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TiVo, Inc.
Cramer and The Emperor's New Clothes

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By DavisFreeberg
June 22, 2006

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Sometimes it's hard being a contrarian investor. In fact sometimes it's really painful because regardless of the fundamentals Wall St. likes to move in a herd. They love volatility because it gives them an opportunity to not only profit from the swings in price, but the added risk creates more value in options which allows Wall St. to profit more from the derivatives that they can create. Over time, your investments will always fluctuate and you can follow the Cramer's of the world and sell your stock every time it swings up or you can do your homework and ask yourself what do you think your stock is really worth and see if Wall St. might be missing something in their haste to sell too quickly.

Rather then looking at a three-month chart of their stock price, I choose to dig deeper with my investments. In running through any valuation you have to make some assumptions. In looking at any long-term investment assumptions are unfortunately required. I feel that I've been conservative with my growth expectations for TiVo's business and I feel that I have enough patience to wait for the company to not only hit profitability, but for their business to mature. If you disagree with my outlook that TiVo will continue to see subscriber growth or that they will be able to achieve profitability through their increasing scale and their more profitable cable revenues, then your valuation will be very different then mine. The Motley Fool has an excellent section on stock valuation 101 and provides some great techniques to look at. I would love to see the bear argument from a financial perspective as to why TiVo is overvalued right now, as well as the bear argument for what TiVo will be worth in five years.

TiVo's a tough stock to value because their losses disguise their true value. You can't apply a simple P/E ratio to the stock in order to get an accurate valuation; instead you have to look at other ways to value the company. Cramer says that TiVo is uninvestable, but I would argue that the market has oversold TiVo and that long term shareholders will see significantly higher returns then those who choose to take the quick buck or those who sell in panics. Unlike Cramer, I'm not looking for a quick return; I'm looking for (as Dean would fondly put it) a "multi-bagger." Because of my return expectations, I accept that risks that come with this investment. Cramer is right that TiVo is not a stock for everyone; it's a stock for growth investors who are willing to take risks. There are risks that could cause TiVo to crap out. I accept that TiVo could go into bankruptcy and think it's important to consider the likelihood of these risks as well as any residual value TiVo would have in a fire sale.

If TiVo had to stop operations today and you looked at them from a balance sheet perspective, on the surface it doesn't look very attractive. The company has about -$30 million at first glance, but if you start looking at some of the intangibles you can at least come to a minimum valuation. Intangibles are hard to quantify and are open to a lot of interpretation, but it's fair to say that TiVo's brands and patents carry at least some value in the case of a bankruptcy and more importantly, the very losses that have caused the analysts so much frustration, actually have a very real value in the case of an acquisition. Right now TiVo has $704 million in tax losses that last for at least another 12 years. If a company that is at a 42% tax bracket were to purchase TiVo (Yahoo, Netflix, Google, etc . . .) the tax losses incurred today alone would be worth close to $300 million dollars, if you add the patents, the reoccurring revenue driven user base and the brand name, I think that you can build an argument that TiVo would be worth a minimum of $400 million in bankruptcy. TiVo closed today with a market cap of $538 million.

I believe that the market has oversold TiVo to the point where they are convinced the company is going to go out of business. I can understand why they see risk in TiVo's model, but if you value TiVo using a price-to-sales comparison, you can see how much of a discount Wall St. has placed on the company.

In the last 12 months TiVo has earned $205 million in revenue. If you divide their revenue into their market cap you get a price-to-sales (PSR) ratio of 2.62. The PSR is especially helpful in analyzing companies with losses because the model only looks at what investors are paying for each dollar coming in and not profitability. Because it does not take profits or losses into account there are limits to its usefulness but it's value allows us to see a fair comparison as to what multiples TiVo should trade at if they were profitable or if they were priced closer to their peers. If we compare TiVo's PSR to their peers you can get some sense for the discount that the market values TiVo's revenue at.

OPTV - 5.43
RNWK - 4.39
NNDS - 2.55
MVSN - 4.99
CCUR - 4.61
SIRI - 15.61 (Danger Will Robinson Danger)
XMSR - 5.18
NAPS - 1.41
GMST - 2.49

As a long-term shareholder I expect that TiVo's revenue will continue to rise over time. Between the blistering growth of the PVR industry, cable partnerships, advertising revenue, all of TiVo's deferred re-occurring revenue and their new higher revenue monthly pricing plans, I think that I can make a strong argument that we will continue to see revenue growth for quite some time. Now it's possible that Wall St. will continue to ignore this aspect of TiVo and it could trade below a 1.0 PSR, but consistent earnings and revenue growth should only increase the PSR and if TiVo can even trade at it's current PSR, then just $100 million in additional revenue (500,000 new stand alone subscribers) could add $263 million to TiVo's market cap (roughly a 50% return to where their market cap stands today)

Of course I'm expecting TiVo to add a lot more then 500,000 new subs, I think that their growth over the next few years will be much more substantial then that. Add to this extra cable customers who will be able to sign up just by downloading to their existing cable box and I think that you can begin to see some of the potential for TiVo's revenue growth.

Of course PSR doesn't take into account losses, so lets address that issue for a moment. Over the last 12 months TiVo has lost $47 million. During a large part of this time, these losses included subsidies of their boxes as well as intensive R&D spending for the new generation of TiVo. While TiVo's no up front cost program does have hardware costs associated with it, the additional revenue they charge will help to pay for these costs and will reduce rebates paid to retail partners. If TiVo earns an extra $7 per new stand alone subscriber, then that means that they actually start making a profit on the hardware if they can keep a customer around for longer then 2 and a half years. This is a much better option for TiVo then their rebate program where they permanently lose for each hardware box that they sell and are forced to replace these revenues with their $12 service fees.

Another major cost for TiVo has been their legal costs. This is a major risk to TiVo because if they lose a lawsuit it could have serious repercussions on the value of their business. Their legal endeavors also create revenue opportunities though and if Dish does in fact lose their lawsuit there is significant upside as well as a recouping of these legal costs. Given this uncertainty, it's difficult to value TiVo's judgment against Dish, but I believe that there is more upside potential here then downside risk.

It's easy to kick a dog while it's down, but it's a lot harder to buy into the stock when the company is showing their losses. Over the next year, as their subscriber base continues to grow and as revenues increase I believe that TiVo will hit an inflection point in their profitability. If you assume that Comcast can add even 1 million customers and even if you assume that TiVo will earn a measly $1.50 per sub, this translates into $18 million in earnings growth per year alone for TiVo. Some may criticize TiVo's partnership with the cable companies as a deal with the devil, but I see this as a very high margin opportunity and as a subsidy for their stand alone growth.

The reason why I take a beef with Cramer is because when he looks at TiVo he sees a $6 stock and when I look at it I see a $538 million stock. This is an important distinction because when you invest in small cap stocks you are buying a larger ownership then when you play in the big leagues. Because TiVo only has about 90 million shares outstanding it means that for every $18 million a year in earnings growth (1 million Comcast subs) it translates into an extra .20 cents per share for shareholders. This is also important because it means that only a minimal investment can move the stock quite a bit. This is why Cramer wants you to trade but not own because the Wall St. sharks can manipulate TiVo's price like a yo-yo. As a long-term shareholder who believes that TiVo will eventually reach at least 10 million subscribers, I see a lot of untapped potential for a company that is worth at least $300 million in tax losses and whose stock is already 20% shorted. Cramer may not share my belief that TiVo is investable, but I think that his thinking is short sighted. TiVo is a long-term play, because when it turns profitable, the disconnect between their market cap and their earnings will catch up very quickly. I know that many investors love Cramer's style, but in the long run being a Buffet investor is much more profitable and much less frustrating. You can discount my arguments just because of Cramer's status but do so at your own risk. Due diligence will always win over the flavor of the day, regardless of how vanilla that makes me. I may not have Cramer's stature or soapbox, but remember that it took a child to point out that the Emperor wasn't wearing any clothes.


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