Investors just don’t understand TiVo. And there’s a good reason for that. It has not done the best job of explaining just what it is to investors, which is why today, after it finally gained agreement from EchoStar that it will pay the $104 million that it owes from a patent court case, that the TiVo share value is more or less the same as it was 5 years ago when we first began covering the company.
Sure it’s up on the day, as analysts factor in the $104 million, which is made up of $74 million, awarded at the end of a patent suit which began in 2004, along with $30 million in interest payments. Quite clearly all that this means to analysts and investors is that TiVo has a bit more cash, but it still has the same old business. Well that could be wrong.
First off the event which triggered this is that the Supreme Court declined to hear the case which had already been decided upon and then failed to be reversed at appeal. EchoStar immediately said ‘big deal’ and that the ‘real’ case was whether or not an injunction would be issued to stop using its DVRs, which it believes it can argue against successfully.
EchoStar now has no higher recourse in the original case, and has to pay the money that it placed into escrow when the finding was made against it. But it still does not plan to license the TiVo technology and is convinced that its ‘workaround,’ a software implementation which has already been loaded to its set tops, and which it says does not use the TiVo patents, will be okayed by the court. We’re not so sure.
TiVo has asked that Dish is made to switch off its set tops, or buy a permanent license to the technology. It’s hard to know how a court is going to proceed, but let’s look at the patent itself which is being breeched.
The key to the case is the Time Warp patent which protects the underlying method for recording one program while playing back another, watching a program as it is recording, and a storage format that supports advanced TrickPlay capabilities. We’ve read the patent in the past end to end, and to us it is clear that it is the whole idea that is patented, not a specific way of spooling the data on and off disk. If the court decides that any DVR needs such a license, then there can be no software workaround, not without disabling most of the function. If it involves spooling live video streams onto disk, it looks to us like it infringes. If the court agrees, then that’s a major issue for Dish.
What is interesting here is that this has become ‘personal,’ with TiVo founder Mike Ramsay having said during the trial that he showed EchoStar’s Dish network the TiVo technology, in the process of trying to sell it to them, and EchoStar went off and came up with their own version of the same technology.
At the EchoStar end CEO Charlie Ergen is clearly not thinking rationally. We wrote two years ago that he should bury the hatchet and put in a bid for TiVo, but when someone put forward that idea on our behalf, his team said it was far too late for that. Ergen could settle this with a phone call, and pay a continuing license fee and sort out a rate for a license which acts as a reference point for all future deals. He might even secure a shareholding in TiVo in return for being generous here.
Once upon a time Ergen would have achieved that, but the last three times that Ergen has been called on to negotiate ‘ with TiVo, with AT&T over who would get its retail support, and with the Chinese authorities on providing satellite support for their Mobile TV system (that was for EchoStar, not Dish) ‘ he has overplayed his hand, and has either lost or delayed an important contract. The investment community must ask if perhaps he has lost his touch, and have already answered that question for themselves by driving down the value of Dish Networks and EchoStar to long term lows. Chances are those prices could go lower.
The truth is that TiVo has a vast amount of intellectual property, not just the time warp trick play patents, but since this case began it has amassed extra tricks for recording the same or similar programs with the same actors etc.., placing advertising on the disk drive and prompting viewing of long form advertising, and also offering up ads which persist when the DVR is being fast forwarded. It is sharing these ideas through license with both Comcast and DirecTV ‘ so why should any broadcaster around the world not have to pay a license for these ideas. They come straight out of the R&D labs of TiVo and they have not been seen anywhere else.
This is not true of the time warp patents. They were hotly contested by ReplayTV and a legal stand off achieved between the two, so that they might both license the underlying idea behind DVRs. Cisco’s Scientific Atlanta licensed this technology from the remnants of ReplayTV. Why would EchoStar during the long run up to this trial, not also take a license from this intellectual property counterpart to TiVo? It looks to us like stubbornness and stubbornness alone. That’s the kind of emotion that can get you thrown out of your own company by embittered shareholders.
To value TiVo now we must look at past licensing businesses, in the same arena, and for that Gemstar stands out as the main source of wisdom. It has significant license revenues for something that is seen as less of a technical breakthrough than the DVR. Now it is part of Macrovision, but it changed hands at $2.8 billion for a $600 million business. Today TiVo is valued at $624 million, for a $250 million business with around $200 million in liquid assets (once it gets the EchoStar money). Not much more than 1.7 times revenues plus cash.
Gemstar when it did that deal had a valuation closer to 3 times revenues plus a whole lot more cash. Now we know that Gemstar had a rough ride, and that successive management had to be litigious and ruthless ‘ and a bit more besides, but that’s the nature of the beast, no-one wants to pay for intellectual property, they have to be ‘made’ to. And if this court case was not about proving that its patents stood up in court, what were they about.
Around the world there are 100s of devices which breach these patents. Every set top maker (around 60 globally) makes DVRs and most of them make them without a license paid to TiVo. What obscures this issue is that there are too many revenue streams for TiVo. It has its own subscription business which it thinks IS its business, it had in the past license fees for its technology from equipment makers, and now it lives on license and other fees from operators, and from research commissioned by them. It puts most of its efforts into its service, and its future appears to us to be more fruitful as an intellectual property company alone. Perhaps the subscription business should be hived off or sold off? Perhaps the entire operation would fetch a far higher price if acquired and do better as part of a Sony or Thomson? We have always said that Apple should buy it.
Meanwhile we have to assess the future for Dish. This entire affair of overplaying its hand is completely unfunny. It has to pay $104 million to TiVo and god knows how much more in the long run. It has to repay AT&T $500 million convertible note that it borrowed in 2003 because it didn’t win its business.
In June sister company EchoStar announced, still run by Ergen, announced that the Loral built CMBStar satellite which it had commissioned and must pay for, to provide China with a satellite based Mobile TV system, was in a dispute and may not be used after all.
And in the last Dish financials it showed that it is losing its HD war with DirecTV, dropping the number of gross additions to its network by 100,000 for the second quarter from a year before, and its churn has ballooned to 1.87% a month, reducing net adds to just 25,000 from 175,000 a year before.
We know that its management pointed at the weakening links with AT&T, hinting that the 25% of sales that came from external operators, with much of that coming from AT&T, was slowing in the run up to cutting off the deal.
If that’s the case, then there is little more in the way of damage that AT&T can do to Dish, then perhaps it has no real long term problems. But suppose that is more or less a smokescreen and that AT&T continues to sell its fair share of subscribers right up until the end of the contract. Then we can expect some 15% to 20% of gross subscriber additions will evaporate after January, making its gross adds between 600,000 and 640,000. If its churn remains the same, net subscribers adds will be negative by some 75,000 to 100,000 a quarter.
With a customer base of 13.79 million it’s going to take a long time before that makes a hole in revenues, but across at DirecTV there could be an additional 110,000 net adds form AT&T, and that would suddenly show it growing by chunks as high as 370,000 a quarter. The gap between the two operations would widen by 480,000 rounded up to half a million subscribers for every quarter. It would only take a few years to grind Dish into insignificance.
Sure Dish is attacking the HD programming issues, and it will reduce its churn, and perhaps that will improve its net additions position too, but the weight of additions in favor of DirecTV will still be considerable and awareness of this has already gone straight to the share price.
A likely future of being a spiraling cash cow will not be tolerated for long, and even a strategy lifted by some clever play in the mobile TV market is unlikely to change that perception.
Cash will never run out. Dish threw off $594 million in net income during the past 6 months on revenues of $5.76 billion, so just over 10% of revenues returned after tax. It has around $1.9 billion in liquid assets, but after paying off AT&T and TiVo and any other obligations that Dish may have (like a license to TiVo if that injunction is granted), it is hard to see what finance Dish can bring to bear to build out (or pay for) its $700 MHz license, without getting itself into further debt, and given the state of the US debt markets, that could be expensive.
Eventually there may be no alternative for Dish, having separated the company in order to stop the decline in fortunes at Dish from affecting EchoStar, and potentially to cash in Dish by selling it, after a few quarters of attempting to find a solution to high churn and low net adds, it may put itself up for sale. Knowing Charlie Ergen that will be over his dead body, and not before he has spent every penny chasing some form of triple or even quadruple play partnerships.
One door that may open is the fact that Verizon may not be happy going to market with the same DirecTV package as its rival AT&T, and may look to change its partnerships in DTH retail, to Dish’s advantage but apart for that it’s hard to see any other relief than a sell out at some stage to DirecTV.