RIMAGE CORP RIMG S
May 03, 2012 - 12:56pm EST by
zax382
2012 2013
Price: 9.00 EPS $0.00 $0.00
Shares Out. (in M): 10 P/E 29.0x 0.0x
Market Cap (in $M): 94 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT -1 0
TEV ($): 30 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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  • Failed Acquisition
  • Cash Burn
  • Secular Short

Description

NOTE: While I still like this idea, I loved it about $2 higher and didn’t get around to writing this until now – barring any EXTREMELY positive news out of the company re: Qumu, any price in the double digits I believe should be shorted aggressively.

I am recommending a short of Rimage (NASDAW: RIMG) common equity.  It is a largely unknown name that recently shot itself in the foot with a sizeable acquisition and is now bleeding out via poor management and execution of all parts of the business.  The below is envisioned to put the name on more radars than to reveal anything earth shattering.

Rimage is a boring little company that many small cap value investors have probably come across at some point in the last two years due to the Company’s extremely high level of cash extremely low EV.

The majority of Rimage’s revenue is derived from the production and sale of digital publishing systems that are used by businesses to produce recordable CDs, DVDs and Blu-ray discs with customized digital content – a fancy way of saying they produce machines that burn data to discs in mass quantity, a pretty simple business.  They also earn a smaller portion of their revenue from services and repairs to these systems and consumables such as blank discs, disc labels, ink, etc. (I'm not going to spend much time on this part - despite it being their largest revenue source, one can see by the decline in the business for the last 5 years and common sense of where the technology world is headed that burning discs is going away)

Their customer base includes law enforcement (digital surveillance and evidence discs), hospitals (transfer of physical film and records to discs), motion picture and tv studios (dailies, post-production discs, consumer video), consumer (photo discs in Walgreens, Wal-Mart, etc.) to name a few.

After you read this, you probably went ahead and wrote it off as a dying business, destined to fade into oblivion like the dodo or RIMM.  You would have been correct and the market agreed, awarding it a multiple floating around 0.3x EBITDA last fall.  However, given the cheap valuation and a number of small activists clamoring for a return of capital, it wasn’t a great short candidate either.  At one point, I myself was even a fan of this overlooked value and applauded the moves by those activists pushing management to give back some of the cash hoard in the form of a large dividend or tender.

However, after several personal conversations with management and numerous other conversations with shareholders whom had also spoken to management, I became increasingly worried that management not only had no intention of returning that cash, but that they were looking for a fancy and likely very expensive way to use it to pivot away from their dying disc-burning  business. 

Qumu Acquisition

Management confirmed all equity owners’ fears in early October, purchasing enterprise video communications company Qumu for $52MM, or ~5x FY11 revenue.  Qumu allows customers to capture, organize and distribute content (primarily video) to computers and mobile devices and primarily targets enterprises with 5,000+ employees and competes with Cisco and Polycom, two much more established and well capitalized companies.  Product deployment costs can range from less than $100k to millions of dollars.

Rimage used approx. $39mm in cash for the purchase (about 1/3 of their total).  To satisfy the other $13mm of the purchase price, Rimage issued 1mm shares of common stock, a move that would generally imply management’s belief its shares are overpriced relative to the cash on hand; however, in this case, management had been actively repurchasing almost 3% of outstanding shares prior to the acquisition, generally a sign that shares were viewed as undervalued – a real head scratcher and definite red flag for shareholder value destruction – not to mention the fact that management was incentivized by their bonus plans to make an acquisition – see below for more on the payout...   

Clearly realizing this was a raw deal for shareholders, Rimage management announced the deal 24 hours before its planned closing – sorry shareholders, no time/ability to try to object.  Management touted Qumu as a “cornerstone acquisition [to] position [Rimage] as a leader in the growing market for video communications and social enterprise applications for business” and projected revenue of $15mm in 2011 and $21mm in 2012.  They raised their FY11 revenue guidance from a midpoint of $82.5mm to a midpoint of $87mm (expecting $4-5mm of revenue from Qumu between close and FYE) and adjusted earnings back slightly to $0.42 to $0.45 take into account transaction costs.  To placate shareholders, Rimage also increased their dividend by 70% from $0.40/share to $0.68/share.

Along with the acquired technology, Rimage more than doubled their R&D staff and brought in a number of other employees including Ray Hood, who received $450k of options awards and will receive a $300k salary.  For their part, existing Rimage management received an aggregate ~$380k (30-45% of base salary for top 4 executives) because Qumu had achieved $154% of their targeted goal for revenue (recall they bought the business in October, so this was a layup).   Though Qumu was (and is) cash flow negative, management needed only to fulfill their revenue goal in order to receive their hard earned bonuses.  The point being, Qumu served as a way for Rimage management to blow part of their piggy bank and enrich themselves on what is effectively a stage C venture capital investment that competes with several tech heavyweights in an area which, from management’s own words in the 10K, has “relatively low barriers to entry.”

Where We Are Today

Despite management hopes for ~$5mm of Qumu revenue between acquisition and their December FYE, the company managed only $1.8mm in revenue, while transaction costs and the business itself (to a small degree) dragged earnings to $(0.13) for the quarter.  As a result, 2011 revenue and earnings guidance were lowered in mid-January, causing the stock to fall 10% that day.  Though the share price slowly climbed back to the level before the announcement in the subsequent two weeks, the announcement of FY11 earnings of only $83mm in revenue and $0.29 share of earnings and guidance for decreased revenue and earnings in 1Q12 started the long slide to where we are today.

For Q1, though Rimage did manage to meet its downbeat guidance for 1Q, full year guidance was softened again and my expectation is that flat revenue would be something between a base and upside case for the company at this point.  Qumu managed a paltry $1.4mm in revenue and the core disc business saw revenue decline 16%.  Below I have laid out my a few scenarios for the rest of the year based on management guidance for significantly higher SG&A and R&D expenses due to both increased headcount from Qumu as well as greater spending towards Qumu and the company’s cloud content pushing system, Signal (which I didn’t really discuss as it is still under development, faces possibly even stiffer competition than Qumu from a number of large cloud-based enterprise solutions and won’t really have a meaningful revenue/earnings impact, only costs for at least the near to medium-term).  Only 2012 is compared against 2011 because frankly, a 3-5yr projection is somewhat meaningless given the share price now and rate of decline in the business.

Though Qumu has not yet achieved its goal of helping Rimage pivot business away from their disc burning business, it has helped to distract management, drastically raise headcount and costs and even misdirect Rimage’s existing sales force.  While it has now been a few months since my last conversations, I spoke to several regional sales reps about the core Rimage business and new business initiatives (Qumu, Signal and new channels for core Rimage), which was discouraging at best.  Management was described as sitting in a tower dictating to the sales people, machine refreshes were decreasing and they did not at that time have much grasp on targeting clients for the new business initiatives.  The final point was just made clear in the latest conference call where Rimage CEO Sherman Black blamed some of the softness at Qumu on their best sales guy (the CEO, Hood) being distracted by the merger and integration process – nobody else on the ground is driving sales.   

Valuation

The financials below are a relatively simple analysis based primarily on management’s own commentary and some conservative assumptions to show that even if management can stop the top line bleed, the costs associated with their ill-conceived pivot of the business will likely overwhelm the positive top line contributions

Upside Case

 

  FY11 FY12              
Qumu 1.76 11.99 FY12 represents 10% revenue increase based on FY11 full-year revenue of $10.9mm
Core Rimage 81.87 71.64              
Change in Core -7.7% -12.5%              
 

 
Rev 83.63 83.63 Flat revenue conservative given accelartion of disc publishing attrition, flat to down YoY guidance for 2Q
 

             
GP 42.02 42.02              
GM% 50.2% 50.2% Assume flat margins - likely generous given Qumu contribution thus far
                   
SG&A 30.09 33.10 Assume conservative 10% increase in SG&A; actual increase from 3Q (pre-Qumu) to 4Q11/1Q12 = 50%
R&D 7.26 7.98 Assume conservative 10% increase in R&D; actual increase from 3Q (pre-Qumu) to 1Q12 = 100%
Amort 0.22 0.22              
 

             
Operating Inc. 4.45 0.71              
                   
Interest Inc. 0.20 0.20 Flat from FY11, though may decrease non-materially
Other 0.03                
EBT 4.67 0.91              
                   
Tax % 42.8% 40.0%              
 

             
Net Income 2.67 0.55              
Min. Interest 0.16 0.16              
                   
Shares 9.670 10.244 Share count stays flat from1Q12
EPS $0.29 $0.07              
   
 
             
EBITDA $7.19 $3.45              

Base Case

 

 

  FY11 FY12                  
Qumu 1.76 10.90 FY12 revenue flat from FY11 full-year revenue of $10.9mm - may be aggressive given 4Q11/1Q12 performance
Core Rimage 81.87 71.64                  
Change in Core -7.7% -12.5% Assume accelaration of decline in core business, same as upside case
 

 
Rev 83.63 82.54 Flat revenue conservative given accelartion of disc publishing attrition, flat to down YoY guidance for 2Q
 

                 
GP 42.02 41.27                  
GM% 50.2% 50.0% Assume margins decrease slightly, stay flat from 1Q12 for the year
                       
SG&A 30.09 39.12 Assumes 30% YoY increase in SG&A; actual increase from 3Q (pre-Qumu) to 4Q11/1Q12 = 50%
R&D 7.26 10.89 Assume 50% YoY increase in R&D; actual increase from 3Q (pre-Qumu) to 1Q12 = 100%
Amort 0.22 0.22                  
 

                 
Operating Inc. 4.45 -8.96                  
                       
Interest Inc. 0.20 0.20 Flat from FY11, though may decrease non-materially
Other 0.03                    
EBT 4.67 -8.76                  
                       
Tax % 42.8% 40.0%                  
   
 
                 
Net Income 2.67 -5.26                  
                       
Min. Interest 0.16 0.16                  
                       
Shares 9.670 10.244 Share count stays flat from1Q12
EPS $0.29 -$0.50                  
   
 
                 
EBITDA $7.19 -$6.22                  

As mentioned above, Rimage has historically traded at very low multiples on an EV/EBITDA basis because the market viewed the business as a slowly dying relic.  Over the last two years, the average EV/EBITDA multiple was only 3.28x and leading up to Qumu, the multiple was at or below 1x.  Assuming that RIMG trades even at its average multiple of the past two years and performs to my upside scenario, there is moderate downside to share price, if it trades at its average multiple immediately preceding Qumu, there is significant downside as seen below:

Upside Case w 2 Yr Avg. Multiple
Multiple 3.28x
EBITDA 3.45
TEV $11.34
Cash 67.92
Market Cap $79.26
Shares 10.244
Price $7.74
   
Current Price $9.09
Delta -14.9%
Upside Case w pre-Qumu Avg. Multiple  
Multiple 1.18x
EBITDA 3.45
TEV $4.07
Cash 57.81
Market Cap $61.88
Shares 10.244
Price $6.04
   
Current Price $9.09
Delta -33.5%
 

Conclusion/Risks

Barring meaningful growth in the Qumu, Rimage is slowly relegating itself to the garbage.  With sharply increasing R&D as well as SG&A costs and slowly decreasing revenue, I believe it will not be too long (likely within 18 months or less if no drastic change) before negative cash flow causes the company to have to cut their dividend or remove it altogether.  As negative cash flow eats away at the balance sheet and the value cushion disappears, the floor is the limit.  I see very little risk of a buyer coming in at all, much less with any sort of premium that may squeeze shorts, because there is little to salvage unless Qumu is written off completely (and soon).  The only real risk is that Qumu outperforms by a large margin, which, with almost 2Qs of performance under its belt has proved elusive.  Though I don’t love the idea at or below $9, the risk/reward is still pretty good and watch out for 2Q – if it looks like 1Q, I believe we’re in for a sharp drop and management will likely have to guide down again…if only they had just returned all that cash to its rightful owners.

Catalyst

1Q earnings just occured and were well short of management expectations - shares will likely continue to slide.  2Q earnings will be the next upcoming known hard catalyst.  A decrease or removal of the dividend would also be a good catalyst though timeframe on when (or if) that may occur are unclear.
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    Description

    NOTE: While I still like this idea, I loved it about $2 higher and didn’t get around to writing this until now – barring any EXTREMELY positive news out of the company re: Qumu, any price in the double digits I believe should be shorted aggressively.

    I am recommending a short of Rimage (NASDAW: RIMG) common equity.  It is a largely unknown name that recently shot itself in the foot with a sizeable acquisition and is now bleeding out via poor management and execution of all parts of the business.  The below is envisioned to put the name on more radars than to reveal anything earth shattering.

    Rimage is a boring little company that many small cap value investors have probably come across at some point in the last two years due to the Company’s extremely high level of cash extremely low EV.

    The majority of Rimage’s revenue is derived from the production and sale of digital publishing systems that are used by businesses to produce recordable CDs, DVDs and Blu-ray discs with customized digital content – a fancy way of saying they produce machines that burn data to discs in mass quantity, a pretty simple business.  They also earn a smaller portion of their revenue from services and repairs to these systems and consumables such as blank discs, disc labels, ink, etc. (I'm not going to spend much time on this part - despite it being their largest revenue source, one can see by the decline in the business for the last 5 years and common sense of where the technology world is headed that burning discs is going away)

    Their customer base includes law enforcement (digital surveillance and evidence discs), hospitals (transfer of physical film and records to discs), motion picture and tv studios (dailies, post-production discs, consumer video), consumer (photo discs in Walgreens, Wal-Mart, etc.) to name a few.

    After you read this, you probably went ahead and wrote it off as a dying business, destined to fade into oblivion like the dodo or RIMM.  You would have been correct and the market agreed, awarding it a multiple floating around 0.3x EBITDA last fall.  However, given the cheap valuation and a number of small activists clamoring for a return of capital, it wasn’t a great short candidate either.  At one point, I myself was even a fan of this overlooked value and applauded the moves by those activists pushing management to give back some of the cash hoard in the form of a large dividend or tender.

    However, after several personal conversations with management and numerous other conversations with shareholders whom had also spoken to management, I became increasingly worried that management not only had no intention of returning that cash, but that they were looking for a fancy and likely very expensive way to use it to pivot away from their dying disc-burning  business. 

    Qumu Acquisition

    Management confirmed all equity owners’ fears in early October, purchasing enterprise video communications company Qumu for $52MM, or ~5x FY11 revenue.  Qumu allows customers to capture, organize and distribute content (primarily video) to computers and mobile devices and primarily targets enterprises with 5,000+ employees and competes with Cisco and Polycom, two much more established and well capitalized companies.  Product deployment costs can range from less than $100k to millions of dollars.

    Rimage used approx. $39mm in cash for the purchase (about 1/3 of their total).  To satisfy the other $13mm of the purchase price, Rimage issued 1mm shares of common stock, a move that would generally imply management’s belief its shares are overpriced relative to the cash on hand; however, in this case, management had been actively repurchasing almost 3% of outstanding shares prior to the acquisition, generally a sign that shares were viewed as undervalued – a real head scratcher and definite red flag for shareholder value destruction – not to mention the fact that management was incentivized by their bonus plans to make an acquisition – see below for more on the payout...   

    Clearly realizing this was a raw deal for shareholders, Rimage management announced the deal 24 hours before its planned closing – sorry shareholders, no time/ability to try to object.  Management touted Qumu as a “cornerstone acquisition [to] position [Rimage] as a leader in the growing market for video communications and social enterprise applications for business” and projected revenue of $15mm in 2011 and $21mm in 2012.  They raised their FY11 revenue guidance from a midpoint of $82.5mm to a midpoint of $87mm (expecting $4-5mm of revenue from Qumu between close and FYE) and adjusted earnings back slightly to $0.42 to $0.45 take into account transaction costs.  To placate shareholders, Rimage also increased their dividend by 70% from $0.40/share to $0.68/share.

    Along with the acquired technology, Rimage more than doubled their R&D staff and brought in a number of other employees including Ray Hood, who received $450k of options awards and will receive a $300k salary.  For their part, existing Rimage management received an aggregate ~$380k (30-45% of base salary for top 4 executives) because Qumu had achieved $154% of their targeted goal for revenue (recall they bought the business in October, so this was a layup).   Though Qumu was (and is) cash flow negative, management needed only to fulfill their revenue goal in order to receive their hard earned bonuses.  The point being, Qumu served as a way for Rimage management to blow part of their piggy bank and enrich themselves on what is effectively a stage C venture capital investment that competes with several tech heavyweights in an area which, from management’s own words in the 10K, has “relatively low barriers to entry.”

    Where We Are Today

    Despite management hopes for ~$5mm of Qumu revenue between acquisition and their December FYE, the company managed only $1.8mm in revenue, while transaction costs and the business itself (to a small degree) dragged earnings to $(0.13) for the quarter.  As a result, 2011 revenue and earnings guidance were lowered in mid-January, causing the stock to fall 10% that day.  Though the share price slowly climbed back to the level before the announcement in the subsequent two weeks, the announcement of FY11 earnings of only $83mm in revenue and $0.29 share of earnings and guidance for decreased revenue and earnings in 1Q12 started the long slide to where we are today.

    For Q1, though Rimage did manage to meet its downbeat guidance for 1Q, full year guidance was softened again and my expectation is that flat revenue would be something between a base and upside case for the company at this point.  Qumu managed a paltry $1.4mm in revenue and the core disc business saw revenue decline 16%.  Below I have laid out my a few scenarios for the rest of the year based on management guidance for significantly higher SG&A and R&D expenses due to both increased headcount from Qumu as well as greater spending towards Qumu and the company’s cloud content pushing system, Signal (which I didn’t really discuss as it is still under development, faces possibly even stiffer competition than Qumu from a number of large cloud-based enterprise solutions and won’t really have a meaningful revenue/earnings impact, only costs for at least the near to medium-term).  Only 2012 is compared against 2011 because frankly, a 3-5yr projection is somewhat meaningless given the share price now and rate of decline in the business.

    Though Qumu has not yet achieved its goal of helping Rimage pivot business away from their disc burning business, it has helped to distract management, drastically raise headcount and costs and even misdirect Rimage’s existing sales force.  While it has now been a few months since my last conversations, I spoke to several regional sales reps about the core Rimage business and new business initiatives (Qumu, Signal and new channels for core Rimage), which was discouraging at best.  Management was described as sitting in a tower dictating to the sales people, machine refreshes were decreasing and they did not at that time have much grasp on targeting clients for the new business initiatives.  The final point was just made clear in the latest conference call where Rimage CEO Sherman Black blamed some of the softness at Qumu on their best sales guy (the CEO, Hood) being distracted by the merger and integration process – nobody else on the ground is driving sales.   

    Valuation

    The financials below are a relatively simple analysis based primarily on management’s own commentary and some conservative assumptions to show that even if management can stop the top line bleed, the costs associated with their ill-conceived pivot of the business will likely overwhelm the positive top line contributions

    Upside Case

     

      FY11 FY12              
    Qumu 1.76 11.99 FY12 represents 10% revenue increase based on FY11 full-year revenue of $10.9mm
    Core Rimage 81.87 71.64              
    Change in Core -7.7% -12.5%              
     

     
    Rev 83.63 83.63 Flat revenue conservative given accelartion of disc publishing attrition, flat to down YoY guidance for 2Q
     

                 
    GP 42.02 42.02              
    GM% 50.2% 50.2% Assume flat margins - likely generous given Qumu contribution thus far
                       
    SG&A 30.09 33.10 Assume conservative 10% increase in SG&A; actual increase from 3Q (pre-Qumu) to 4Q11/1Q12 = 50%
    R&D 7.26 7.98 Assume conservative 10% increase in R&D; actual increase from 3Q (pre-Qumu) to 1Q12 = 100%
    Amort 0.22 0.22              
     

                 
    Operating Inc. 4.45 0.71              
                       
    Interest Inc. 0.20 0.20 Flat from FY11, though may decrease non-materially
    Other 0.03                
    EBT 4.67 0.91              
                       
    Tax % 42.8% 40.0%              
     

                 
    Net Income 2.67 0.55              
    Min. Interest 0.16 0.16              
                       
    Shares 9.670 10.244 Share count stays flat from1Q12
    EPS $0.29 $0.07              
       
     
                 
    EBITDA $7.19 $3.45              

    Base Case

     

     

      FY11 FY12                  
    Qumu 1.76 10.90 FY12 revenue flat from FY11 full-year revenue of $10.9mm - may be aggressive given 4Q11/1Q12 performance
    Core Rimage 81.87 71.64                  
    Change in Core -7.7% -12.5% Assume accelaration of decline in core business, same as upside case
     

     
    Rev 83.63 82.54 Flat revenue conservative given accelartion of disc publishing attrition, flat to down YoY guidance for 2Q
     

                     
    GP 42.02 41.27                  
    GM% 50.2% 50.0% Assume margins decrease slightly, stay flat from 1Q12 for the year
                           
    SG&A 30.09 39.12 Assumes 30% YoY increase in SG&A; actual increase from 3Q (pre-Qumu) to 4Q11/1Q12 = 50%
    R&D 7.26 10.89 Assume 50% YoY increase in R&D; actual increase from 3Q (pre-Qumu) to 1Q12 = 100%
    Amort 0.22 0.22                  
     

                     
    Operating Inc. 4.45 -8.96                  
                           
    Interest Inc. 0.20 0.20 Flat from FY11, though may decrease non-materially
    Other 0.03                    
    EBT 4.67 -8.76                  
                           
    Tax % 42.8% 40.0%                  
       
     
                     
    Net Income 2.67 -5.26                  
                           
    Min. Interest 0.16 0.16                  
                           
    Shares 9.670 10.244 Share count stays flat from1Q12
    EPS $0.29 -$0.50                  
       
     
                     
    EBITDA $7.19 -$6.22                  

    As mentioned above, Rimage has historically traded at very low multiples on an EV/EBITDA basis because the market viewed the business as a slowly dying relic.  Over the last two years, the average EV/EBITDA multiple was only 3.28x and leading up to Qumu, the multiple was at or below 1x.  Assuming that RIMG trades even at its average multiple of the past two years and performs to my upside scenario, there is moderate downside to share price, if it trades at its average multiple immediately preceding Qumu, there is significant downside as seen below:

    Upside Case w 2 Yr Avg. Multiple
    Multiple 3.28x
    EBITDA 3.45
    TEV $11.34
    Cash 67.92
    Market Cap $79.26
    Shares 10.244
    Price $7.74
       
    Current Price $9.09
    Delta -14.9%
    Upside Case w pre-Qumu Avg. Multiple  
    Multiple 1.18x
    EBITDA 3.45
    TEV $4.07
    Cash 57.81
    Market Cap $61.88
    Shares 10.244
    Price $6.04
       
    Current Price $9.09
    Delta -33.5%
     

    Conclusion/Risks

    Barring meaningful growth in the Qumu, Rimage is slowly relegating itself to the garbage.  With sharply increasing R&D as well as SG&A costs and slowly decreasing revenue, I believe it will not be too long (likely within 18 months or less if no drastic change) before negative cash flow causes the company to have to cut their dividend or remove it altogether.  As negative cash flow eats away at the balance sheet and the value cushion disappears, the floor is the limit.  I see very little risk of a buyer coming in at all, much less with any sort of premium that may squeeze shorts, because there is little to salvage unless Qumu is written off completely (and soon).  The only real risk is that Qumu outperforms by a large margin, which, with almost 2Qs of performance under its belt has proved elusive.  Though I don’t love the idea at or below $9, the risk/reward is still pretty good and watch out for 2Q – if it looks like 1Q, I believe we’re in for a sharp drop and management will likely have to guide down again…if only they had just returned all that cash to its rightful owners.

    Catalyst

    1Q earnings just occured and were well short of management expectations - shares will likely continue to slide.  2Q earnings will be the next upcoming known hard catalyst.  A decrease or removal of the dividend would also be a good catalyst though timeframe on when (or if) that may occur are unclear.
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