Monday, December 10, 2012

Avid Technology, Inc. (AVID)

We believe we have come across a value play.  Although the stock has moved up 10%+ during the last 2-3 weeks, we believe there is still some attractive upside to this turnaround.

Avid Technology (AVID) makes software and hardware that ad agencies, news organizations, music producers, and other marketing and entertainment companies use to create, edit, and add effects to film, video, and audio.  After a Q3 earnings warning in October, the stock tanked from nearly $9/sh to $5.87/sh.  Since then the stock has formed a base or support at around $6/sh and has slowly climbed back up to $6.83/sh.We note that trading volume of this stock has tapered off since the downturn in Oct.  Based on this, we do not anticipate too much further selling during the short to medium-term.

AVID is a very well-known and respected technology company in the media sector.  It has a very large installed base along with many loyal users.  Businesses utilize AVID's technology to create, edit and distribute content to audiences of all sizes on a variety of platforms.  The Company conducts business globally.  Its revenues are 40%/60% US/international.

Again, we think this is a turnaround story.  One of the mistakes that AVID made a few years back was that it tapped into the consumer side of this business by making a few acquisitions.  Although the results were impressive initially, they led to a consistent decline in the Company's margins given the increasing pricing pressure the Company faced in its consumer business segment.  Given declining margins and increasing operating losses, AVID took steps to make itself a more efficient and profitable company.

AVID divested its consumer business earlier this year, which we believe will help expand gross margins, although it will have a negative impact on the Company's top-line.

In addition, AVID is making its products more open and less dependent on its hardware.  This will also help expand margins by making the Company more of a software company.  By focusing on maximizing the sales of its differentiating software products, AVID will be taking another step towards making higher margin recurring software and maintenance revenues a bigger chunk of its total revenues.

The Company has also taken steps to lower operating expenses going forward.  For example, its manufacturing and R&D teams are now much more closely aligned.  AVID has also reduced its headcount by 15% - 20% during the last 12 months.  Management has said it expects to save around $80MM in opex.

From a revenue standpoint, we do not expect impressive growth.  In fact, we have assumed a below 4% 5-year CAGR.  However, again, a higher percentage of AVID's revenues will be recurring.  From a high-level standpoint, AVID's revenue drivers include trends within the media and entertainment industries such as centralized media asset management systems, increase in creation and distribution of 3D content, prioritization of not only distributing but also creating and editing content on mobile platforms in real-time, and, of course, the continuing transition towards HD content. Although the HD content transition can be considered as nearly complete in the US, we believe there are opportunities for AVID within the emerging markets.

Large events also drive some top-line growth for AVID.  In fact, the Company has long been successful in selling new products or upgrading products before very widely covered US and/or international events.  The Presidential election and the Olympics this year are a couple of good examples.  Sales generated by such events usually close 2 - 3 quarters before the actual events take place.  Looking ahead, we believe US midterm elections and the World Cup in 2014 will drive more top-line growth in the second half of FY '13.  What makes the 2014 midterm elections 'special' is that they include 36 gubernatorial races.  CA, NY, and TX are just a few examples of the states having gubernatorial elections.  Those races will certainly be widely covered.  Of course, the worldwide coverage of the 2014 World Cup doesn't need any further explanation.

AVID faces many competitors such as Apple (AAPL) and Adobe (ADBE).  However, given its sizable installed base, we do not expect the Company to lose big opportunities or current clients to competitors.  In fact, AVID's divestment of its consumer business, we believe, will help it differentiate more effectively from its competitors.


From a valuation standpoint, we did a DCF on AVID and came up with a $10/sh valuation.  In our opinion, a valuation based on comps is much more realistic.  For this reason, we value AVID at $9/sh based on 7x FY '13 EBITDA plus the Company's $1.83/sh in net cash (no debt).  Other companies in the space are trading at an average EV/EBITDA multiple of 8.  At $6.83/sh, AVID is trading at only 5x forward EBITDA.  It appears the Street is not expecting any return from AVID's restructuring at least during the next 12 months.  We note the Company is also trading at only 0.75x book value.

The 32% upside that our $9/sh valuation represents is only based on valuation.  The stock could go above $10/sh during 2H of 2013 as the Street begins to recognize the benefits of the restructuring.  We believe its institutional fan base may increase further, which then will likely push up the stock a bit more.  The near-term catalyst is AVID's Q4 results, which will be announced in Feb.  We think the Company will generate positive non-GAAP EPS and may breakeven on a GAAP basis.

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