|Shares Out. (in M):||43||P/E||25||9.3|
|Market Cap (in $M):||364||P/FCF||29||13|
|Net Debt (in $M):||171||EBIT||44||62|
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Avid was last written up on VIC in spring 2016 and the stock has performed roughly in-line with the Russell 2000 since then. The prior write-ups (and Q&A) are worth reading for context as Avid has attracted controversy in the past. Since it was last written up, we believe Avid has evolved its business mix and product portfolio, improved and continues to improve its operating performance and greatly enhanced its management team. These actions have largely addressed legacy issues and put the business on firmer footing, making the opportunity much more compelling today.
As Avid’s budding subscription business continues to grow, excess costs are removed, debt is paid down and its end-markets increasingly shift towards cloud offerings, we believe Avid will re-rate and/or potentially be acquired. We see ~80% upside or a low 20’s % IRR over the next several years.
Avid is a leading provider of software and integrated hardware products to the media and entertainment industry. Avid’s products are used primarily in “post-production” settings to edit, store and manage video and audio content. Avid’s customer base is skewed towards the “high-end”, with primary customers including post-production facilities, professional film, television, news and music studios, with sizable exposure to freelancers and individual creatives as well. In most of these markets, Avid enjoys monopoly-like positions and is considered the “industry standard” for editing.
In 2019, Avid’s revenue was ~53% software and maintenance (maintenance comprising ~30%, license and subscription comprising ~20%), 40% hardware and integrated software (video storage, audio workstations) and 7% professional services (implementation, etc.). On a gross profit basis, we estimate software and maintenance comprised the vast majority of gross profit (~75%) while hardware and services made up the remainder. Overall, the business is skewed approximately 2/3rds video (key products: Media Composer, MediaCentral, Nexis Storage) and 1/3rd audio (key products: Pro Tools, Sibelius).
Avid’s (and Digidesign’s, which now comprises its audio business) origins date back to the late 1980s. This first-mover advantage allowed Avid to develop a multi-decade track record helping edit high-end video and audio content and often leads to Avid being the default choice by editors. In addition to the halo effect generated by this successful history, Avid’s long-held position has also led to a very large and growing pool of users that are trained on its tools, which helps reinforce its choice status due to ease of recruitment and availability of talent. While difficult to estimate precisely, we believe in its core market of high-end movies, television shows and broadcast news, Avid’s share is in excess of 80% and ~70% within professionally created music.
Avid’s dominant share at the low-end of the market (commercials, corporate videos, etc.) has admittedly been whittled away by larger competitor such as Adobe and Apple over the past 10 to 15 years, but its position at the high-end has remained incredibly resilient due to the risk averse nature of its customers, for which Avid comprises a minimal expense but delivers immense value. Over time, we believe Avid’s share at the high-end will remain firm while its share at the low-end should ultimately grow as the company better markets its “Hollywood halo” and due to the impact of COVID on its more nascent subscription business (more below).
Key Thesis Points
High-Quality Business Masked by Legacy Missteps and Complicated Financials
We believe Avid is a high-quality business, with dominant market positions, limited capital needs, pricing power and high degrees of recurring revenue/profit. However, the company has had a troubled past, including being led by low quality and overly promotional management teams, poor free cash flow generation, an overleveraged balance sheet, a large accounting restatement and a NASDAQ delisting in 2013. We believe Avid’s more troubled past has detracted from what is an otherwise attractive underlying business.
The most notable of Avid’s prior transgressions was a major accounting restatement in 2013 that ultimately resulted in Avid being delisted from NASDAQ. In addition to the negative ramifications the delisting had on Avid’s perception in the market, the underlying causes of the restatement obligated Avid to recognize significant non-cash revenue over the subsequent years, which has masked and muddled the performance of the underlying business ever since.
The effects of Avid’s 2013 restatement have been massive -- more than $400m in non-cash revenue has been recognized from 2012-2018. This non-cash revenue stems from implied bug fixes and other free support that was embedded in the original sale of software and hardware products. Rather than being recognized ratably over time, this revenue was recognized entirely upfront. The company/accountants later determined that a portion of the customer’s purchase price was tied to the implied maintenance services being provided by Avid and should have been recognized over a multiple year period, up to 8 years in some cases. The net result was a ~$700m write-down to stockholders’ equity (prior revenue and earnings were overstated) and the creation of a deferred revenue balance in the amount of over $400m for historical sales made before 2011. Starting in 2011, Avid began amortizing the deferred revenue balance into revenue. This “non-cash” revenue was significant and it had 100% flow-through to EBITDA.
The “non-cash” revenue component was extremely outsized at the outset (2012-2016) but has dwindled in significance since 2017. Over the 2013-2018 period, Avid’s reported GAAP revenue appears to have declined by a 6% CAGR while EBITDA appears to have declined at a 10% CAGR. In reality, Avid’s “cash” revenue has been relatively flat (weighed down by a temporary lull in product innovation under prior management as well as pricing pressure in a key product) from 2013-2018, while “cash” EBITDA has improved from ($20m) to $45m, primarily due to a $100m cost reduction program initiated in 2014. Bottom-line, these accounting movements have effectively rendered Avid’s reported financials meaningless. However, Avid’s reported financials are finally converging with reality, with non-cash revenue expected to account for ~1.5% total revenue and ~10% of EBITDA in 2019. These non-cash impacts will diminish even further over the subsequent years. We believe this convergence will present an increasingly clearer depiction of the health of the business and attract more investor interest.
New Management Team and Board Driving Change
To put it mildly, Avid’s previous management team was overly promotional and untrustworthy. Under prior CEO Louis Hernandez (now a private equity fund manager), the company badly damaged its credibility with shareholders, the morale of the company and its strong heritage of innovation.
Our channel checks on Avid’s new CEO, Jeff Rosica, have been uniformly positive and we believe he is steering the company in the right direction. Jeff most recently served as a Chief Sales Officer at Avid and previously was its SVP of Operations. He has over 30 years of industry experience, including senior roles at Grass Valley (a competitor of Avid), and is well respected by employees, customers and the broader industry. Since taking the helm in early 2018, Jeff has focused the company on several key areas including repairing the company’s frayed culture, a re-prioritization of the product roadmap (including a major user interface revamp of its key video editing product, Media Composer), and instilling more discipline around operational efficiency. Jeff has also ushered in changes in the C-suite, bringing in a new CFO, CMO and Head of Supply Chain, while implementing additional talent refresh within certain internal groups such as finance and supply chain. Under Jeff’s leadership, Avid has launched several new video and audio products, refreshing and modernizing a portfolio that, while iconic, had somewhat languished under Louis. These updates have not only generated new product cycles but should also allow Avid to move down market and expand beyond what has primarily been a higher-end TAM.
70% of the current Avid board joined AFTER its restatement. We believe the new board is much higher caliber and holds management to a greater degree of accountability. Of the members that remain are Peter Westley, who runs Blum Capital (previously the company’s largest shareholder, in the process of exiting) and Bob Bakish (CEO of ViacomCBS). Lastly, Impactive Capital, an activist firm made up of two former senior investment professionals from Blue Harbour, now own >15% of Avid and has board representation. Our checks on Impactive are very positive and we take comfort in their large stake in the company and role as a check on management and value-added member of the board.
Increasing Recurring Revenue and Gross Profit Mix
Historically, Avid’s revenue streams have been inherently lumpy, due to a variety of factors including product mix, customers’ fourth quarter budgeting seasonality and some degree of product cycle sensitivity. This has made forecasting Avid’s business, particularly on a shorter-term basis, somewhat difficult. Over time, Avid has sought to shift its revenue model to be more recurring in nature, which is a characteristic shared by many technology companies. To achieve this, Avid has introduced more subscription options for its software (contractual commitments paid ratably, rather than one-time, perpetual software sales). Additionally, Avid recently began entering into “long-term agreements”, or LTA’s, with its larger enterprise and reseller customers. A typical LTA would lock in a fixed amount of annual product and service sales over a multi-year period. These new recurring streams are supplemented by Avid’s significant base of maintenance revenue which makes up ~30% of sales.
Based on our definition of recurring revenue, which includes contractual maintenance, subscription revenue and enterprise (not reseller) LTA’s, Avid’s recurring revenue mix has improved from ~28% in 2013 to ~53% today. Similarly, we estimate recurring gross profit has improved from ~47% in 2013 to nearly ~70% today. We have excluded reseller long-term agreements from our recurring revenue definition given their typically shorter duration contracts. Under Avid’s definition, these recurring elements would be slightly higher given they include enterprise and reseller agreements as well.
Over time, we believe Avid’s mix of recurring revenue and gross profit will continue to expand due to an increasing contribution from higher-margin subscription revenue sold to the growing funnel of individual users adopting Avid’s new products. Further upside exists from the migration of enterprise customers to subscription products as well as the introduction of certain cloud services (more below). Overall, this recurring revenue and gross profit mix has the potential to reach 65% by 2023, resulting in a more predictable business that is less dependent on quarterly and year-end sales processes, which we believe will be deserving of a higher valuation multiple.
Inflection in Free Cash Flow and Operating Margins
Despite owning a strong collection of brands and deeply embedded products, Avid has historically struggled to generate adequate margins or consistently positive free cash flow. For example, Avid’s “cash” EBITDA margins were negative from 2013-2015 and more recently have hovered in the low double-digit range, with little of this EBITDA flowing through to free cash flow.
Avid’s poor free cash flow generation has been attributable primarily to perennial restructuring expenses, accounting restatement costs and its high-cost financing. However, the impact of these items is abating, leading to a dramatic improvement in free cash flow generation. Going forward, we expect restatement expenses to be non-existent, restructuring expenses to be minimal after 2020, interest expense to become more manageable (either through natural debt pay down or a refinancing into a more traditional debt facility from the current facility provided by Cerberus) and working capital management to improve.
At its 2019 investor day, Avid pledged to achieve low 20% margins (consistent with our benchmarking analysis) and convert at least 60% of EBITDA into free cash flow by 2022. We are confident in the company’s ability to achieve these targets given the rigor around expense and working capital management by Avid’s new management team, which is a major departure from prior leadership regimes.
Favorable Industry Backdrops (Video and Audio)
The scripted television industry is currently going through a strong growth phase. From 2014 to 2019, total video entertainment content spend has increased from $66bn to over $100bn in 2019, or a 10% growth CAGR. This has been driven by a 5% growth CAGR in the number of scripted television series over the same period. This trend is being driven by the decline of the traditional cable “bundle” and the introduction and success of internet-based options such as Netflix, Hulu, Amazon and Apple (or Over-The-Top/”OTT” players), as well as more recent direct-to-consumer (or “DTC”) options from legacy media companies such as Disney and AT&T/Time Warner (with new products such as Disney+ and HBO Max). Collectively, this increase in content spend and consumer choice has been dubbed the “streaming wars”.
While difficult to pinpoint the exact impact on Avid, the sheer amount of new and high-quality content being created that naturally requires editing and storage should be supportive of growth for the company. We believe both its video software and hardware business should benefit as it serves as an “arms dealer” to this continuing trend. We believe the vast majority of content becoming available on these platforms is edited on Avid, which is driven by the stringent quality controls and standards set by the studios, which few providers can meet.
In terms of the music business, while still ~30% below its 1999 revenue peak, the US recorded music industry has recorded five consecutive years of mid-to-high single digit growth, aided by new streaming monetization options such as Spotify. This has been a reversal of the decade-long decline that the industry previously endured. Today, over 75% of recorded music revenues are from streaming sources. Additionally, after years of closures, the number of professional music studios (key Pro Tools/audio customers) has stabilized as well. We believe this improving backdrop has helped make the music industry a more viable career path and provides a fertile environment for Avid’s audio business.
Long-Term Cloud Opportunity
To date, enterprise level video content producers have been reluctant to place their workflows “in the cloud”, strongly preferring to store/manage content on local servers. This hesitation is due to security concerns around potential data/IP loss or misappropriation. Additionally, latency is another consideration. In light of the very large and growing file sizes of video content, the risk of losing or having delayed access due to bandwidth issues is top of mind for large media organizations. Prior to COVID, our research suggested these reservations were unlikely to abate meaningfully in the intermediate term. However, as we discuss below, we believe COVID is causing a fundamental rethink in workflows and processes in the video and audio industries that will cause cloud adoption to accelerate in the coming years.
Avid has been putting steps in place to be cloud-ready including forming a partnership with Microsoft Azure in 2017 to jointly develop and market cloud solutions for the entertainment industry. In September 2019, Disney announced it would pilot putting certain production and post-production processes into the cloud, powered by Avid’s tools, as part of the Microsoft partnership. In doing so, they stated, “By moving many of our production and post-production workflows to the cloud, we’re optimistic that we can create content more quickly and efficiently around the world”. This announcement came after years of testing (and several million dollars of cost) by Disney, Avid and Microsoft to ensure the Avid File System (the differentiated software underlying Avid’s storage products) would work in the cloud and was secure. Avid is hopeful that this pilot is helping compel other large media companies to move workflows to the cloud given Disney’s imprimatur and their status as a thought leader in the industry. We believe that this cloud income stream will be valued considerably higher than the income currently generated by the company’s storage hardware business
Long-term COVID beneficiary
COVID-driven shutdowns have materially impacted Avid’s business as the inability to produce films/shows or host concerts and abbreviated sports seasons have crimped the need for Avid products. In Q2 2020, Avid’s “Products” (hardware and license) business declined by nearly 50%. This decline was offset by substantial growth in the subscription business (+68%) and steady maintenance revenue. On a consolidated basis, revenue declined ~20%. As highlighted below, significant cost savings cushioned the revenue decline, causing EBITDA to improve ~40% YoY.
We believe over time the pandemic will ultimately benefit the company as a transition to increased remote editing serves as a boon to Avid’s subscription and cloud business and the company permanently reduces its cost base, leading to a structurally higher margin profile.
Shift to subscription/cloud: Coming into 2020, growing its subscription and cloud business was already a strategic imperative for the company. However, as seen with other software-oriented businesses, COVID has sped up the adoption of remote working for enterprises. As a result, we expect the adoption of Avid’s cloud offerings as well as subscription versions of its various software products to accelerate. Not only will these lead to improved growth (life-time value of a subscription is 2-3x that of maintenance), but it will also result in a stickier customer (license is a one-time sale while subscriptions are recurring, storage gets converted to a recurring revenue stream, etc.). Another ancillary benefit from COVID is the growth of the individual or freelancer user. Shelter-in-place orders have given people more time to pursue personal interests and revisit old hobbies. This phenomena has benefitted Avid and helped fueled YTD subscription growth (+100k users).
Cost reduction/margin improvement: The pandemic has also given Avid management the opportunity to reexamine and realign its cost structure. The company recently outlined a plan to reduce expenses by $40m ($30m of OpEx, $10m of COGS) without impacting the R&D pipeline or growth profile. For context, the company did $50m of EBITDA in 2019. In total, Avid expects over 60% of these savings to be permanent, resulting in margin improvement of 750bps.
Growth, Valuation & Returns
On a long-term basis, we believe Avid should be able to grow revenue at 3%-4% per annum, excluding any benefit from cloud adoption. This is driven primarily by annual growth in Avid’s subscription business of ~20%. We believe this growth is supported by overall industry growth driven by the explosion in content creation, the appeal of subscription pricing options, the introduction of Avid’s more approachable and intuitive products and a new digital marketing push by Avid. For context, Adobe adds several million new Creative Cloud users annually (a subset of which is video-only). The balance of Avid’s businesses – hardware, maintenance, license and services – are expected to experience minimal to modest growth given the mature nature of these products and impact of the shift from license to subscription. A positive mix shift towards higher gross margin subscription revenue and planned cost reductions should result in Avid growing EBITDA at a low double digit to mid-teens % rate over time.
Avid currently trades at ~8x our estimate of 2021 EBITDA (~$66m), which benefits from a full-year of cost savings and a recovering revenue base (95% of 2019) as production gradually resumes. We believe this valuation is attractive on an absolute basis for a growing, highly recurring, software-centric business with a well-entrenched brand.
As Avid is a mix of both software and hardware, we apply a sum-of-the-parts analysis to derive a reasonable range of fair value. On the software side, closest peers Adobe and Dolby trade at 30x and 13x 2021e EBITDA respectively, while on the hardware side, businesses such as NCR, Teradata, Belden, Quantum and Evertz trade at ~8x EBITDA. In other words, Avid trades at parity with hardware oriented businesses and comps, despite primarily being a software business. We believe this disconnect is unsustainable. On a blended basis, we feel a 9x-10x EBITDA multiple is appropriate.
Applying 9x-10x EBITDA to our 2023 EBITDA ($88m) while crediting interim cash flow generated, results in fair value of $15-$17 per share, or 70%-90% upside (20%-25% IRR) over the next several years.
Deep pocketed competition
Potential demographic headwinds (video software segment)
Broadcast television/news industry exposure
Reliance on movie industry
Leveraged balance sheet
Consistent execution – While temporarily disrupted due to COVID, we believe Avid’s new management team is on course to demonstrate much enhanced execution, cash flow conversion and credibility relative to Avid’s prior management team. We believe consistent performance and the evolving business mix should ultimately be recognized by the market and rewarded with a higher multiple.
Sale of the company – If the market fails to recognize Avid’s improved business mix and performance, given its attractive portfolio of well-known and well-protected assets, the attractive growth tailwinds benefiting its industry and the incongruent valuation being assigned to the company, we believe Avid could make for a compelling acquisition by either a strategic or financial buyer(s), in whole or in part.
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