Description

Introduction

I wrote up Xperi’s predecessor company for the VIC in 2019 and the company has been through a lot since then, most notably a split between its products (XPER) and IP (ADEA) businesses many years in the making but finally executed in the fall of 2022. Despite keeping the corporate name, new XPER technically constituted the spun-off entity and I believe it has evolved into a classically undervalued spinoff situation. As an aside I also think ADEA is substantially undervalued at current prices, but that is a story for another day. This writeup will focus on why I believe that the products spinoff XPER is a compelling long with several paths to success and the potential to increase its value several-fold over 5-7 years. The company has exciting products in the early stages of roll-out that give it decent visibility on accelerating growth over the next couple of years, and I think execution success on this front could plausibly lead to a double from current prices by 2025. The company also may have substantial break-up value with a potential for cost cuts (with or without prodding from activists) and/or a division sale to further streamline the business, and the math behind this implies a significantly higher value for equity holders. Finally, XPER’s emerging media platform business could develop into a significant competitor to ROKU in the connected TV (CTV) market and gives the overall company multi-bagger potential.

Company History

Pre-split Xperi resulted from a chain of corporate mergers that began with Tessera Technologies, known primarily for semiconductor IP licensing in the memory space, buying DTS, which licensed embedded audio and video enhancement software and also owned iBiquity, the developer of the IP and software behind the HD Radio standard, for $850M in 2016. The renamed Xperi merged with TiVo, itself a product of a merger between Rovi and legacy TiVo, both owners of software and IP around digital television programming guides and video delivery, in an all-stock merger completed in 2020.

The combined previous incarnation of Xperi had a profitable amalgamation of businesses, some driven by embedded software product sales and some driven by pure IP licenses forced by the threat of litigation. This situation placed the entire company in an awkward situation, as one division would call on customers to sell embedded software while the same customers might be facing a lawsuit around a different product line from a different division of Xperi. For this reason, and the fact the market did not award combined Xperi a favorable multiple despite its profits and leading market position, management decided to split the company into separate IP (Adea, ticker: ADEA) and product (new Xperi, ticker: XPER) companies. ADEA would be a highly profitable and cash flow generating but slow growth business while new XPER would be a higher growth but less profitable business investing heavily in the future of automotive in-cabin technology and OTT connected TV streaming. 

Effecting this spin-off took over two years of planning and execution, and finally occurred in the fall of 2022. Notably in my view, the CEO and CFO of combined Xperi elected to continue on with the new Xperi products business despite the fact that ADEA would retain most of the profits (and enterprise value). The spin-off was structured so that previous Xperi converted into Adea and spun off four shares of new XPER for each ten shares of previous XPER/new ADEA held. I believe the apparent lack of profitability of new XPER and the fact that it constituted the spun-off entity (rather than the surviving entity which remained in various small cap indexes) caused the new XPER to trade poorly. 

Current Business Overview

Currently, new XPER trades for a market cap of around $460M and an EV around $410M. The company has over $500M per year of high-margin, 75%+ GM software revenue but little in the way of profits because of the company's heavy investments in two growth areas- connected TV media platforms and automotive in-cabin entertainment. The company also has steady, profitable revenue streams from licensing Pay TV guides on a per-subscriber, per-month basis and licensing its audio and video enhancement software to consumer electronics companies. It divides its revenue streams into 4 inter-related categories, which I believe can be viewed as two pairs of businesses aimed at TV/video and automotive/consumer electronics, each with a legacy and growth component:

Pay TV (legacy, 50% of 2022 revenue, down 5%)-  This business comes from the TiVo merger, where TiVo sold Pay TV guides for smaller regional cable companies. Larger cable (and satellite) companies like Comcast or Charter make their own programming guides, but Xperi provides them for the companies that need to outsource and gets paid on a per-subscriber, per-month basis. Obviously with cord cutting Pay TV is now a declining market, and this revenue line declined 5% in 2022. The decline of Pay TV subscribers is one of the chief risks to Xperi, but two factors mitigate this decline such that management expects this revenue line to be flat to down low single digits going forward. First, the regional cable companies Xperi services tend to be in middle America, where the subscriber declines and conversions to streaming TV are much slower. Secondly and more importantly, within this business the cable companies customers’ subscribers are undergoing a transition from legacy low-ASP Rovi guides to fully-featured IPTV guides that have the best-in-class TiVo user interface, content discovery and streaming app integration features with about 2x the monthly price. So, even as overall pay TV subscribers decline, Xperi may experience flat or even increasing revenue as its subscribers upgrade to IPTV, depending on the pace of conversions.

Media Platform (growth, 7.5% of 2022 revenue, up 10%)- Xperi’s connected TV media platforms business basically takes TiVo's best-in-class content discovery user interface and enables it for licensing by TV and STB manufacturers as an alternative to ROKU’s platform- initially in Europe but eventually in ROKU’s core North American market. I assume that readers are generally familiar with ROKU’s business model, but ROKU’s platform revenue comes from selling advertising slots and getting a cut of subscription revenue from streaming TV content on its platforms, sometimes sharing a cut of the revenue with its integrated TV partners.  ROKU is the primary competition here, but Samsung, LG and Vizio also make their own platforms, while Google and Amazon license Android TV and Fire TV. Xperi initially sold TiVo Stream4K dongles as an alternative to Roku boxes, a product which generated great reviews for the user interface enabling unified content discovery instead of simply showing a collection of apps, but got limited traction in the market. Instead of marketing directly to consumers, Xperi’s strategy is to license the 40% of the TV market not owned by Samsung or LG or already committed to Android or Fire TV.

Xperi announced its first major media platform deal with Vestel, who markets TVs in Europe (where Roku has a limited presence) under the Toshiba, Hitachi, Polaroid, JVC and other brands. ROKU recently announced it would make its own TVs, entering competition against its licensee partners and  opening up the market for the new TiVo platform which will hopefully result in U.S.-market licensing partners by 2024. This market represents an enormous new revenue opportunity for Xperi, as Roku gets about $42 per year per active user in its Platform business. Xperi management has stated a goal of getting into 7M TVs by 2025, which could be approximately $140M in new annual revenue at $20 annual ARPU per year. This would only represent a small fraction of the 200M or so TVs sold annually worldwide (and existing base of around 1.3B internet-connected TVs worldwide), an enormous potential TAM. Modest success in penetration with the TiVo media platform could result in hundreds of millions in new annual revenue as the world transitions to connected TV streaming and if this business succeeds it will likely be the largest revenue contributor 5 years out.

Consumer Electronics (legacy, 26% of 2022 revenue, up 27%)- Xperi licenses audio and video enhancement technologies to TV, stereo, set top box, headphone and other consumer electronics products under variations of the DTS and IMAX Enhanced brands. Since many pieces of audio and video media encode audio under the DTS standard, a DTS license is virtually required for consumer electronics products, and they are second in this market to Dolby. This revenue line grew substantially in 2022 after declining in 2021 due to COVID production issues, and is expected to be a slow growth market going forward and despite being a legacy product line does not face the same decline curve as the Pay TV business. 

Connected Car (growth, 17% of 2022 revenue, down 3%)- Virtually all existing revenue in this area is from iBiquity, which owns and licenses the HD Radio IP and gets paid a license on all new cars that incorporate the HD radio standard. This revenue has grown slowly over the last few years as HD radio has achieved high penetration, recently declining due to automotive supply chain production issues. XPER has also been spending large amounts of R&D dollars to modernize DTS and other software to make a next generation automotive entertainment interface (AutoStage) and driver and passenger monitoring system (AutoSense) which are becoming more desired and even necessary as cars adopt greater levels of driver assistance. The company has made these investments over several years and has early design wins which give it visibility on accelerating revenue growth in 2024 and 2025 after what should be a slow growth year as auto production returns to normal in 2023.

3 Ways to Win and Outcomes

I believe there are basically three forward-looking scenarios that could result in substantial appreciation of XPER Shares:

Modest execution success- Xperi’s growth revenue lines (Media Platform and Connected Car) are currently at early stages of development. In the Media Platform business, the company has shown its platform works with the TiVo Stream4K product, but the company is still in the early stages of getting its TV licensee partners to sell TVs with its integrated software. Vestel will begin selling TVs in Europe this year with Xperi’s Media Platform software integrated, and the company has stated its goal is to have 7M TVs in the market by the end of 2025, representing $140M in incremental revenue at $20 per active platform user per year. At the same time, it has announced it has $40M of design wins for its AutoSense and AutoStage connected car software. Starting from a 2022 revenue base of around $500M, I believe the company will have accelerating growth in 2024 and 2025 as these initiatives kick in, getting to $650M of revenue or so in 2025. This revenue should layer on at relatively low incremental costs given XPER’s 76% gross margins, and I believe they could achieve a 12.5% EBITDA margin up from 7.5% expected in 2023. This would result in $81M in EBITDA, a double in two years from $40M or so expected in 2023. At 14X EBITDA (not crazy for an accelerating growth company) and factoring in cash flow generated between now and then the company could be worth $22 per share, more than double current prices. 

Break-up SOTP value and cost cuts- In 2022 XPER had over $500M of 76% gross margin revenue, but limited EBITDA because of very high operating expenses, around $200M each of R&D and SG&A. While they are pursuing multiple ambitious technology projects, I believe that the succession of mergers has left the company with a bloated cost structure and multiple levels of senior management in its various business lines. In particular, the $194M of non-GAAP SG&A expense stands out for a technology company with a sub $500M market cap, especially considering that it primarily does OEM sales to a small number of relatively large technology, consumer electronics and media companies. I have not even mentioned that Xperi also funded an “internal startup” called Perceive doing a semiconductor chip aimed at AI processing on edge devices, a business they have little or no expertise in and that may be consuming $15M to $20M of annual opex. So, I believe they could cut out this likely wasteful spending on Perceive and a further $45M of SG&A, adding at least $60M of annual EBITDA and achieving roughly $100M of annual EBITDA at a 20% margin, not a huge number for a high-margin software business. 8X $100M of EBITDA would also be roughly a double in the stock price from here.  

I also believe it might make sense for the company to consider splitting further along the business lines as I laid out above into pure play media platform and automotive/consumer electronics licensing businesses. In particular investors currently ascribe high valuations to automotive technology companies, and a strategic acquirer might want to own the DTS/HD Radio/Auto Stage/Auto Sense businesses which currently generate over $200M of revenue with little or no Auto Stage or Auto Sense revenue yet being recognized. CRNC trades at around 4x (currently declining) revenue and publicly traded driver monitoring software startups Seeing Machines (SEE.L) and Smart Eye (SEYE.ST) trade at around 4x and 8x, respectively. For reference, Tessera bought DTS (including HD Radio) for $850M in 2016, and DTS’s revenue has grown since then. If these business lines were acquired, we would be left with a pure-play competitor to ROKU with around $300M in annual revenue. ROKU trades at 2x currently declining revenue with a significant hardware portion that investors likely don’t care about, so the remainder could be worth something at or above the current $410M EV. Even 3x automotive/consumer electronics revenue (about $600M, still well below the value DTS was purchased for) and 1.5x Pay TV/Media Platform revenue (around $450M) would be more than double current enterprise value.

Xperi has generated negative total shareholder return over many years despite a substantial amount of high margin software revenue, not to mention a dizzying array of strategic mergers, a major spin-off and hundreds of millions of R&D investments. So, I believe they would be vulnerable to an activist pushing them for some combination of cost cuts and divestitures, and indeed management may want to consider these moves on their own before someone forces their hand.

Significant execution success- I won’t spend a ton of time on this but needless to say, if the connected Media Platform TV streaming business achieves substantial success as an alternative to Roku, this company could generate hundreds of millions per year in revenue and be a multi-bagger from here. Just to give a framework, there are approximately 1.3B connected TV devices worldwide. If Xperi got to 5% market share (mostly in Western Europe and the U.S.), that could be 65M accounts generating a blended $30 annual ARPU, or around $2B in annual revenue. At ROKU’s 2x revenue multiple, this would be $4B of enterprise value before even considering the connected car/consumer electronics business, making XPER a potential 10 bagger. For reference, ROKU had 70M active accounts at the end of 2022, $2.7B of platform revenue and has a current market cap of over $8B. TV maker VZIO also makes its own ROKU-like operating system and after formally launching its Platform+ business in 2020 it did $478M of Platorm+ revenue on around 17M active accounts in 2022. Even this level of success would double XPER’s revenue. The market is there and the business model is proven, the question is if XPER can execute over the next few years and get on enough TVs.

Summary

To summarize, I believe that new XPER became somewhat of an orphan spinoff stock but could be poised to enter a new era of revenue growth and technology leadership which should expand its profile on Wall St. and lead to a higher multiple. If accelerating revenue growth does not materialize, the company has numerous opportunities to cut costs and enjoy the inherent profitability of its high gross margin software licensing and royalty business. The company could also split further and separate its automotive and consumer electronics licensing business from the TiVo guides and media platform business given that Wall St. is currently paying high multiples for next-generation automotive technology. Legacy Tessera paid $850M for DTS back in 2016, more than double the current EV of XPER. This valuation seemingly ascribes significant degradation to the value of DTS (which has continued to grow) and nothing for TiVo’s profitable legacy programming guides business and emerging position in connected TV platforms, neither of which I believe to be accurate.

Catalyst

• Acceleration in revenue growth in 2024 and 2025
• Traction in media platform business
• AutoSense and AutoStage design wins entering production
• Possible division divestituture or split into Pay TV/Media Platform and Connected Car/Consumer Electronics businesses