Film/video stocks would definitely be in my circle of competence as I have some experience in the field from interning at post production facilities (e.g. Optix). I also have a degree (in Radio and Television Arts), but I wouldn’t take anybody with a piece of paper too seriously. Experience matters a lot more (you can’t get it in school) and many professionals in high-end film/video have no relevant degree (nor do they need one).
In brief, I dislike stocks related to film/video technology and film/video production. There is a curious absence of shareholder profits. For this reason, I usually do not research these stocks very much as they usually aren’t good longs.
Avid (AVID): Something very good happened to Avid when Apple decided to abandon the high-end market with Final Cut X (FCX). It left some shops that were entrenched in Final Cut high and dry as it decided to stop selling the old version of Final Cut (Final Cut 7). Apple did this without any advance warning. FCX is totally unusuable for high-end production (high-end editors need some esoteric features such as support for the decades-old EDL format) compared to previous versions. Apple later reversed its decision and continue to sell the old Final Cut 7. (Apple used to be a company that specialized in high-end workstations after their NeXTSTEP operating system acquisition. However, I think people at Apple realized that broad consumer markets are much more profitable than niche professional applications.) At the end of the day, Avid will see the return of its customers that Apple took away.
The problem with Avid is this: it has dominant market share and manages to lose money. On top of that, Avid has bought other businesses and is now selling them for a fraction of their purchase price.
*Disclosure: I have shorted Avid in the past before the whole FCX thing happened. I don’t like shorting market leaders.
Chyron (NASDAQ:CHYR): Used to have dominant market share. Shareholders lost money. Don’t ask me why or how.
Evertz (ET.TO): A very well-run company that makes hardware for TV broadcasters. I wouldn’t short it. Evertz isn’t really in my circle of competence as I don’t know much about their product line. I don’t know how to use any of their products except maybe the frame synchronizer.
Their IPO prospectus is worth reading as their options accounting is a little outrageous (valuing options with an expected volatility of 0 should not be allowed). One of Evertz’s officers received several million dollars worth of options but this was expensed at close to 0. They own at least 2 corporate aircraft… I don’t understand why such a small company would need multimillion dollar private aircraft.
Miranda Technologies: Similar to Evertz, though Evertz may be better run. Bought out by Belden (NYSE:BDC). Belden may have overpaid and the synergies may not materialize.
Image System (STO:IS): Their Digital Vision product competes against online editing systems from Avid, Autodesk (Discreet Flame, Inferno, Smoke), SGO Mistika, and Quantel. It also competes in the Digital Intermediate market against Autodesk’s Lustre, Pandora, and Blackmagic’s Da Vinci products. It has very small market share and may or may not hit the point where revenues are greater than R&D costs and sales costs. I haven’t researched this much since it is a foreign microcap that may well go bankrupt.
Ikegami (TYO:6771): Ikegami is very similar to Sony’s Broadcast division and somewhat similar to Evertz. They make hardware for TV production (including cameras and monitors). Sony’s broadcast division is better run in my opinion as they have a sales force that speaks English well. At NAB, I noticed that most of the people who work for Sony’s booth are native English speakers (I even worked for Sony’s megabooth at NAB one year… long story). Whereas the booths for many Japanese companies are frustrating because the employees do not speak English well and the booth does not have many non-ESL employees. I’m not sure what these Japanese companies are thinking by going to a convention in an English-speaking country with tons of ESL employees. Convention booths are not cheap (e.g. price gouging by unions, the convention center, hotels, etc.) so they may be wasting their money. This may explain why some Japanese companies have low market share in English-speaking markets despite making great products. I’m sure the opposite is true but the English-speaking market is much greater than the Japanese-speaking one. Some Japanese companies like Ikegami may be at a disadvantage. Sony and Panasonic (both Japanese companies) have strong sales staff in English-speaking broadcast markets. Ikegami does not.
Sony Broadcast: This is a nice franchise. Its reputation helps it sell new products and to enter new markets. Its VTRs are the de facto standard in the industry and it has a nice moat in that regard. But you can’t invest in Sony Broadcast because it is engulfed inside Sony Corporation.
Digital Domain (DDMGQ): I should have shorted this but didn’t (my limit order didn’t fill). Visual effects for Hollywood movies is a terrible business to be in. Visual effects houses regularly go out of business even though they do incredible work.
Technicolor (EPA:TCH): I don’t like post production companies so I never really researched Technicolor. If I researched this company I would likely be inclined to short it.
Real-D (RLD): Originally I thought that this company would be a good long since they have good technology and dominant market share. Of all the 3-D projection technologies out there, Real-D’s is probably the most economically viable (it is the cheap and has good quality). Then I looked at their financials and saw that they have been bleeding money for the past few years. Short interest is still very high.
Imax (IMAX): See my writeup on Imax.
Adobe (ADBE): Premier is a good video editing application but second-rate compared to some other applications. After Effects is a great application. These video applications are only a small part of Adobe however… analyzing Adobe should focus on its main products. Adobe has great products in general though I’m not sure I want to pay P/E 20 for Adobe when Microsoft has a stronger moat and a lower P/E.
Dolby (DBE): Their main cash cow depends on Dolby Digital patents, the last of which expire in 2017. Dolby Digital is associated with digital television broadcasting, the DVD format, and Blu-Ray. Dolby receives revenue for every Windows computer sold, every non-infringing DVD player, every Blu-Ray player, etc. Dolby Digital plus is associated with the Blu-Ray format and digital TV broadcasting in certain countries. These patents expire between 2018 and 2026. I see Dolby having difficulty in finding new licensing streams as audio compression is less of a problem today than it was in the past. I see royalty-free formats (the DVD format and MPEG-2 will eventually become royalty-free in 2017) continuing to remain popular, much like how the JPEG format is still popular today even though it is not the most efficient compression scheme (JPEG2000 is superior). Dolby may be able to license newer audio compression technology to IPTV providers and to content streaming companies such as Netflix. However, its revenues in the future will likely be much lower than in the past.
Ray Dolby (79), the founder and majority shareholder, has been a consistent seller of Dolby shares in two underwritten public offerings and on the open market. Dolby did not repurchase shares in 2008-9 but started repurchasing shares in 2010 near Dolby’s all-time high.
Mass-market products that benefit from economies of scale are slowly chipping away at higher-end markets. Final Cut took some market share away from Avid (though it is now giving it back). Companies that don’t make consumer or prosumer equipment such as Ikegami may see some of their market erode.
For post production software, the rise of the GPGPU (general purpose GPU) could spell some trouble for some companies. Editing software can take advantage of a cheap mass-market GPU to do video processing. Many high-end systems are already using a high-end GPU for video processing (whereas in the past it would use expensive custom hardware or expensive specialized hardware). This can eventually create a situation where a mass-market video editing application has comparable performance to the high-end systems since they can use the same GPUs. Many vendors are already experimenting with extremely low price points (e.g. Blackmagic/Da Vinci, Autodesk, etc.). In the long run, this may be bad news for Avid. Avid has continually failed in the high-volume consumer/prosumer space. However, the mass-market trend may be slow in taking over as the high-end has some esoteric needs that mass-market products don’t have (e.g. EDLs / OMF / the ability to move projects from one system to another).
Evertz should be safe from the mass-market trend as its products usually cannot be duplicated by mass-market hardware. Evertz’s future depends more on the future needs of television broadcasters and whether or not the TV industry will continue to push the technology. If TV moves towards 4K/UHDTV or 3-D then this would be really good for Evertz because it will have to make new high-margin products. The current shift towards HDTV is good for Evertz. If the TV industry does not push for new technology, then competition will duplicate Evertz’ products and margins will erode. If Evertz bets on the technology that doesn’t take off (e.g. 4K, 3-D) then it can lose money.
None of these companies have moats except for Sony Broadcast in its VTR segment.
Everybody else is vulnerable to competition. Having better software than your competition serves as a weak moat (e.g. Avid, Adobe). However, another company can always develop even better software. Like the rest of the technology sector, having better software is not always a durable moat.
My biases and preconceptions
I feel that I have all the wrong biases and preconceived notions about companies in this space. Having domain knowledge could potentially be a handicap. With Avid, I would be inclined to go long after the whole Final Cut X debacle happened. However, Avid is a bad stock with current management and may go bankrupt someday.
Every company listed in this blog post has good products or does excellent work. It’s just that something bizarre occurs with the economics of these stocks. If you simply applied Peter Lynch’s philosophy of buying the market leaders and future market leaders (based on the quality of the company’s products, how busy they are, etc.) then you could lose a lot of money. Back in the day, you could have been smart enough to figure out that computer-based video editing was the future and that Avid’s non-linear approach would kill off most of the linear editing systems. And Avid did kill off almost all of the linear editing market. But Avid as a company has not made money for shareholders.
At the end of the day, I like this industry. I feel bad for thinking about shorting some of these companies. A lot of them have many very smart, hardworking, and honest people working for them. I have huge respect for Matt Cowan of Real-D and read some of his papers from his days at Entertainment Technology Consultants… so I have a mental obstacle against shorting Real-D. The companies in these markets make good products and do excellent work (e.g. the now bankrupt Digital Domain did something really cool with the Tupac hologram and their VFX work for Hollywood movies such as Transformers is top notch). They generate a lot of value for their customers. Unfortunately, you probably want to stay away from buying the stocks.