DivX, Inc.: Premium digital video at a discount
For digital aficionados downloading videos from the Internet, DivX, Inc. (Nasdaq: DIVX) is as close to Nirvana as they can get. The San Diego, Calif.-based company offers a variety of software tools for creating, transmitting, playing and sharing digital video, widely considered the best in the business.
That also pitches the small cap up against some scary competition, including Microsoft Corporation (Nasdaq: MSFT), Google Inc. (Nasdaq: GOOG), Apple Inc. (Nasdaq: AAPL) and Sony Corporation (NYSE: SNE). Add to that the fact that its business and history of successes and failures have the clarity of an Ingmar Bergman film, and you have all the trappings of a hit investment.
DivX’s products have been surprisingly successful. Its codec software—a compression/decompression programs that shrinks video for quick downloading , then restores it to picture-perfect clarity—has been downloaded 180 million times since the company debuted eight years ago. Its video player software is embedded in over 1,800 consumer electronics products, including DVD players, video game consoles and digital cameras—a total of 200 million units altogether. Its software is used in 25% of the world’s DVD players and in some European countries that penetration rises to 90%.
But if the popularity of DivX software has seemingly climbed a stairway to heaven, its stock price for most of the past year has been on an express elevator to hell. DivX went public in September 2006 at $19 and peaked at $31.98 (its current 52-week high) two months later. Then it took a long slide, losing 60% of its value over 11 months, bottoming out at its 52-week low of $11.35 on Oct. 30.
Suddenly, though, investors love the company again. On Nov. 5 DivX reported third-quarter revenues up 42% to $21.9 million, but net earnings rose only 9.5% to $21.9 million. The reaction was swift: From a close of $11.98 on Nov. 5, the stock rose 56% to close at $18.63 a week later. It’s currently trading at about $17, with a market cap of about $589 million and a hefty P/E of about $42.
Among eight brokers polled by Thomson/First Call, four rate it a “buy” and four a “strong buy.” Target prices range from $20 to $30 with a median of $22. Cowen & Co. analyst Robert Stone, who does not give target prices, believes DivX will outperform the market by 25% to 30% in the next year.
Confused? As usual, the angel is in the details. Until recently, investors didn’t know what to make of the company. In the last several months, both the CFO and CEO have resigned. Former CEO and founder Jordan Greenhall was notorious for vague guidance, repeatedly disappointing investors with weaker-than-expected earnings.
“Greenhall is more of an entrepreneur and less well-suited to running a larger public company,” Stone says.
The solution: Kevin Hell, the company’s chief operating officer. Hell took over the company last July, and although it took the board until Nov. 5 to grant him the position permanently, the Street likes the change.
Hell has been better at setting expectations and explaining finances. Those third-quarter earnings, for example, were depressed by stock option grants and heavy investments in Studio 6, a YouTube-like video sharing site launched this year to showcase and distribute DivX videos made by both professionals and amateurs. Without these special items, net income would have been up 73% to $5.9 million.
And in order to improve the bottom line, former CEO Greenhall is exploring options for taking Studio 6 private. In the meantime, DivX just announced the acquisition of competitor Main Concept for $21 million. Analysts applaud that buy because it adds another codec standard, called H 264, to its arsenal.
“That was the missing ingredient in its suite of codecs,” says James Goss of Barrington Research.
Cowen’s Stone agrees, speculating that the DivX codecs could become a de facto standard because of their immense popularity. He also sees strong potential in DivX Connected, a new program that enables any electronic device to communicate with another through a home network. You might, for example, stream a YouTube video from your home office PC to your wide-screen TV in your family room.
DivX gets 80% of its revenues from software licenses to consumer electronics companies and the rest from an advertising partnership with Google, although the partnership was shifted to Yahoo! Inc. (Nasdaq: YHOO) this month. It has recently released software to deliver high-definition video from consumer devices such as high-def DVDs and video game consoles. That puts it into competition with Sony’s Blu-Ray and the HD DVD standard backed by Microsoft. Sony announced last week that it would include the DivX program in its Play Station 360 and Hell is in discussions with Microsoft over the Xbox. Significantly, however, Sony has not indicated any willingness to use the software in its DVD players.
There are plenty of obstacles, primarily continuing to succeed against enormously wealthy giants. DivX is also trading lawsuits with Universal Music Group over whether it is liable for copyrighted material posted on Studio 6 by users.
But then, DivX (DIVX) could also make a good acquisition by one of its wealthy competitors. For now, however, CEO Hell is doing his best to give the competition … well, you know
