There’s some interesting stuff in the latest 10-K that Avid has filed. While some of these details are good for the short thesis, I still think that there are better shorts out there.
Revenue recognition
Avid has changed its revenue recognition policy so that some portion of the revenue is deferred. This shifts revenues and associated profits into the future. This decreases the accounting profits of prior years and increases the accounting profits of future years. I’d be curious to see how this change in revenue recognition affects the bonuses paid to insiders (some of which are based on earnings). One of the footnotes in the 10-K suggests that this might be the case:
Stock-Based Compensation
As a result of the change in the timing of revenue recognition described above, the timing and amount of stock-based compensation expense attributable to performance-based awards, where expected vesting was based on profitability, also changed. Due to the restated historical financial statements, many of the performance-based awards have vested earlier than originally estimated.
What’s strange about the revenue recognition is that there is a dramatic difference for transactions before and after January 1, 2011 [emphasis mine]:
For transactions occurring after January 1, 2011, our revenue recognition policies have generally resulted in the recognition of approximately 70% of billings as revenue in the year of billing, and prior to January 1, 2011, the previously applied revenue recognition policies resulted in the recognition of approximately 30% of billings as revenue in the year of billing. We expect this trend to continue in future periods.
For whatever reason, the percentage of revenue booked in the year of billing increases from 30% to 70%. This doesn’t make much sense to me given the nature of Avid’s products and its pricing structures. I’d be curious to see how this change affects insiders’ bonuses.
Overall, my opinion is that management does not want to help investors understand the business. Their investor presentation (PDF) about the restatement does not walk investors through the accounting.
Valuation
Firstly, the restatement does not affect the intrinsic value of the company (if you ignore issues of insider compensation).
Secondly, I think the new revenue recognition policies are an accounting distortion. Avid’s financials would be clearer without the new policies.
Thirdly, Avid has historically spent a lot of its profits making bad acquisitions. This ultimately results in intangible assets that are eventually written down, causing wild swings to earnings and book value.
Adjusted book value
Here’s a quick and dirty method for tracking the financial performance of Avid:
Adjusted book value = (Assets – intangible assets) – (Liabilities – deferred revenues)
2008: $229.2M
2009: $186.7M
2010: $149.9M
2011: $152.1M
2012: $164M
2013: $103M
I ignore the value of intangible assets to avoid fluctuations caused by impairments. The overall trend is that adjusted book value goes down every year. Viewed this way, the company is losing money.
*Note that this value likely understates Avid’s intrinsic value. There are probably parts of Avid that are profitable and have the potential to be even more profitable in the hands of better management. The value of such businesses within Avid should be worth significantly more than their book value.
**My figure does not capture the cost of share dilution from stock-based compensation.
***Avid does sell support contracts where using deferred revenue for accounting purposes makes sense.
What will Avid be worth in the future?
Over time, I expect Avid’s intrinsic value to drain away due to:
- Poor management.
- To a lesser degree, intense competition in most but not all of Avid’s markets. In particular, price competition in video editing is intense (e.g. Final Cut going from $1,000 to $300).
If management stays in place (and they have taken some steps to entrench themselves), then eventually Avid will get close to bankruptcy. It would then have the opportunity to sell off some of its businesses and stay afloat for a while. Or, the CEO may be replaced before such a scenario would occur.
Currently, I could see a private buyer optimistically paying $200-300M for the business. The current market cap has risen to $390M, which is a little higher than my estimate of the best-case scenario. Nonetheless, I believe that Avid’s intrinsic value will be considerably lower in the future. Basically, I am betting on management destroying a good set of assets.
*Disclosure: Short Avid.