Value Investors Club / Macrovision 2.625% 8/15/11 Con (MVSN)

Description

Description

With a yield to maturity of 14% for an investment in a rapidly de-levering company with very stable, high-margin revenues, the 2 5/8% Convertible Bonds of Macrovision Solutions Corporation (MVSN) present a compelling risk-reward opportunity, resulting from the retrenchment of traditional convertible arbitrage funds and their financing sources. The Converts are due 8/15/2011 and currently trade at 75, giving this $240M issue a current yield of about 3.5%. It bears mentioning that the Converts are struck at $28.28 per share, which means that upside from option value is not entirely out of reach.

The yield on the converts should decline as: (i) the supply overhang in the convertible market is soaked up; (ii) the Company closes announced and pending asset sales; (iii) Macrovision further improves its credit profile by receiving IRS approval to convert some or all of a >$2 billion capital loss into an operating loss; and (iv) the Company continues to drive growth in its core businesses from increased penetration of digital television and new IP licensing agreements (currently under negotiation with several large Consumer Electronics manufacturers). We estimate that a high single digit yield in 12 months time should produce a Convert price in the low 90s, which along with the current yield should product a one-year total return in excess of 25%.

Capital Structure and De-levering Through Asset Sales

In addition to the Converts, the Company’s capital structure consists of a $550M Term Loan and a $100M issue of 11% Senior Notes, both of which mature in 2013. Offsetting MVSN’s total debt of $889M (including leases and netting out amortization payments) is about $369M of cash and investments. On 12/18/08, the Company announced the sale of its TV Guide cable television channel to Alan Shapiro and One Equity Partners (part of JPMorgan Chase) for $255M in proceeds plus an earn-out of $45M. Due to losses from the sale of the TV Guide magazine (completed 12/1/08), the proceeds from this latest sale will be tax free and will be used to reduce the outstanding Term Loan balance, bringing net debt down from $570M to $315M and gross debt to $647M. Macrovision is also in the process of selling its TVG horse race gambling channel, with an expected sale announcement early next year. The Company’s revenues largely come from recurring IP and technology licensing streams, putting Macrovision in position to reduce debt further, irrespective of the overall economy. During its analyst day on 11/10/08, the Company had guided that it would pay off the entirety of its term loan by May 2009. While proceeds from asset sales will likely be below the original low end guidance of $350M (though still very accretive at valuations near 10x EBITDA), MVSN should still be able to pay off the term loan in 2009, leaving only $340M of debt outstanding.

CAPITALIZATION

Assuming $75M in proceeds from sale TVG Network

	Coupon	Maturity	Annual Interest Expense	As of 9/30/08	Asset Sale Procceds	Pro Forma As of 5/30/09
Term Loan	L+375	5/02/13	$39.2	$548.6	($548.6)	$0.0
Sr. Notes	11.0%	11/15/13	11.0	100.0		100.0
Converts	2.625%	8/15/11	6.3	240.0		240.0
Capital Leases			0.0	0.7		0.7
Total Debt			$57.1	$889.3		$340.7

Add: Cash Restructuring				5.3		5.3
Less: Cash				(368.9)	218.6	(150.3)
Net Debt				$525.7	($330.0)	$195.7

Stock Price				$11.77		$11.77
Shares O/S				102.7		102.7
Equity Market Cap				$1,208.5		$1,208.5

TEV				$1,734.2		$1,404.3

’08E EBITDA				$185.0		$150.0
’09E EBITDA				$230.0		$195.0

VALUATION

Pro Forma for Divestitures of TV Guide and TVG Networks

FYE Dec 31,	Pre-Deal 2008E	Pro Forma 2008E	Pre-Deal 2009E	Pro Forma 2009E
Revenue	$625	$425	$655	$455
EBITDA	$185	$150	$230	$195
Capex	$20	$20	$20	$20

EV/Revenue	2.8x	3.3x	2.6x	3.1x
EV/EBITDA	9.4x	9.4x	7.5x	7.2x

Total Debt/EBITDA	4.8x	6.0x	3.9x	4.6x
Net Debt/EBITDA	2.8x	1.3x	2.3x	1.0x

EV/EBITDA Through Convert @ 75	2.4x	0.7x	1.9x	0.5x
EV/(EBITDA – Capex) Through Convert @ 75	2.6x	0.8x	2.1x	0.6x
Assuming Midpoint of Guidance Range

Background

MVSN is the merger (announced 12/7/07 and closed 5/5/08) of the historical Macrovision Corporation’s copy protection software business with Gemstar’s Interactive Programming Guide (IPG) offerings (acquired for $2.2 billion), along with some smaller acquisitions mixed in as well. The Company now offers a variety of entertainment industry IP and software products to cable and satellite MSOs, Hollywood studios, set top box makers and consumer electronics manufacturers. While the Gemstar acquisition was criticized for being expensive and complex, with the planned divestiture of the TV channels, the Company’s strategy of becoming a pure-play IP and software licensing Company is finally coming to fruition.

Products

The Company derives the majority of its revenues from (i) the license of its IPG IP portfolio, (ii) the sale of programming guides based on this IP and (iii) the license of its ACP copy protection technology. The Company’s earlier stage products include: (i) BD+ copy protection technology for Blu-ray discs, (ii) the Mediabolic platform which allows set top box users to access content from other media sources such as networked computers and the internet, and (iii) the All Media Guide (AMG) collection of metadata such as music recording artists’ names, movie actors, etc. Lastly the Company also generates license revenues from its declining VCR+ technology. MVSN faces little competition in the IPG IP licensing, copy protection technology and VCR+ businesses as it is either the industry standard or the patent holder. The Company competes with the in-house efforts of some of its MSO customers and NDS Group plc (NNDS) in the design of IPG software but is often able to bundle its IPG software with IP licensing agreements.

Customers/Revenue Stability

Following the merger, MVSN began segmenting its revenues into Service Providers ($208M per 2009 guidance), Consumer Electronics ($196M per 2009 guidance) and All Other ($51M implied by latest 2009 guidance which adjusts for the sale of TV Guide Online). The Service Providers segment is largely made up of license revenue from the sale of IPGs and related IP to cable and satellite MSOs. This revenue stream is both high margin and highly recurring, as payment is generally based on per-user per-month licenses. Roughly half of the Consumer Electronics segment revenues come from sales of the ACP product. A substantial portion of these are to set top box makers whose products are generally distributed by the MSO according to regularly set upgrade cycles, rendering them less cyclical. This segment also contains over $50M of IPG sales to CE manufacturers, which are of a more cyclical nature but have been growing along with increased shipments of LCD TVs. The Company expects BD+ increases to roughly offset the ongoing decline in VCR+ sales, while AMG and Mediabolic should continue to grow.

MVSN has opportunities to grow revenues further from (i) increased penetration of digital television driving increase IPG penetration, (ii) the signing up of additional MSOs and CE manufacturers (the Company’s recent IP defense against Sharp in a German court is a good catalyst for this) and (iii) growth in the fledgling market for IPG-based advertising (of which MVSN is entitled to a revenue share). The Company’s medium-term revenue growth guidance is 10-15% per annum.

Guidance

During their 11/10/08 analyst day, the Company gave ’09 revenue guidance of $460-$500M revenue and EBITDA guidance of $185-$215M, which was pro forma for the planned divestitures. On 12/18/08 this was reduced to a range of $435-$475M to reflect the inclusion of TV Guide Online in the sale of the TV Guide Network. We estimate that the EBITDA impact was about $5M moving the midpoint EBITDA to $195M. MVSN also adjusted EPS guidance to reflect the lost EBITDA and the impact of the new projected closing date for the TV Guide Network and TVG Network divestitures (originally expected on 1/1/09) on net interest expense.

Valuation/Debt Multiples

Assuming an additional $75M of proceeds from the TVG Network sale (the Company had expected $125M a few months ago), you can create the Company at 1.0x EV/EBITDA through the debt at book value, or 0.5x EBITDA assuming par for the Term Loan and 75% as the market value of the unsecured debt (Sr. Notes & Converts). In a downside case of $150M for ’09 EBITDA, these multiples increase to 1.3x and 0.7x, respectively. Based on the Company’s capex forecast of $20M, the EV/EBITDA-less-capex multiples are 1.1x and 0.6x at book and market value in our base case, and 1.5x and 0.8x in our downside case.

Credit Profile/NOL

There are some intricacies to the credit profile of the Company. The Converts were issued by the historical Macrovision which is currently, along with historical Gemstar, a subsidiary of MVSN. The Term Loan and Senior Notes are co-issued by historical Macrovision and MVSN, so that the Converts do not structurally have a claim to the assets of Gemstar and are subordinate to the Term Loan and pari passu to the Senior Notes with regards to the assets of historical Macrovision. In addition, some of the Company’s cash is domiciled outside the US and approximately $72.6M of long term investments are in the form of auction rate securities which MVSN has the right to sell to UBS at par value of $79.4M beginning in July 2010. The Company has applied to the IRS for a letter ruling allowing from operating loss treatment for the roughly $2.5 billion capital loss incurred in the recently-completed sale of TV Guide magazine. This would improve debt paydown and potentially allow the Company to repatriate offshore funds more tax-efficiently. A ruling is expected in H1 2009.

Debt Repayment/Amortization

The Term Loan has a 1% prepayment penalty that lapses on 5/2/09, and the Senior Notes have a 0.5% prepayment penalty that lapses on 11/15/09. However, the Senior Notes are required to receive interest at least through 11/15/09, giving the Company no incentive to prepay the debt before then. During the Company’s analyst day in November, they forecasted repaying the Term Loan in May ’09 and the Senior Notes in November ’09, though this assumed $350M in divestiture proceeds from the TV Guide & TVG Network sales. The Term Loan has a mandatory 1% annual amortization with quarterly payments and matures on 5/2/13, except if there is more than $50M of the Converts outstanding and the total leverage ratio is greater than 2.5:1, in which case the Term Loan matures 182 days before the Convert maturity date of 8/15/11.

Covenants

The Converts and the Senior Notes have no financial covenants but limit additional Senior Indebtedness. The Term Loan contains two financial covenants: a Maximum Total Leverage Ratio (gross debt/adjusted LTM EBITDA) and a Minimum Fixed Charge Coverage Ratio (LTM adjusted EBITDA/cash interest + capex + cash taxes + mandatory debt repayments). The Maximum Total Leverage Ratio was 4.25-to-1 as of October 1, 2008 and steps to 3.75-to-1 on April 1, 2009 and by 0.25x per quarter thereafter until it bottoms at 2.25-to-1 on July 1, 2010. The Fixed Coverage Ratio is 1.30-to-1 until March 31, 2010 when it steps to 1.4-to-1 until September 30, 2010 when it plateaus at 1.5-to-1.

Given the significant de-leveraging effect of the asset divestitures (likely resulting in a complete paydown of the Term Loan), the covenants are only relevant should the announced TV Guide channel transaction fail to close. Should the transaction not close, we estimate that roughly $300M of cash could be used to reduce the outstanding Term Loan balance, resulting in a Total Leverage Ratio of approximately 2.6x and a Fixed Charge Coverage Ratio of 2.9x, as of year end 2009, assuming the midpoint of the company’s ’09 EBITDA plus an additional $35M of EBITDA contributed from the TV Guide, TV Guide Online and TVG channels. This would put them easily in compliance with covenant tests.

Catalyst

- Completion of announced TV Guide Channel Sale (expected in April 2009)

- Announcement and completion of TVG network sale (expected in Q1 2009)

- Payback of Term Loan (expected in 2009) and Senior Notes (possibly in 2009)

- Ruling on NOL treatment for capital losses from TV Guide magazine sale (expected in H1 2009)

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			2008	2009
Price:	75.00	EPS
Shares Out. (in M):	0	P/E
Market Cap (in $M):	240	P/FCF
Net Debt (in $M):	0	EBIT	0	0
TEV (in $M):	0	TEV/EBIT