like this. It works out to anywhere between $1.50-2.10 in eps and fcf. Could it get a multiple of 15x? Could operating margins go higher than 10%? See what I mean? It’s not often that I can make a decent case for a stock to be worth 5x in a couple years. The last time I had this feeling was Virtus.
I put these things together and a side of me begrudgingly admits that management might have done the right thing by adopting the poison pill. I’m not terribly interested in selling the company at ~$9/share today when it appears all hope is lost and it could be worth $20-30/share in two years.
Risks here, obviously. The most likely one is that the restatement drags on longer than expected, which will cost more money and create more unease. I don’t think liquidity will be an issue as they have almost $50m in cash and $60m available on a Wells Fargo credit line. The burn to get them through the restatement should be $15-20m.
Also, sorry I didn’t post this a day ago.