|Shares Out. (in M):||40||P/E||0||0|
|Market Cap (in M):||240||P/FCF||0||0|
|Net Debt (in M):||115||EBIT||0||0|
Avid is a somewhat controversial name that is well-known from the VIC community. The company is approaching the end of its turnaround that we believe will finally highlight the significant free cash flow generation of the business and in all likelihood will herald a sale of the company in 2018. Over the last few years, the company went through a management change, a long accounting restatement, a change in business model and is now executing on a significant cost reduction program that should end towards the end of 2016. Pro-forma of its recent refinancing, AVID has an enterprise value of around $355 million and a market cap of around $240 million. The company shared some long-term guidance when they recently announced their Q4 results. 2017 EBITDA guidance is between $80 and $95 million and 2018 EBITDA guidance is between $90 and $105 million. The company also provides free cash flow guidance. 2017 free cash flow guidance is between $25 and $40 million and 2018 free cash flow guidance is between $40 and $60 million. If the company comes even close to reaching these numbers, the stock will be a homerun. Just as an illustration, if 2018 EBITDA is $75 million, $15 million below the low end of the company’s guidance, at a 10x multiple (which would be conservative in our opinion for a number of reasons including the fact that they won’t be a tax payers for years) and without assuming any FCF generation in the meantime, the stock would be at $16 per share, an upside of 150%. We think that the downside is limited here and the investment is a bet on the management team hitting its cost savings target.
Description and history of the company
Avid is a leading technology supplier to the media and broadcast industries. The company revolutionized the film and video post-production process in 1989 with the introduction of Media Composer, a digital nonlinear editing (NLE) system that allowed studios to piece together digital files to produce video content. Since that time, Avid has expanded into many verticals serving the media and broadcast industries including storage and server solutions (approx. 22% of revenue), media asset management (approx. 7% revenue), digital audio software (approx. 14% of revenue), live sound systems (approx. 10% of revenue) and notation software. The company has a good reputation and our calls with customers highlight the reliance of these customers on AVID’s products. The media and broadcast technology market is an approximately $65bn industry and is very fragmented. Avid’s current addressable market within the media technology industry is about $8bn and growing in the low-to-mid single digits. Through Avid Everywhere (more below) the company is expanding into adjacent markets that will increase the addressable market to approximately $20bn and provide an opportunity for higher growth. Other technology suppliers to the media and broadcast industry include Belden’s Broadcast Solutions segment (in particular Grass Valley), EVS Broadcast Equipment, Adobe Systems and Evertz (less of a comparable, but still some insight into the media and broadcast technology market). In Tier 1 (large enterprises) and Tier 2 (SMB), Avid has the largest market share as most media professionals are trained on AVID’s products.
In 2013, Avid hired Louis Hernandez as CEO and shortly thereafter was forced to delist in order to restate its financials due to software revenue recognition changes. The company relisted in late 2014 and has been executing on the new management team’s vision to transition the business from a perpetual license revenue model to a recurring subscription revenue model. As part of this transition, Louis introduced Avid Everywhere, a common services platform that digitally connects all the workflows in the media/broadcast value chain. Part of Avid’s strategy is to engage customers with this offering and then cross sell its solutions to its customer base. At the same time, the company is also engaged in a significant cost cutting program. We believe there is significant room for value creation as the company completes this transition over the next 18 months and emerges as a more profitable and higher quality business. As an illustration to that transformation, bookings are increasingly recurring which we believe make the company more valuable and the results less lumpy. 38% of full year bookings are recurring in 2015 from 18% in 2012 and 26% in 2014.
Avid currently benefits from high market share in its core markets and moderate switching costs in tier 1 and tier 2 markets where there is a level of standardization around its products. However, the historical perpetual license revenue model has many challenges. Because the industry is relatively mature, most product changes are incremental, forcing Avid to compete against its own installed base of products during new launches. Under the new license revenue model, Avid engineers will be able to integrate new features into the product in real time instead of being forced to wait for the next version upgrade. In other software providers, we have seen this dynamic lead to an increase in the cadence of innovation and the ability to more fluidly push price increases. Perhaps most importantly, it will incentivize solution selling instead of point-to-point sales. In this industry, solution selling embeds the product deeper into the customer workflows which reduces the substitutability of competing point solution products. Adobe recently went through a similar business model transition and realized the benefits mentioned above as well as an increased addressable market due to the lower entry price of licensed products.
Cost savings program
The company has announced a $68 million cost cutting program to be fully in run rate by the first quarter of 2017. The cost savings come from a number of areas including 1. reduction in duplicate spending while Avid built out its MediaCentral Platform for Avid Everywhere, but still had to support its point of sales solutions (sale of individual products instead of the platform) and 2. Rigorous facilities and personnel realignment. The CFO has experience with cost cutting exercise from his time at Open Solutions where he worked for Louis Hernandez. We understand from talking to management that they have gone line by line and have good visibility on the $68 million. The current CFO was previously the CFO of Open Solutions during the great recession where he had to do a lot of cost cutting so this is not the first time this management team engages in a cost savings program. Also private competitors have much better margins giving credence to the fact that there are significant cost savings.
Complicated accounting, financials and free cash flows
The company has complicated accounting and we will refer to the prior write-ups and Q&A to provide context. The company also has some presentations to explain the different issues. The main point to understand is that the company still needs to recognize pre-2011 revenue which flows 100% to the bottom line even though this revenue doesn’t have an economic reality at this point. This overstates the real economic EBITDA of the business. So in 2015, adjusted EBITDA was $55 million but pre-2011 revenue was also around that number implying that the real economic EBITDA was around zero. For 2016, the company has guided 2016 EBITDA between $60 and $75 million but there will be around $20 million of pre-2011 revenue implying economic EBITDA of $40 to $55 million of EBITDA. In 2017, most of that pre-2011 revenue will be gone and the adjusted EBITDA that the company has provided will be close to the economic EBITDA. We believe that this complexity is part of the opportunity as few investors take the time to understand what is going on.
Here is an illustrative EBITDA bridge from 2015 to 2017 (sorry for the formatting). As one can see, the bet at this point is mostly about the company being able to meet its cost savings target – we like to bet on things management has control over.
2015 Adj EBITDA 55
pre 2011 revenue for 2015 -55
Cost savings 40
Revenue growth 5
pre 2011 revenue for 2016 20
2016 Adj EBITDA 65
2016 Adj EBITDA 65
pre 2011 revenue for 2016 -20
cost savings 25
revenue growth 10
pre 2011 revenue for 2017 5
2017 Adj EBITDA 85
With current bookings of around $520m, we believe once the business model transition is complete in the middle of 2017, the company could be earning north of $1.25 in free cash flow per share and be worth substantially more than implied by the current stock price. This is not currently obvious because the financial effect of the transition to a recurring revenue model is to push out current sales and cash collection resulting in a temporary period of reduced cash flow generation.
One of the reasons the stock sold off so significantly in 2015 is because of the significant underperformance in cash flow generation compared to earlier expectations. The company generated negative $30 million of free cash flow in 2015. This happened because more customers switched to the subscription model (compared to earlier expectations) which put pressure on free cash flow. Also the operating environment across the industry was difficult which lead to bookings being pushed out, also impacting free cash flow. As value investors, we typically would not touch a company with this profile, however, the fact that most of the improvement comes from cost cutting (Avid has always been thought of as a bloated company and peers operate at significantly better margins) gives us a lot more comfort, combined with the attractive valuation and the strategic value of the business.
We believe management projections are realistic and use these projections as a basis to value the business. If 2018 FCF is $30 million, $10 million below the low end of the guidance and applying a 15x multiple, one gets to $11 per share. Using 2018 EBITDA of $70 million and a 10x multiple yield a $16 stock price. The upside is obvious. The issue is the downside. Assuming the business is worth 10x EBITDA (which I think is justified for a business that will have an increasing proportion of recurring revenue and won’t pay taxes for years), the current enterprise value of $370 million implies a 2018 EBITDA of around $37 million versus the company’s guidance of $90 to $105 million of EBITDA. Given that the economic EBITDA is currently around zero for 2015 and they have announced a $68 million cost savings initiatives, I think that achieving $37 million should be pretty doable. Also it is important to note that the company just raised debt so that it has the runway to go through this transformation.
Potential M&A target
We wouldn’t be surprised to see market consolidation and a sale of the company once the transformation is done. The CEO sold its prior public company Open Solutions to private equity in 2007 and then sold that Company to Fiserv in 2013. He was also a board member of Unica, a public company that was sold to IBM. Our channel check indicates that the CEO is a very commercial guy and, is not emotional about his companies and will sell at the right time and price. The Company recently added his largest shareholder Blum Capital on its board. Blum owns around 20% of the Company and will likely also favor a sale at the right time. For example, Belden Inc., a large competitor has been acquiring companies in an effort to consolidate the market and exert increased negotiating leverage on the larger media and broadcast entities. While we are not underwriting this event, Avid’s product suite could make a good addition to Belden’s portfolio and result in an attractive premium for investors. Once the company has switched to a recurrent revenue model, other companies like Adobe may also be interested.
1. company starting to generate real FCF in 2017
2. sale of the company in 2018 (hopefully!)
|Subject||Free Cash Flow|
|Entry||04/11/2016 05:16 PM|
I am confused by the 2018 guidance. By 2018, the pre-2011 Dfd Revenue should be gone, and I had expected bookings, billings, and revenue to converge by then, but the guidance says:
EBITDA midpoint: $97.5mm
FCF-to-Equity midpoint: $50mm.
How do we reconcile these two numbers? I do not expect capex to increase dramatically above $15mm . . . am I wrong?
And cash interest on the converts is only $2.5mm.
And I expect cash taxes to be minimal for a long time.
So where is the other $30mm going? I must assume it is going to fund working capital. And the forecast has bookings equal to (or slightly higher than) revenue (and I do not think this is caused by accounts receivable increasing). By 2018, I had expected the subscription-based model to dominate the financials and for revenue to largely equal billings (which would largely equal cash receipts). I cannot figure out how to reconcile this $30mm difference. Any help would be appreciated.
|Entry||04/11/2016 08:43 PM|
Thanks for the interesting write up.
A few contacts have brought up Apple's Final Cut. Are these products even comparible? Any reason why you didn't mention Final Cut? Is it MAC only?
|Subject||Re: Free Cash Flow|
|Entry||04/12/2016 10:25 AM|
Thanks for the questions. Regarding the 2018 FCF guidance, here is the back of the envelope calculation I think they are putting out there. At the midpoint, Adj. EBITDA will be 97.5m. Interest expense should also include the new Sr. Secured Credit Facility they just took out with an effective interest rate of 8.75%, so the total interest is ~11.5m. Regarding taxes, management says the NOL will reduce, but not eliminate the tax rate and estimates it will be in the low-to-mid double digits. That would equate to ~9m in taxes. Capex I am guessing grows slightly into 2018, so ~17m. With respect to the bookings conversion into revenue, if I play out the logic in their revenue presentation I show the difference is almost gone, but is still about $5m (this will change slightly based on your assumption of their ability to grow bookings). That gets you to about 55m in adj. FCF with the residual to their midpoint being working capital / conservatism.
jhu2000, with respect to Apple's Final Cut, it is comparable and it could have been included on that list. The reason it was not on the list is that it appears a number of years ago Apple (because they had gotten so big) determined the broadcast / media market was not one they were pursuing as hard as in the past. Final Cut Pro is comparable to Avid's Tier 3 products aimed at prosumers, but does not overlap as much in Tier 1 and 2 where Avid has the biggest market share. My understanding is Final Cut is only available on MAC, but there are back door means to get it on Windows.
|Subject||Re: Re: Free Cash Flow|
|Entry||04/12/2016 11:49 AM|
Thanks. I did some more work last night and got similar numbers. I am bothered by the interest. I would think by 2018, they would have repaid credit facility. Further, the fact that they have a fully drawn credit facility of that size with that interest rate is not comforting. If their FCF numbers are remotely accurate, they do not need to be shelling out that kind of interest. So either they are contemplating yet another acquisition or they are not confident in those FCF predictions. Either way, not good.
As well, even in 2018, they will still be unwinding the deferred revenue as customers roll off perpetual licenses to subscriptions. It seems very reasonable that this will be $10mm of cash lost. So I can now reconcile EBITDA with FCF-to-Equity.
As for being an acquisition target, the NOL value will be severely limited by any acquisition so no longer terribly cheap. It becomes all about strategic value, which I continue to believe it has.
|Subject||Re: Re: Re: Free Cash Flow|
|Entry||04/12/2016 12:13 PM|
Yes they told us that they will refinance the debt at some point if the FCF is close to what they expect but for modeling purpose they assume that this is the interest payment in 2018 (it would be weird for them to do otherwise). I can also tell you that they believe these numbers are conservative and after disappointing investors, they have taken a more conservative outlook. I think they believe the numbers but want the margin of safety and if they are right on the FCF, it won't matter and if they are wrong, it's better to have more liquidity.
We also pushed them on the need for such a large loan and the interest rate. There are large working capital swings intra quarters and that's why they wanted the margin of safety + they are going through a transformation so wanted to make sure they have the runway. But I hear your point and we didn't like this either.
In M&A, you may lose some of the tax benefit but you would get significant synergies.
Looks like you know the name based on your comments here and from the prior AVID posts. What are your thoughts on the company, management, valuation and risk/reward at this price?
|Subject||Re: Re: Re: Re: Free Cash Flow|
|Entry||04/12/2016 12:42 PM|
I am on record (on the other thread) as saying I think they will get to $500mm revenue and 15% op margins. So $75mm of real EBIT. This would get us very close ($100mm EBITDA less $10mm stock comp less $18mm capex/d&A). I still think they get there but story has taken a lot longer than expected. Difficult to evaluate wisdom of acquisition. As well, cash taxes higher than I thought. And change-in-deferred higher than I thought. So I get 2018 unlevered FCF of $50mm (i include stock comp and change-in-dfd) versus Adjusted TEV of about $400mm (I use mkt value of converts rather than face and then add in $25mm for restructuring cash costs and $50mm to bridge gap to 2018).
If they execute, I think TEV will be 15 * $50mm in 18 months, which gets you a $15 stock price. We had a position but unwound last year based on seeing better positions. I re-visited after seeing your write-up. I continue to like it, and the timing is much better. I am neutral on mgmt. I was very positive on mgmt, but acquisition, bank facility, and lack of consistent clarity on story has soured me a bit.
And I think there is still a probability of this being taken out by strategic acquiror at a large premium. I would think that Adobe and Microsoft, among others, would have an interest.
|Subject||Re: Operating cash flows|
|Entry||04/14/2016 11:29 AM|
It is all quite complex. But we have two fundamental things going on: accounting change on Jan 1, 2011 and biz model transition to subscription-based software.
The first effect has now almost completely passed thru. The basic effect was that pre-2011 dfd revenue was an accounting ghost and should not have been considered.
The second effect is fairly common and lots of software companies transitioning from perpetual licences to subscriptions have the same effect.
aa and I discuss this. My rough sense is that by 2018, steady-state change in dfd revenue (which will be 100% post-2010 dfd revenue) will be about $10mm per year for a long time as they transition all customers to subscritpion. We get this $10mm by reconciling EBITDA guidance with FCF guidance. As well, this number makes rough sense when you build a model that transitions perpetual customers to subscription customers.
note that full subscription does not mean zero deferred revenue, and I have tried unsuccessfully to figure out precisely where steady-state deferred revenue on the pure subscription model is. My guess is about $150-200mm. Anyhow, I just assume that after 2017, they have $10mm less cash per year in perpetuity. This is obviously overly conservative.
another way to look at everything is to assume they buy out all the perpetual licenses today and immediately transition everyone to 100% subscription. This would probably add $200mm to TEV to buy out licenses (my guess) but then the (pro-forma for cost-cutting) unlevered FCF would be about $70-75mm. This is obviously a theoretical exercise but another way of looking at the business.
I have run the numbers every which way and the outcome is the same. If (big IF) you believe cost-cutting numbers and their bookings/revenue numbers in the $525mm range, you are buying at 8x unlevered FCF. And this fully adjusts for the fact we are 18 months from the pieces falling into place.
I think the good news is that the accounting mess will no longer be the key to understanding the biz. The stock will now rise or fall based on their cost-cutting and sales.
|Subject||Re: Re: Operating cash flows|
|Entry||04/15/2016 12:21 AM|
Thanks for the clarification. After digging in here a bit I suspect this sees $4 before it goes to $7. Seems like a great short. There are a lot of moving pieces and no real clarity that this is operating well. The management teams seems excited to go do more M&A. I guess if my base business was as messed up as this appears to be I'd probably opt to try and buy stuff too.
|Subject||Re: FInal Cut..|
|Entry||04/15/2016 07:14 PM|
Good description of competetive moat:
|Entry||05/11/2016 12:02 PM|
Wanted to provide an update since we initially posted.
1. CFO is leaving. Usually not a good sign although in this case, we believe that the CFO is sick and had no choice but to leave to take care of himself
2. AVID reported disappointing Q1 numbers. While most of the metrics were in line, Q1 bookings were well below guidance for 2 reasons. 1. customers have been delaying purchase decisions regarding storage in expectation of the release of their new product NEXIS which was unveilved a couple of weeks ago 2. Tier 1 customers are delaying purchasing decisions. According to the CEO, the sales cycle is elongating as their own business is in flux and they try to figure out what they want to do (see transcript from last call for more insights).
3. FCF for Q2 below our expectations as a result of Q1 booking being below guidance. Company has maintained FCF guidance for the year but we are somewhat skeptical. We are still believers in the long term financial model of the company and the significant FCF in 2017 and 2018.
4. 2 days ago, the CEO bought 150K shares around current prices. It is being done by an entity that is de facto his family office.
|Subject||Also here is a recent review of Pro Tools|
|Entry||05/11/2016 12:29 PM|
|Subject||more insider purchase|
|Entry||05/17/2016 10:58 PM|
CEO bought another 100K shares.
|Subject||Light at the end of the tunnel?|
|Entry||08/04/2016 02:31 PM|
Your thoughts on the quarter?
My thoughts are very positive and surprised stock not up more.
- The $8mm in additional cost savings alone seems worth more. I now have them producing an annualized $60mm of unlevered FCF starting Q3'17. This includes stock comp, $10mm in continued change in deferred revenue, and cash taxes.
- And we should now have turned the corner on levered and unlevered FCF. They should be quite positive henceforth.
- And they seem to be accelerating the timing of the first "normal" quarter to Q3'17.
- And their products have been well accepted although Tier I continues to lag.
I have their adjusted TEV at about $450mm versus $60mm of unlevered FCF starting in 12 months. And unlevered FCF will be quite positive over next 12 months as well.
|Subject||Re: Light at the end of the tunnel?|
|Entry||08/10/2016 11:10 AM|
Straw - long-term thesis has not changed altough I have been surprised by the stock reaction since earnings. the metrics that matter are bookings and free cash flow. FCF was in line and bookings was at the low end. So surprised why the stock is up 40% since earnings - what are your thoughts? Louis was positive but he always is :-) Also I am concerned they will miss bookings and FCF for this year as the guidance for Q3 (which is probably realistic) implies very high booking expectations in Q4.
|Subject||Re: Re: Light at the end of the tunnel?|
|Entry||08/10/2016 11:49 AM|
I am not sure we have different impressions because when I wrote note a week ago (and suggested stock should be higher based on news), stock was near $7. It is now at $8.75. I do think news warranted a bigger move than $7. But I can assure it is not I buying at these levels.
As you note, the future outlook was far more positive than the actual results. So it comes down to mgmt credibility.
On the cost-cutting, mgmt has credibility. So I thought the additional cost cutting alone was positive news.
On the bookings (and FCF), they have this heavily back-ended. Mgmt has limited credibility on this issue, but at $7, the market is not believing anything close to mgmt's H2 2016 numbers or medium-term numbers.
|Subject||Re: Re: Re: Light at the end of the tunnel?|
|Entry||08/10/2016 04:30 PM|
Agree on all counts. Btw you and I have been involved in same names. would love to make real contact (instead of just virtual). if you are interested, please send me your contact info at email@example.com
|Entry||09/13/2016 10:55 AM|
|Subject||No sugar-coating these results|
|Entry||11/09/2016 05:15 PM|
Kudos to the shorts.
I had expected some shortfall on the Q4 bookings but this is far worse than expected. Q3 is bad and Q4 is worse. Difficult to give management any credibility on the revenue side of things (although they do execute on efficiency program). They must have seen this coming on last call but said nothing.
There is strategic value here, but now difficult to understand future bookings trajectory and give a value as a standalone company. At best, management visibility into bookings is very limited and at worst, management integrity in question here.
|Subject||Re: No sugar-coating these results|
|Entry||11/09/2016 06:21 PM|
If I understand the details, they are going to come in $110mm short (versus midpoint) in Q3/Q4 bookings. Mind you, this is 1/3 of expected Q3/Q4 bookings.
Two-thirds of this shortfall is the grinding-to-a-halt of enterprise storage as customers shun the older line and are waiting for proof-of-product for the new Nexis line.
And one-third is "conservatism" in forecasting lumpy large enterprise deals.
In the case of the storage, this is a failure of the product rollout roadmap. A complete failure of sales and marketing to understand proper rollout strategy. Horrible execution.
And on these lumpy large enterprise deals, it sounds like their sales method is much too complex for these deals and delays their closing.
So even if you believe mgmt that these are all bookings deferred, not bookings lost, the turnaround is deferred by at least 2 quarters.
The one big positive was their answer to whether these non-existent storage deals meant that the Avid applications were not being used and were simply sitting idle while competetive products were being used. I thought the answer was specific and believe-able.
And they have found $30mm more in cost savings to be implemented over 2017.
The cash and covenant situation is precarious and it seems very likely they will now need to do yet another equity raise although they denied that on the call as past cost savings kick in and as new $30mm cost savings is implemented.