TIVO: Ignore the Mysterious Mystro, Look to the Leader Pt1 09:34am EST 1-Apr-03 Rodman & Renshaw, Inc. (Daniel Ernst 212.356.0510) TIVO
TiVo Inc. (TIVO)
MEDIA TECHNOLGY
MARKET OUTPERFORM / SPECULATIVE RISK
COMPANY UPDATE
APRIL 1, 2003
TIVO: Ignore the Mysterious Mystro, Look to the Leader
Daniel Ernst
212.356.0510
dernst@rodmanandrenshaw.com
SUMMARY
MAINTAIN MARKET OUTPERFORM Following a discussion with management, we provide an analysis of the company's plan to increase revenues through new services and advertising, and to lower operating costs with new technology. In addition we analyze news of a new VOD service under development at AOL Time Warner and find it non-competitive with TiVo.
AOL's MYSTRO TV MISSES According AOL Time Warner's 10K the company is currently working to develop an advanced form of Video On Demand (VOD) that could offer features and benefits similar to those provided by TiVo. Because the service is only expected to reach the trial phase during 2003, and because of other limitations inherent to VOD, we do not believe that this development will pose any threat to TiVo's leadership position in the near to medium term.
HOME MEDIA OPTION GOES LIVE SOON As expected, Tivo is set to launch its Home Media Option upgrade early this month. The Upgrade, an additional cost of $99, enables the TiVo to manage most other digital media content such as MP3 and JPEG files. We estimate that the option could generate a high margin $6 million in CY2003.
COST OF OPERATIONS DECLINING Over the last year, TiVo has reduced its service cost per subscriber from $4.88 to $2.78 per month. The company has developed a three-tier strategy to continue to lower costs. TiVo will employ users' broadband technology and has developed a unique data delivery technology to further lower costs.
MAINTAIN TARGETS In line with seasonal consumer trends, TiVo management expects FY1Q04 results to be fairly modest. The company expects subscriber additions to fall in the range of 55,000 - 65,000.
VALUATION ROOM FOR UPSIDE We maintain our $7.00 price which equates to 27x our EBITDA estimate. Further, we believe that the company's advertising and licensing models allow for additional growth not currently factored into our model.
DETAILS
AOL UNVEILS PLANS TO TRIAL MYSTRO TV According AOL Time Warner's 10K report filed with the SEC on March 28, 2003, the company is currently working to develop an advanced form of Video On Demand (VOD) that could offer features and benefits similar to those provided by TiVo. Because the service is only expected to reach the trial phase during 2003, and because of other limitations inherent to VOD, we do not believe that this development will pose any threat to TiVo's leadership position in the near to medium term.
Specifically, AOL Time Warner has created a wholly owned subsidiary, AOL Interactive Video Group Inc., operating under the name Mystro TV to develop the service. According AOL's 10K:
"As currently contemplated, Mystro TV will store video content at a cable operator's facilities and allow subscribers to access these stored programs through the operator's cable system at any time. For example, if Mystro TV is successfully developed and the appropriate rights secured from owners of video programming, a subscriber could use the Mystro TV service to watch a program that aired the previous day, or to begin watching from the beginning a show already in progress. The Interactive Video Group expects to conduct a trial of the Mystro TV service in 2003. The Interactive Video Group will continue to be 100% owned by the Company following the completion of the TWE Restructuring."
VOD LIMITATIONS While we believe that VOD will continue to grow in both scale and scope, we believe it will be difficult for VOD to replace the PVR. Our argument here follows around the same logic that drove the dynamics between the desktop computer and the networked computer. Because network computing lacks the ability to fully customize environments for individual users, and because network in-availability prevents users from accessing critical data on a just in time basis, the desktop computer has emerged the standard for both businesses
and consumers. Nevertheless, the evolution of the Internet, which began
as a
network of computers, has created an environment where the concept of network computing co-exists and complements the desktop computer. We see the same dynamics governing the development of the PVR/VOD market. We believe VOD will provide consumers access to features and popular content, while PVRs will provide users access to customized sets of widely available content.
Specifically we identify the following limitations of VOD systems including
Mystro:
ú Content Rights While consumers currently maintain the right to record any programs under the doctrine of "Fair Use", cable network providers would have to obtain access (likely at a cost) from the producers of such content before installing copied versions of that content on a network. We believe that it is highly unlikely that any one cable operator would be able to profitably obtain rights to all the content that TiVo and other PVR users currently enjoy. ú Storage Capacity After obtaining the content rights, cable operators would then have to maintain vast storage facilities in each cable network in order store the diversely required content. Where PVRs like TiVo's select from 17,000 hours of programming each week on digital cable and satellite networks, VOD storage systems average well under 500 hours. While we expect that as VOD grows in popularity, operators will increase storage capacity, we do not believe they will be able to profitably store ALL available content. For this reason, VOD content libraries will be edited down to the most popular, and more recent titles. As a result, we expect that PVR's will continue to provide customized content sets side by side with VOD systems. ú Not Available On all Networks or on Satellite. We note that the Mystro service, even when fully developed and deployed across all of AOL Time Warner would address less than 10% of all television households. Further, even as other cable MSOs seek to develop similar services, we note that that Satellite, lacking two-way communications and sufficient bandwidth, will continue to rely on PVRs for the delivery of on demand content. Satellite provider DirecTV accounts for between 30% - 50% of TiVo net subscriber additions.
SONICBLUE FILES CHAPTER 11 - PLANS SALE OF REPLAY TV: On March 21, Sonicblue Inc. the producer of a TiVo competitor, Replay TV announced it plans to file chapter 11. The company's principal revenue source came from the Rio line of MP3 players. We believe the company had not yet gained much traction with its Replay TV PVR product, and we estimate had less than 200,000 subscribers. Subject to court approval, Sonicblue plans to sell its Rio and Replay assets to Japan's D&M holdings for approximately $45 million. D&M holdings produces Denon and Marantz brand consumer electronics devices. In addition, Sonic Blue expects to sell its GoVideo unit, which makes DVD players to Opta Systems LLC, run by a former Sonicblue executive. Sonicblue plans to continue operating the Replay TV service during the transition period. While we have little insight into the plans of D&M with respect to Replay, we would not expect the company to invest heavily to build out the service component of the PVR technology. We expect that during the transition TiVo's competitive position will be enhanced as consumers question the outcome of the Replay asset sale.
HOME MEDIA OPTION (HMO) GOES LIVE SOON As expected, Tivo is set to launch its Home Media Option upgrade early this month. The option has been advertised on TiVo showcases recently, and is currently featured on the company's Website. The TiVo Home Media Upgrade (software available to current Series2 users for an additional cost of $99) enables the TiVo to manage most other digital media content such as MP3 and JPEG files. The TiVo can also be networked to other TiVo devices or to the PC. TiVo also announced a strategic relationship with LinkSys for the WiFi networking option. Further, the upgrade enables consumers to remotely program the TiVo using the Internet. The upgrade also contains with new copyright protections that prevent users from improperly distributing unauthorized content out of the home. While we are not specifically modeling the revenue potential for the service upgrade - we note that were 10% of TiVo's current Series 2 users and 10% of net new subscribers take the upgrade during CY2003, the company would generate $6 million in additional revenue the bulk of which would be pure margin.
PLANTS STAKE ON DESKTOP: As part of the Home Media Option package, TiVo users will download a software application (client) onto their computers. The TiVo Desktop will interact with existing applications that manage digital music and pictures and stream that content form the PC to the TiVo. We believe that this foothold could serve as the base of operations for the expansion of TiVo created PC software for the management of digital content.
TiVo Music: With the TiVo HMO, subscribers can access digital music (MP3) files stored on home computers from the comfort of their living room. We believe that MP3 use in the home has been limited by its sheltered location on the computer. Studies indicate that most home entertainment systems are not connected to computer systems. With the TiVo HMO consumers can now listen to digital content on their typically better quality home stereo system.
TiVo Pictures: Want give the neighbors a slideshow of photos from your trip to the Grand Canyon shot on your digital camera? Not enough room in the Den? With the TiVo HMO consumers can stream digital photos from their PC to the TV via the TiVo. This features provides for viewing images on a screen (TV) typically twice the size of thos found on home computers.
Remote Scheduling: The HMO also enables consumers to program their TiVo from remote locations via the Internet. E.g. consumers can log onto their TiVo account from work or from the road to set up or change recording events.
APPLE VERSION IN DEVELOPMENT The company is currently working with Apple to provide integration with future versions of iTunes and iPhoto. Apple with a strong position in the digital music space (i.e. the iPod) could prove to be an excellent partner for TiVo in our view.
REQUIRES HOME NETWORK Home networking is considered to be the fastest growing area within communications and computing (and may be the only area of growth in those sectors). As discussed in previous notes, home media networking was a key hot topic at the January Consumer Electronics show. In order for the HMO to work, users must network their computer with their TiVo. TiVo supports standard USB connections to both wired and wireless Ethernet connections. In order to facilitate that requirement, TiVo has partnered with the home networking leader, Linksys. Linksys, a privately held company, recently agreed to be acquired by Cisco. TiVo is currently offering for sale Linksys networking products from its web site. Because the networking component is based on standards, other products will also work, but TiVo does not provide set up support for other vendors. We note that according to management, and high percentage of existing TiVo subscribers already have established a home network.
Figure 1: TiVo wireless home networking using WiFi (802.11b)
TIVO: Ignore the Mysterious Mystro, Look to the Leader Pt2 09:34am EST 1-Apr-03 Rodman & Renshaw, Inc. (Daniel Ernst 212.356.0510) TIVO
COST OF OPERATIONS DECLINING - MEET THE BLIZZARD Over the last year TiVo has reduced its service cost per subscriber from $4.88 to $2.78 per month. The company has developed a three-tier strategy to continue to lower costs. 1) As previously discussed, DirecTV which accounts for approximately 35% of its base subscribers and between 30% and 50% of net additions is now assuming responsibility for servicing TiVo/DirecTV subscribers. 2) TiVo has now enabled subscribers with broadband connections to link to the TiVo data stream via that connection. According to management between 60% and 70% of TiVo subscribers are also Broadband subscribers. 3) The company has developed a unique data transfer process that travels over broadcast signals. The technology dubbed Blizard encodes the TiVo programming data within a standard television broadcast. As with the downloading of its showcases, TiVo rents unused airtime late at night to transmit the data. As the Blizzard data is transmitted, the rented channel turns to static (as if the television had no reception). The principal cost savings in all three of these strategies is the elimination of the dialup modem channels that TiVo currently maintains for the transmission of that data.
ADVERTISING ON TRACK As we have previously discussed, in February, TiVo signed what we believe to be its first material advertising contract - a multi-film agreement with 20th Century Fox. With this agreement, TiVo subscribers will be able to view full-length theatrical trailers, exclusive interviews, and other tailored content for upcoming releases. Management has recently stated that advertising could account for as much as 10% of revenues in FY2004. While we had previously assumed zero advertising revenue, we now include a FY2004 estimate of $2.2 million - or 3% of service and licensing revenues and believe
room for upside exists. Management stated on its March earnings call that
all
of the recent showcases aired on TiVo were revenue producing contracts. Further, management recently hired a new ad veteran to lead its ad sales program. TiVo's ad sales team are currently selling ad space using rate card with a premium price to standard add contracts. As TiVo users must select to view the material - typically an entertainment focused long-format ad, the ad hits delivery higher returns in theory. According to recent commentary recorded in the industry trade magazine ad-age, and conversations with ad professionals, there is a great deal of current interest in producing long-format ads like those offered by TiVo.
MAINTAIN TARGETS In line with seasonal consumer trends, TiVo management expects FY1Q04 results to be fairly modest. The company expects subscriber additions to fall in the range of 55,000 - 65,000 - which is lower than our prior estimate of 75,000. We expect the company will generate an EBITDA loss for FY1Q04 of $4.2 million. We are maintaining our $15 million FY04 EBITDA target which is above management's previous guidance of $5 - $10 million.
RODMAN & RENSHAW RATING SYSTEM: Rodman & Renshaw employs a three tier rating system for evaluating both the potential return and risk associated with owning common equity shares of rated firms. The expected return of any given equity is measured on a RELATIVE basis of other companies in the same sector, as defined by First Call. The price objective is calculated to estimate the potential movement in price a given equity could achieve given certain targets are met over a defined time horizon. Price objectives are subject to exogenous factors including industry events and market volatility. The risk assessment evaluates the company specific risk and accounts for the following factors, maturity of market, maturity of technology, maturity of firm, cash utilization, and valuation considerations. Potential factors contributing to risk: relatively undefined market, new technologies, immature firm, high cash burn rates, intrinsic value weighted toward future earnings or events.
RETURN ASSESSMENT
ú Market Outperform: The common stock of the company is expected to outperform a passive index comprised of all the common stock of companies within the same sector, as defined by First Call. ú Market Perform: The common stock of the company is expected to mimic the performance of a passive index comprised of all the common stock of companies within the same sector, as defined by First Call. ú Market Underperform: The common stock of the company is expected to underperform a passive index comprised of all the common stock of companies within the same sector, as defined by First Call.
RISK ASSESSMENT
ú Speculative - The common stock risk level is significantly greater than market risk. The stock price of these equities is exceptionally volatile. ú Aggressive - The common stock risk level is materially higher than market level risk. The stock price is typically more volatile than the general market. ú Moderate - The common stock is moderately risky, or equivalent to stock market
risk. The stock price volatility is typically in-line with movements in
the
general market.
RATING HISTORY
RATING SUMMARY
Investment Banking Services include, but are not limited to, acting as a manager/co-manager in the underwriting or placement of securities, acting as financial advisor, and/or providing corporate finance or capital markets-related services to a company or one of its affiliates or subsidiaries within the past 12 months
ADDITIONAL DISCLOSURES
Rodman & Renshaw, Inc. (the "Firm") is a member of NASD and SIPC and a registered U.S. Broker-Dealer. ANALYST CERTIFICATION: I, Daniel Ernst, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject
company(ies) and its (their) securities.
None of the research analysts, the research analyst's household or the Firm, has a financial interest in the securities of TiVo (including, without limitation, any option, right, warrant, future, long or short position). As of December 31, 2002, neither the Firm nor its affiliates beneficially own 1% or more of any class of common equity securities of TiVo. Neither the research analyst nor the Firm has any material conflict of interest with TiVo, of which the research analyst knows or has reason to know at the time of publication of this research report. The research analyst principally responsible for preparation of the report does not receive compensation that is based upon (among other factors) any specific investment banking services transaction but may receive compensation based in part upon the Firm's overall investment banking revenues. The Firm or its affiliates did not receive compensation from TiVo for any investment banking services within twelve months before, but intends to seek compensation from TiVo for investment banking services within three months, following publication of the research report. Neither the research analyst nor any member of the research analyst's household nor the Firm serves as an officer, director or advisory board member of TiVo. The Firm makes a market in TiVo's securities as of the date of this research report. Any opinions expressed herein are statements of our judgment as of the date of publication and are subject to change without notice. Reproduction without written permission is prohibited. The closing prices of securities mentioned in this report are as of March 31, 2003. Additional information is available to clients upon written request.
Readers are advised that this analysis report is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy. The information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does not purport to be a complete statement or summary of the available data. Past performance is no guarantee of future results. First Call Corporation, a Thomson Financial company. All rights reserved. |
