TiVo's Battle Only Beginning

By Stephen D. Simpson, CFA | May 27, 2011 AAA

It has been a multi-year roller coaster ride for TiVo (Nasdaq:TIVO) bulls, and yet plenty of volatility and uncertainty remains. Not only does the company have several significant IP lawsuits still in progress, but the company is a long way from establishing that it has a business model capable of producing attractive free cash flow in the years to come.

On the other hand, the company has won legal validation for its IP and signed up several major TV partners. With valuable technology and patents, and several large tech companies likely coveting the in-home reach and potential of this technology, TiVo could yet attract some interest from a bidder. As I said, the roller coaster ride isn't over yet.

First Quarter Results Include a Major Win and Significant Concerns
There is no question that the company's settlement with DISH Network (Nasdaq:DISH) was a dominating factor this quarter. After another legal setback, DISH chose to take a settlement with TiVo - agreeing to pay $500 million in damages, with $300 million upfront and $200 million coming between 2012 and 2017. With that settlement, TiVo was profitable on an accounting basis.

TiVo reported that revenue fell more than 25% this quarter (and about 18% from the prior quarter). Hardware revenue plummeted 62%, while service revenue dropped 8%. TiVo once again had net subscriber losses of over 50,000 in its owned service business, and deals with Charter (Nasdaq:CHTR), Virgin Media (Nasdaq:VMED) and others cannot yet replace that fully.

TiVo did see a better gross margin this quarter, but the company would have reported a sizable increase in its operating loss were it not for recognizing almost $176 million of settlement proceeds. Given the size and timing of the DISH settlement, as well as possible settlements with Verizon (NYSE:VZ), AT&T (NYSE:T) and Microsoft (Nasdaq:MSFT) in the future, this is likely to be a common feature of earnings reports for some time to come.

TUTORIAL:Economic Indicators

Some Progress with New Partnerships
While TiVo continues to offer its own premium-priced DVR services, it is pretty clear that the company's future rests with partnering with service providers and keeping its technology in the foreground of the market. To that end, a deal with Comcast (Nasdaq:CMCSA) is an encouraging step forward; customers will get to access Comcast's Xfinity TV On Demand platform, as well as accessing content from providers like Netflix (Nasdaq:NFLX), Amazon (Nasdaq:AMZN), YouTube, Hulu and so on. (For more, see Online Video Competition Heats Up.)

On the other hand, TiVo bulls would do well to remember that this is still a tough and competitive market. Cablevision (NYSE:CVC) is advancing its network DVR concept, a DVR system where the storage is all at the headend instead of the box. Moreover, there still seems to be some uncertainty with the timing of the rollout of an HD "combo box" with DirecTV (NYSE:DTV).

More Litigation a Near-Certainty, but What About a Bid?
With a major win against DISH in hand, TiVo is continuing its infringement actions against Verizon, AT&T and Microsoft. Legal wins, whether through settlement or verdict, could possibly be worth amounts similar to the DISH settlement, even allowing for the fact that many bulls were disappointed with the size of that win. Of course, the timing and eventual outcome are still uncertain - these companies are fighting back. Microsoft and Motorola (NYSE:MMI), which manufactures the box used by Verizon, are making counter-claims.

All that said, TiVo could still be attractive to certain tech companies looking to build a consumer-facing, in-home interactive media business. Even with the Skype deal in hand, TiVo could make sense to Microsoft. Likewise, Google (Nasdaq:GOOG) could be an interested party as well. And what about Netflix? There is some speculation here and there too that Cisco (Nasdaq:CSCO) or Apple (Nasdaq:AAPL) could be in the mix, but both seem unlikely; Cisco has gotten burned more than once on consumer-facing deals and Apple seems to vastly prefer to build than buy.

Bottom Line
Absent real proof that TiVo can turn a profit (or produce positive free cash flow) from its partnership model, it is difficult to value the stock. The DISH settlement shows that the technology is clearly worth something and that the company has enforceable IP. Given the possibility of future litigation wins and a bid from a larger company looking for in-home technology, bulls have their argument for hanging on today. For newcomers to the story, it is still a difficult task to assign a value to these shares - "more than today's price" seems reasonable, but how much more is very much open to debate. (For more, see Viva La TV!)

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