Breaking Down TiVo’s Valuation

Since last month, shares of TiVo (TIVO) have dropped from over $7 to under $5 each. This 32% selloff got my attention. Based on the company’s 3.6 million subscribers, each customer is being valued at $114 given the stock’s current price of $4.94 per share.

Since TiVo’s large distribution deal with Comcast (CMCSA) won’t take shape until mid-to-late 2006, the company has chosen to invest heavily in marketing (and show operating losses) until such deals kick in. Fortunately, the company has a large net cash position of $104 million, which can fund the company’s projected quarterly loss projection of $20-$25 million.

There is no doubt that TiVo faces extreme competitive pressures in the DVR marketplace. Nonetheless, the current value per subscriber of $114 seems low to me, given the scope of TiVo’s service and brand. Why somebody would not want to consider buying this company at this valuation escapes me. TiVo looks like an attractive speculative play at current levels.

What Do You Do When Your Market Is Going Away?

This is a question movie rental giant Blockbuster (BBI) is trying to answer. So far though, the company is at a loss for words. BBI shares lost 12% of their value Tuesday as the company lost more than twice as much money as expected in its second quarter. Blockbuster’s CEO predicted a return to profitability in Q4 and for all of fiscal 2006, but that will be a tall task.

With the advent of online DVD rental services and movies available on-demand from your local cable operator, the storefront-based rental market is going away. It might not be overnight, but instead little-by-little over the course of many years, but it is still going away.

Is it completely farfetched to think that 10 years from now you will be able to get Blockbuster’s entire movie lineup straight from your cable box? If this happens, and you can be sure companies like Comcast (CMCSA) have this idea in mind, Blockbuster’s stores and DVD mail order service are rendered useless.

Blockbuster’s Q2 2005 sales dropped 2% to $1.4 billion. The revenue breakdown was as follows: rentals 73% (down 5% vs 2004), merchandise sales 26% (up 12%), and late fees 1% (down 87%). Included in rental sales were the company’s 1 million online customers, who will now pay $17.99 per month. BBI raised the price from $14.99 this week since it wasn’t making money at the lower price originally targeted at taking market share from NetFlix (NFLX).

Now granted, merchandise sales were the only category up year-over-year, but Blockbuster has huge compeititon in this area. Best Buy (BBY), Wal-Mart (WMT), Circuit City (CC), Target (TGT), Amazon (AMZN), and the list goes on. All in all, how BBI expects to make money going forward is questionable.

As for the $7 stock, Blockbuster’s market cap is $1.35 billion, but they have more than $1.2 billion in debt and cash in the bank is falling precipitously. Blockbuster needs to figure out how to change their current business model to a profitable one in order to justify a $2.5 billion enterprise value.

Martha’s Rich Share Price

Somebody seriously should call Martha Stewart and give her a stock tip; tell her to sell her own stock. Martha Stewart Living Omnimedia (MSO) reported 2nd quarter numbers and the results do little to explain why the stock, at $28, is worth $1.43 billion.

Sales for the quarter were $46 million, broken down as follows: publishing (69%), merchandise sales (22%), internet sales (5%), and television programming (4%). Amazingly, MSO lost $33 million in the quarter, hardly a profitable business model. Even if you exclude items like equity compensation, and focus just on product costs as well as selling, general, and administrative expenses, MSO lost $11 million on $46 million sales.

Clearly investors are focused on the upcoming Apprentice show for added profitability. However, given that Martha’s current shows are contributing only 4% of sales, investors would be correct in asking how much the new NBC series could possibly materially add to earnings.

Can anyone out there please explain how this company is being valued at more than $1.4 billion? Until I can understand such a justification, I’d be betting against MSO shares.

Martha is Creeping Back Up

After making a hefty profit betting against Martha Stewart Living Omnimedia (MSO) earlier this year, it appears investors will get another chance to repeat that performance.

With Martha’s Apprentice show gearing up for its premiere, MSO shares once again look too expensive at nearly $30 each after rising 50% in the last few months. If the recent momentum carries this stock back into the 30’s, it’ll look like a good one to bet against again. To find out why I was bearish earlier in 2005, you can read my MSO piece from February 19th here

Sirius Momentum Accelerates Yet Again

Five Year Chart of Sirius:

The last year or so has been very volatile for shareholders of Sirius Satellite Radio (SIRI). A deluge of retail investor buying sent the stock soaring from $4 all the way up over $9 per share. However, such a dramatic move was not rooted in fundamentals but rather a feeling that the stock was a “must own”, especially in the single digits. Sirius quickly fell back to the $5 level and settled down.

In recent weeks the momentum has picked up once again, with SIRI shares trading above $7 each. The market value of the company stands at $9.44 billion, prompting me to once again remind investors that although the share price alone seems “cheap” on an absolute price basis, the expectations of the market are indeed very high once again.

Let’s assume a very bullish scenario and project the ultimate value of the Sirius franchise. There are about 200 million vehicles in the United States. Let’s assume half of all vehicles eventually have satellite radio, and of these, XM and Sirius split them 50/50. A subscriber count of 50 million nets Sirius annual revenue of $7.77 billion. It’s conceivable that Sirius could ultimately generate a 20% EBITDA margin when it gets to be that large. That puts annual EBITDA at $1.55 billion. A very generous 15x EBITDA multiple puts a fair value on Sirius of $23.25 billion, about 146% above current levels.

Sirius began 2005 with 1.1 million subscribers. It could take 20 years to get 50 million subs, much like it did with the cable tv industry. Investors willing to wait that long have a 7% annual return over 20 years waiting for them. Hardly impressive. And that assumes a lot of good things happen in the future that have not happened yet, such as a profitable business model and a 50% market share. And who’s not to say there won’t be more than two competitors in the marketplace in the future?

Kodak, Take Two

The upswing I caught in shares of film giant Eastman Kodak during 2003 and 2004 pretty much defines the kind of contrarian calls I tend to look for. The stock had fallen from nearly $100 down to the low 20’s. Sentiment was about as negative as it could get. Nobody was recommending investors buy and nearly everybody had a sell rating on it. The story was pretty bleak from a fundamental point of view. Consumers were all shifting from film-based cameras to digital and Kodak was far, far behind.

To diversify away from the traditional film business, EK started to beef up their digital camera product line and made some acquisitions in the medical imaging business, hoping for higher margins. In fact, they borrowed money to pay for the acquisitions. You can imagine how much Wall Street liked that. Investors hate it when companies take out debt for mergers or dividends, and usually they’re right.

However, what the Street failed to realize was that medical imaging was indeed a faster growing and more profitable business than film. Kodak cut their once 7% dividend to help fund the turnaround plan. Did it work? Well, the stock went from the low 20’s to the mid 30’s. Few people noticed because nobody owned the stock, but I was happy to cash out with a more than 50% gain in less than a year.

All of the sudden a weak first quarter earnings report has sent EK shares back down to $25 each. There haven’t been many downgrades though, as only 2 analysts have buy ratings on the stock, versus 6 with sells. Most people have dropped coeverage completely. The strategy must have failed, right?

Well, not exactly. Do you know who is the leading digital camera maker in the United States? That’s right, it’s Kodak. Just because they got a late start and didn’t think the digital revolution would sweep the world as quickly as it did, they still are selling a lot of cameras. After all, Kodak is a pretty good brand, so consumers have warmed to their products very quickly.

The stock is down 30 percent. The P/E is 10. The dividend is 2 percent, and sustainable. The company’s total debt load was cut from $3.2 billion to $2.3 billion during the 2004. Sounds like it’s prime time to start focusing on Kodak stock once again.

Sirius Inks Martha Stewart Deal

Back in the hey day for satellite radio stocks, today’s news that Sirius Satellite Radio (SIRI) has partnered with Martha Stewart Living (MSO) to create a 24/7 radio channel would have most likely resulted in a 10% jump in Sirius stock. Not so today though, as MSO added 6% while Sirius lost 1% of its value.

I think there are many reasons why Sirius shares were down on this news. First, I highly doubt this channel is going to prompt hundreds of thousands of women to sign up with Sirius. Perhaps even more problematic for Mel Karmazin’s company is the structure of the MSO deal. Once again, Sirius’s business model is flawed with this new channel. MSO is putting nothing into the joint venture. That’s right, no cash outlay whatsoever. In essence, they are taking on no financial risk, and getting free marketing in return. Sirius, meanwhile, is footing the entire bill, and not getting anything except hope that women will flock to Sirius to tune in.

XM Satellite Radio (XMSR) continues to lead the industry, with 3 times as many subscribers as Sirius. Even worse, the majority of new subscribers are going to XM. The Sirius model is not working from a financial perspective, as evidenced by their far inferior margins. Deals such as the one inked today are not going to help this company reach cash-flow positive, which is needed for the stock price to prove reasonable.

Interestingly, XM’s market cap still trails Sirius, despite having more than 200% more subscribers and a better path to profitability. Makes for an interesting arbitrage opportunity for the aggressive investor.

London Exchange Awaits Party Poker IPO

Certain events signal the height of fads, manias, and bubbles. Just think back five years ago when the New York Stock Exchange was considering an IPO. Is it any coincidence that the stock market peaked shortly thereafter? Whether it be the record number of technology sector mutual funds that opened in 1999, or Nasdaq traders quitting their day jobs, we can point to many events that, looking back, should have warned us that there was indeed a stock market mania.

While the company has yet to initiate the process, it is widely expected that PartyGaming, owner of the Party Poker online gambling site, could begin trading on the London Stock Exchange as early as this summer. Analysts have already begun to estimate such an IPO could fetch as much as $5 billion in market value, based on the company’s 2004 EBITDA of $350 million. If true, PartyGaming would find itself a member of London’s FTSE 100 index.

First it was the World Poker Tour (WPTE) IPO last year, and now Party Poker. Nobody should really be surprised, but the real question is, what can we deduce from this? Would a Party Poker IPO mark the top of a fad, or the beginning of what will become a cultural mainstay? Will WPTE turn out to be worth $19 per share, 16 times forward sales, and 106 times forward earnings? Highly, highly doubtful.

However, it’s hard, if not impossible, to know for sure and it certainly gets market observers and poker enthusiasts wondering. Can these companies make enough money to justify their equity valuations, and can those cash flows be sustained and grown long term? It should be interesting to see how it all plays out.

Is Martha Stewart Worth $1.75 Billion?

Martha Stewart Living Omnimedia (MSO) is trading at $35 a share, giving the company a market value of $1.75 billion. Short sellers covering and momentum players have contributed to this stock’s meteroic rise from $8 within the last 12 months. At today’s price the stock trades at 194 times 2006 earnings. Now, I’ll be the first to tell you I don’t really trust those estimates. I don’t think anyone really knows how much MSO will earn next year. There are just too many uncertainties to come up with an estimate that one should feel confident with.

What we can do is take a look back and see how this company did when business was great. Here are the historical sales numbers for Martha Stewart’s company. The 2004-2006 numbers are current estimates. MSO reports its full year 2004 numbers next week (Edit–2004 sales came in at $187 million – as reported on 2/23).

1997: $133 million
1998: $180 million
1999: $232 million
2000: $286 million
2001: $296 million
2002: $295 million
2003: $246 million

2004: $187 million
2005: $176 million
2006: $219 million

As you can see, this company has never had $300 million in annual revenue. The highest net profit margin the company has ever earned is 7.5 percent. This stock trades at 6 times peak sales! That translates into 80 times peak earnings! How long will it take MSO to get back to peak sales and profit margins? No way to know for sure, but it won’t be anytime soon.

Granted, this stock has not traded on financial metrics for a long time. It has been event driven recently; the jail sentence, the Mark Burnett “Apprentice” show, etc. Interesting side note — Burnett got 2.5 million options when he agreed to make the show. When he exercises them it will dilute the company’s owners by a whopping 5%, as there are about 50 million shares outstanding right now.

Eventually, this stock will once again trade based on how much money it can make. Judging from history, it looks like that might be bad news for shareholders.

Covering the Tivo Short

I’ve decided to cover my short position in Tivo (TIVO) a little earlier than expected. The stock was trading at $12 per share last year when it became fairly obvious that cable giants like Comcast (CMCSA) were not going to partner with Tivo, but rather build proprietary DVR technology into their own digital set-top boxes. This development left little room for Tivo to differentiate itself enough to outdual the cable companies in providing a soon-to-be standard feature.

With the premise that Tivo’s fundamentals were going to be in steady decline, and profitability was years off (if ever in the cards), covering the short wasn’t something I was really considering. However, with today’s announcement of Tivo’s 3 millionth subscriber, I once again found myself looking at the stock’s valuation. After a precipitous drop from $12 to $3 and change, the time has come to take my profits off the table.

The financials are still pretty ugly. Sales for 2005 are expected to be just under $200 million, with a net loss of approximately $25 million. Tivo has boosted marketing expenses recently as it realized that its partnership with DirecTV will become less and less valuable over time. As a result, it wouldn’t surprise me if sales come in ahead of expectations this year, but losses are higher than anticipated.

The losses are less of a concern given that Tivo has little debt and a sizeable cash position. Further funding may be required later on, depending on how well increased marketing spend boosts sales and its impact on margins, but for right now the company is okay financially.

With the stock up 5% on the subscriber figures, the market cap is about $300 million, or about $100 per subscriber. This valuation seems to be very reasonable to me, and I have a tough time making the case it should be lower than that. As a result, today I am moving on to bigger and better opportunities.