|Shares Out. (in M):||47||P/E||21||17|
|Market Cap (in $M):||1,200||P/FCF||22||0|
|Net Debt (in $M):||130||EBIT||0||0|
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Set-up / Thesis
Business description – Avid is a small software-led technology company that has a dominant franchise in audio recording and post-production (Pro Tools) and strong market share in professional video editing (Media Composer), in particular on the high-end where Avid also sells vertically-integrated storage products (NEXIS). The business has historically focused on enterprise customers (large media companies, production studios etc.) to which it sells the MediaCentral platform, essentially the 3 tools packaged together. In recent years, Avid has also had success down market selling its tools individually into the growing prosumer class of users, which management refers to as its “creative users.” For the enterprise channel, Avid sells both directly and through resellers. For creatives, it sells DTC online including a freemium onboarding option (also available through resellers). Revenue is diversified internationally. The US and Europe each account for ~40%, Asia 15%, and LatAm the remaining.
Description by product:
Pro Tools is technically referred to as a digital audio workstation (DAW) and is Avid’s largest product at ~2/3 of subscriptions that cost ~$30/month. It is the undisputed leader in its category, which it achieved through 1) superior technology/IP (including a co-developed Dolby Atmos Production suite) and 2) its early entrenchment within the key community of Hollywood pros. For context, I have a friend who works in film audio in LA, and this is how he describes Pro Tools’ competitive positioning –
“it is just accepted that if you want to do any kind of audio or recording/mixing work in LA you have no choice but to use it. I think even if something else came along that was a better product (not likely in my opinion) I'm not sure how much business it would take away from ProTools as everyone uses it and being able to share compatible project files from team to team on a recording or movie is crucial. For something to really challenge protools they would have to be way better and way cheaper to the point where a critical mass was reached and massive segments of the industry shifted at the same time”
While that is just one account, I am confident you will find similar sentiment across resellers and users. Even those who gripe about Media Composer losing share to Adobe’s Premiere Pro acknowledge that Pro Tools remains dominant.
Media Composer is also a well-established product and the clear leader for high-end video post-production because its technology is uniquely suitable for non-linear editing (aka collaborative editing where many people are working on a project at the same time). However, it is #2 behind Premier Pro in the broader prosumer market. Neither of these conditions are expected to change. Premiere Pro comes standard with Adobe’s Creative Cloud subscription that includes 20 other apps (Photoshop and Acrobat etc.) bundled into a $50/month package vs. Media Composer subscriptions starting at $24/month. Premiere Pro’s functionality and UX has improved over the years such that it is typically the better option for one camera, one editor type of work. That be said, Media Composer remains the only option for multiple editors working on a deadline, and I have found no indication that Adobe has or will make inroads on the high-end. So despite being the more expensive and complicated tool, Avid successfully differentiates Media Composer as the premium “Hollywood” brand, and has started showing healthy growth within the massive prosumer market after releasing a significant UX/UI upgrade in mid-2019.
NEXIS is a hardware/software tandem built to handle high-performance editing and storage on massive data files (films/shows). This is what Avid refers to as “Integrated Solutions,” which historically was an on-premise only option. Given its high attachment with editing tools and significant market share today, NEXIS positions Avid strategically to facilitate the industry’s move to the cloud. While cloud adoption presents unique challenges for the film industry given the high data rates needed and obvious security concerns, the transition is viewed as inevitable driven by 1) the value of distributed work and 2) cost savings derived through AI-enabled automation only available in cloud architectures. Avid partnered with Azure to move MediaCentral workflows into the cloud. Note that Microsoft was the obvious choice given Amazon is viewed as a competitor by studios. Avid’s cloud storage options are multi-tiered spanning high-performance, nearline, and archival.
Context – This stock has been pitched on VIC multiple times, including a recent timely and well-written post from about a year ago that I suggest reading for more background. The stock was at $8 then versus $26 now so I realize it screens as less interesting, in particular to value folks. However, I think the company remains poised to create significant value for shareholders through earnings growth and excess cash generation. Management finally completed a decade-long turnaround effort and recent results indicate the business is just now hitting its stride. Avid is well-positioned to capture tailwinds from the proliferation of content across streaming platforms that supports durable growth characteristics. Furthermore, as a company with a checkered past that just crossed $1B of market cap, it is not hard for me to believe that Avid remains underfollowed within the investment opportunity despite the stock’s recent appreciation.
Growth – At their investor day last May, management provided financial goals for 2025 that show a 5-yr 31% CAGR for EPS to $2.50 (21% CAGR if you use 2021 guidance as a starting point). Inclusive of opportunistic capital allocation, the company’s aspirational EPS goal is $3.11 (37% 5-yr CAGR, 28% 4-yr). Net debt / EBITDA is already under their 2x target and the business is steadily generating cash so this capital allocation scenario is warranted. The 2025 metrics are not guidance, but this management team has earned credibility for providing realistic goals. The primary drivers in their forecast are 1) continued transition of software from legacy license to subscription model enabling Avid to capture higher recurring revenue and better upsell opportunities, 2) sustained end-market tailwinds (streaming content wars), and 3) attaching new cloud workflows building off its incumbency in vertically-integrated storage assets.
Valuation – AVID currently trades 21x 2021 EPS, in-line with the S&P. Adobe is the bell-weather for creative software and trades 50x ’21 EPS. ADBE is obviously a higher-quality franchise but is growing more slowly (mid-teens EPS CAGR) and both companies are benefitting from similar end-market tailwinds. I think it is reasonable to assume AVID can hold its current valuation metrics, in which case shareholders can underwrite attractive returns via earnings growth. Pushback will predictably be around the multiple’s recent rerating, but because Avid was an over-levered turnaround story, backwards looking EBITDA-based valuation metrics are no longer relevant. The balance sheet is healthy and the business has clearly transformed under new leadership. I expect Avid to keep growing revenue and expanding margins to support 20%-30% shareholder returns over the next 3-5 years.
Recent trading – The stock got ahead of itself and ran up to $40 in July only to get whacked after Q2 earnings underwhelmed. It has now settled in the ~$26 range, which I believe presents an attractive entry point from which to keep compounding. The key question is if Avid’s business momentum coming out of COVID is sustainable, or did Q2 earnings completely catch management by surprise such that their 2025 goals, which were given just two months prior to reporting Q2, should now be viewed as overly aggressive.
Please reference prior write-ups for more context, but upon doing my own homework via transcripts, investor days, and expert calls, here are some key points:
In late 2012, Avid announced they had been booking software revenue upfront that should have been amortized over time. This necessitated a large accounting restatement and a temporary delisting from the NASDAQ (Feb 2014 – Dec 2014). The restatement also makes analyzing past periods through 2017 difficult. Even as of 2017, non-cash revenue associate with the restatement accounted for over 60% of adjusted EBITDA and almost 20% of maintenance revenue. There remains a small amount of non-cash amortization but it now represents < 10% of EBITDA and < 4% of maintenance revenue and gets minimal attention.
While the accountants sorted through the mess, two other factors were pressuring Avid’s business. 1) It had large exposure to TV broadcasters and the decline/consolidation there presented headwinds. Weak broadcast trends remain but its impact on Avid has diminished. Streaming companies like Netflix and HBO are also big customers so things have evened out. 2) Apple made inroads into Avid’s core high-end business with its Final Cut Pro product. This project was Steve Jobs’ baby, and apparently could have killed Avid had Apple kept pressing. Tim Cook since deemphasized it, and Final Cut no longer represents much of a threat. However, it was a disruptive force that opened the door for Adobe and Blackmagic to try to push through. Avid fended them off and remains dominant among studios, but this created a period of heightened risk.
A new CEO, Louis Hernandez Jr., stepped into role in 2013. He was known as a financial operator and pushed Avid on a path towards subscription sales over licenses. While the right strategy directionally, he ended up damaging the company further. He was fired in early 2018 amidst complaints of sexual abuse and misconduct, and his reign saw considerable brain drain and a lack or reinvestment in products. The fact that Avid survived under such poor stewardship is testament to how entrenched its products are among users. However, it came at the cost of share loss to Adobe within the mid-tier video market, in particular among millennials and new users. During this period, Avid rested on its laurels as the “Hollywood brand” while Adobe kept improving Premier Pro. New management has since stemmed the bleeding, and while Adobe remains a threat, at least Avid is now proactively competing and showing healthy growth.
The current CEO, Jeff Rosica, took over in early 2018 as an internal promote from the President role. Reference checks on Jeff have been consistently strong, but given he had been with Avid since 2013, it took a while for investors to get comfortable. The company has now finally turned the corner by implementing the right playbook:
Refreshed the c-suite and reorganized leaders across business solution areas
Put greater emphasis on listening to users, tailoring the product with new UX/UI, and investing in customer success teams. This was critical because whereas Avid always had leading technical capabilities, it was seen as too complicated for prosumers to adopt. The company also stepped up its pace of innovation to fortify its position, aided by more frequent upgrades facilitated through the subscription model.
Brought new energy into educational outreach to high schools and colleges, an important way to seed adoption among younger generations that were increasingly going Adobe-only
This management team has largely delivered on financial targets thus far, and the turnaround is best captured in the numbers. Note that I am only showing 2018 onward because historical comparison prior are complicated by 1) the restatement and 2) Avid switched to the 606 accounting standard in 2018.
First subscription growth took off:
Revenue followed (note the fall-off in integrated solutions is primarily a function of live events declining during COVID and will bounce back):
Manifesting in meaningful growth in EBITDA and FCF (again EBITDA would be even better if not for integrated solutions):
Execution during COVID – Growth throughout 2020 underscored Avid’s its ability to push the subscription model across both channels – creatives and enterprise:
As demand for remote editing picked up, Pro Tools and Media Composer subscriptions saw spikes in net adds among creatives. Retention commentary from management and resellers on new cohorts has been encouraging thus far, and the steady conversion to paid upfront is testament to that.
Enterprises that had been pushing out software refreshes are now finally seeing a need to reinvest in their tech stacks to support more distributed workflows. In Q4, Avid started reporting enterprise conversions to subscriptions for the first time (orange bar).
A few more points to add:
For a long time, a primary concern for the thesis had been that Avid is not actually adding new customers, just converting old users to subscription (license holders who had stopped paying maintenance). This risk is diminishing. When demand spiked for remote editing tools during COVID, Avid was clearly able to participate (similar to Adobe). This is also backed up by data released in the investor day deck. Active maintenance users on creative software declined by approx. -10,000 in 2018 and -9,000 in 2020 while creative software subscriptions grew +63,000 and +109,000, respectively. The difference in magnitude is evidence that the company is clearly adding net new users at a healthy clip.
Standing up an e-commerce channel while managing reseller relations was critical to unlock subscription growth. E-comm has been Avid’s primary source of subscriptions to date, and now accounts for over 20% of revenue, up from 12% in 2019. Adding a freemium option in 2017 was an important step, and download data remains strong. Avid surpassed 3 million downloads in early 2021 with the third million taking 11 months versus 18 months for the second.
Although Media Composer is most exposed to the Adobe threat, subscriptions have been growing 40-60% growth since 1Q20 following the mid-2019 product upgrade. Also, It was notable to see Avid add a tighter integration between Premier Pro and NEXIS in 3Q20. This was a defensive move, but suggests management is comfortable competing alongside Adobe.
Reasons for the sell-off:
Elevated expectations – Avid reported in-line numbers and reiterated full year guidance for most metrics with a slight increase for FCF. The stock fell -20% that day and has continued sliding. Given the huge run-up in shares following the strong Q1 report and analyst day, it was not surprising to see some weakness. The market was clearly positioned for a beat and raise.
Delta outbreak hurting rebound in live sound – This created continued drag on Avid’s integrated solutions business, which was likely the main reason management did not raise guidance.
Underwhelming subscriber net adds and declining ARPU – Q2 net adds of +19k was -22% yoy. Calculated ARPU was -11% yoy. Both these numbers look even worse given enterprise subscriptions are just starting to contribute to the base (+4k in 2Q21 vs 0 in 2Q20). This implies the “creative” tier net adds was -39% yoy like-for-like. Also, enterprise subscriptions are supposed to be higher ARPU, so the decline there was surprising given the mix in net adds.
Given points #1&2 are transient, #3 is the one worth focusing on, and here are some mitigating factors:
Lapping an extremely strong number in a seasonally weak quarter – Q2 is soft seasonally due to the education market calendar. COVID boosted numbers massively last year. The +15k net adds in creatives was still up 43% from 2Q19.
COVID pulled forward demand, which appears to be a market-wide trend – Given the surge witnessed last year during WFH (2Q20 net adds +132% yoy), naturally there was some temporary pull-forward that will even out over time. Adobe’s Q3 (June – August) guidance was also weak versus expectations and showed net new ARR down sequentially by -15%. I realize Adobe’s product suite is broader and their reporting dates do not match up perfectly so this comparison is not perfect. However, it was interesting to see Adobe’s management provide similar commentary explaining the soft guide (i.e. seasonality returning after an unusual 2020 with expectations for a strong Q4–
From Adobe’s call 6/17/21:
Analyst: …on the guide into Q3. The net new ARR guide is about down 15% sequentially. I think that's more than we've seen seasonally. Is there anything we should be aware of in terms of either kind of onetime items, if you will, in Q2 or something we should be looking out for in Q3 that explains that broader than -- or sort of bigger than normal seasonality or seasonal decline into Q3?
ADBE CFO: When I look at the guide for Q3, it's the largest guide we've done for ARR into Q3. As we talked about the last couple of quarters, last year was kind of a really strange year, right? We didn't see the seasonality we typically saw because of the pandemic and everybody being locked down. As things are starting to open up, we're anticipating kind of a return to some of that seasonality that we saw in the past. And so we factored that into the guide. But we're really excited that we can actually target the highest ARR guide ever in Q3. So overall, great performance, and we can see the momentum is still in the business.
Avid’s CEO on their Q2 call:
First of all, the comp, as we know, Q2 is a tougher comparison given the abnormal condition we saw last year due to COVID. But I'll say that we continue to see really strong subscription adds across the portfolio and gross license. Don't forget too Steve that Q2 is -- if you take -- you got to kind of look at COVID has a kind of a weird anomaly and also even seasonality. But if you remember going back a couple of years, Q2 has always been one of our seasonally weaker quarters for net adds just because you've got the calendar of education markets. And so, that's always going to weigh on Q2 from a net adds. But again, we delivered a very, very strong net adds for the quarter and we're very happy with that progress. I think it's just -- again this is a tougher comparison given where we are last year. But we like what we're seeing on the trajectory of the market. And we like what we see as we look towards the second half and we look towards '22.
A higher paid upfront mix is a good thing but can drag ARPU. Paid upfront in 2Q21 grew to 31% of total subscriptions versus 22% in 2Q20. For Pro Tools, paid upfront translates to $25/month vs $30 annual paid monthly and $35 month-to-month (similar spread for Media Composer).
606 accounting can distort the ARPU math. Subscription revenue is not always recognized ratably, even outside enterprise deals. This is not intuitive, but the CFO explained it back on the 1Q19 call. As a result, big bookings quarters last year created tough comparisons doing the simple rev divided by subs math. This lumpiness can distract from what is fundamentally going on with the business.
Avid CFO on 1Q19 call - Also, ASC 606, when you have an enterprise deal or a big -- or even a large consumer deal, under the 606 standard, you book 80% of it roughly in the quarter. So there were just more transactions in the fourth quarter due to those promotions that resulted in the revenue being recognized in that period.
Mix of Pro Tools was lower, which makes blended ARPU math look worse but is not necessarily concerning. Pro Tools is the highest ARPU product at $30/month vs Media Composer $24. Pro Tools subscriptions were growing close to 70% throughout last year versus Media Composer 50%. In 2Q21, Pro Tools decelerated to 40% while Media Composer remained at 50%.
#1 - Migrating from licenses to subscriptions: This remains a big opportunity and is a tried and true recipe for software companies that have been underearning their potential. Office 365 is a famous example of what a successful transition can look like, and this only works for entrenched products with strong user engagement. While I do not intend to equate Avid with Microsoft, Avid’s tools have proven exceptionally resilient despite a decade of poor stewardship. By steadily moving legacy users into a higher recurring monetization model, Avid can generate revenue growth with low incremental CAC. Among creatives, there were still 175,000 active maintenance users under the legacy model as of the end of 2020. More than half of Media Composer’s users remain on perpetual licenses. The company does not provide investors with the granularity to run exact uplift calcs, converting to subscription is clearly driving higher recurring revenue as demonstrated by the following comment by Avid’s Senior VP of Video at the 2021 analyst day -
“We have seen tremendous growth in subscriptions as we transition existing customers to subscription while adding net new users. In the past 12 months, more than 18,000 new Media Composer subscription licenses were activated, and that grew our installed base by 41% while driving a 136% increase in revenue year-over-year. Now we accomplished these results by adding value to our subscription offers with technology innovation.”
Subscriptions are also a better way to price to support new user growth and enterprise net retention. For the prosumer market, subscriptions open up access because new users can avoid a large upfront payment. A Pro Tools perpetual licenses costs $600 vs monthly subscription ~$30. You would have to be a hardcore user to justify $600, and by bringing down the financial barrier to adoption, Avid is seeing user growth. For the enterprises tier, under the old model, license acquisition was a capex decision requiring procurement cycles. Per convos with resellers, enterprise users would typically not think about upgrading unless new features justified repurchasing licenses, and we know Avid historically was not reinvesting aggressively enough. Also, the software is stable such that old versions did not require much maintenance. As a result, enterprise users would aggressively try to negotiate maintenance fees lower over time. The subscription model fixes this by 1) shifting capex decisions into opex that can be flexed up and down and 2) attaching a higher recurring stream that includes maintenance. Through subscriptions, Avid can also more easily keep users updated with new software releases without needing to battle sunk cost inertia. This benefits net retention through more frequent cross-sell/upsell opportunities. Avid provided a slide (below) in their 2017 analyst day contrasting the two models for enterprises. It showed a 26% lift in total dollar value, and Avid’s CRO reiterated at the 2021 analyst day that they are seeing a 20-30% lift in enterprise ARPU in enterprise migrations to subscriptions.
This slide (also from 2017) captures the strategy nicely –
#2 - Penetrate a large and expanding market: In recent years, Avid has clearly found success in the prosumer market, which has been an open-ended growth story for Adobe. Adobe has $2B of creative cloud ARR that is still growing 25%, and management there recently revised their TAM estimate for Creative Cloud up to $41B from $31B. Adobe’s product suite is obviously broader, but directionally this shows underlying end market strength driven by growth in creative professionals, communicators, and consumers. Avid is investing into a backdrop of media democratization whereby artists and creatives face lower barriers to produce and distribute their work. The proliferation of iPhones and Youtube serve as an onramp for the space. Avid benefits as amateurs naturally become more sophisticated and seek out premium tools. Management pegs Avid’s TAM at 3M users today and plans to invest such that it can attack a 10x greater pie. Adding new tools (including via tuck-in M&A) is a natural playbook to follow for editing platforms like Pro Tools and Media Composer. While I do not pretend to know the exact TAM for Avid, I feel confident that it is large enough to support long-term growth, and their existing 350,000 subscription count is just scratching the surface. The following slides (pasted from analyst day deck) highlight these trends:
#3 - Cloud + enterprise SaaS: This is just getting started but momentum is clearly building:
In September 2019, Disney, Azure, and Avid announced a partnership exploring how to migrate workflows into the cloud. This news was an important proof point to establish that Avid will continue to play an important role even among the heavyweights.
Then COVID created new urgency for the industry to adopt cloud-enabled tools. In 1Q20, Avid launched an early access program for Edit-on-Demand, its first enterprise SaaS tool that combines Media Composer’s editing functionality with NEXIS intelligent storage hosted on Azure. Given the circumstances, this product saw good early traction and was released for general availability in March 2021. This is how one of Avid’s UK resellers describes Edit on Demand and the value prop is clear enough –
Post pandemic, all bets are off. You've got a situation where your customers don't necessarily want to come in to Central London. They certainly don't want to sit in crammed rooms with lots of people with whom they may or may not want to be in close proximity. And the technology is allowing the customers to act upon the realization they've made, which is fundamentally that they missed an enormous trick that their entire customer base are across the entire country. So you've got the guys who run London post-production companies realizing that they could -- all this time, they've been selling their services to people in Leeds and Glasgow and all over the U.K. rather than insisting on them coming to a physical location in Central London in order to do what they need to do. So on with that realization, there's this -- there's been this sort of freeing effect. And with editor on demand, so a technology which is now maturing at just the right time, you've got a situation where previously you'd have to make an enormous investment in real estate, in personnel, in equipment; and rent that investment pretty hard to get a return. So an opportunity to use EOD to service that demand whilst not exposing their business to any more risk is hugely attractive.
In December 2020, Avid added two executives focused on the cloud – new CTO (role had been vacant since 2018) and created a new role for SVP & GM of Media Platform & Cloud Solutions.
This cloud transition will take years to play out, but it adds an exciting new growth engine for Avid. While difficult to predict the exact impact for Avid, it is clear they are attractively positioned, and it has the potential for an outsized financial impact on a company doing under $300M of recurring revenue today.
Bridging to 2025 aspiration goals