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DirecTV Can’t Kick the Tivo Habit

Tivo LogoTivo (TIVO) announced today that they have extended their agreement with DirecTV (DTV) for three years. In addition to this, both parties have agreed to not assert patent rights against each other. The previous agreement was due to expire in 2007.

The market appears to be viewing this positively. As investors in Tivo, we won’t complain, but fundamentally the two companies have not changed their relationship. DirecTV continues to develop and market their own set-top with homegrown DVR software and not market the Tivo version.

From the Reuters Article:

DirecTV is a top TiVo customer and the extension of the deal was initially greeted positively on Wall Street, where there had been concerns that DirecTV would transition their TiVo customers to its own service if an extension was not reached.

This is silly. Extending the agreement is much cheaper and easier than replacing 3 million set top boxes. The reality is DirecTV could have done nothing, and their customers with Tivo boxes would have continued to work. From the most recent Tivo 10-Q:

While DIRECTV would have the right to continue to service existing DIRECTV receivers with TiVo service without payment to us, it would not have the right to add new DIRECTV customers with TiVo service. And while TiVo would no longer be able to generate additional revenue from the then-current DIRECTV customers with TiVo service, we would have no further obligation to provide upgrades, fixes, new features, or software support.

Tivo currently gets about $1/month per box from DirectTV, or around $36MM a year in revenue. The announcement indicated that the new agreement has very similar pricing.

In short, we’re a little stumped why the market thinks this is such a great deal beyond protecting a recurring revenue stream. If DirecTV had agreed to use Tivo exclusively and stop in house development, that would be big news. All that has really happened is a further extension of the status quo. Regardless, if this brings more attention to Tivo and the strong value they provide, I’m OK with it.

The consensus opinion on Tivo is that they are in a death spiral, attacked by low-end commodity DVR’s from all sides. Their ‘only hope’ is to hit the litigation jackpot with Echostar and land a big wad of cash. We disagree vehemently with this opinion. Tivo is an exceptionally strong brand and commands incredible user loaylty. The Tivo software provides a significant differentiator in a future of commoditized video delivery by Cablecos and Telcos.

Our worst case scenario for Tivo assumes that they transform themselves into a software-as-a-service company, selling subscriptions to run on set-top-boxes from a multitude of hardware suppliers. A $12/year income stream from 20 million households (roughly 20% of US market) would yield $250M/year in revenue at substantially higher margins than the company enjoys now.

A more optimistic future would have Tivo turn their hardware devices into content delivery systems, utilizing the broadband connections available in homes to deliver content to the hard drive in each Tivo. Instead of recording a show from the tuner, content would be downloaded and stored on the Tivo. The new Series 3 Tivo will have HDTV capabilities and provides an ideal platform for storing and delivering content. DirecTV is working with Microsoft to potentially use the Xbox 360 as a content delivery platform, it’s unclear why they wouldn’t pursue a similar agreement with Tivo.

The problem with both scenarios is that they are totally incompatible business models. The first would require strong relationships with the content delivery folks, and an implicit agreement that the second model would not be implemented as a way to compete with the video delivery mechanisms of their customer. The second would require significant partnerships with content owners and distributors to provide them with an alternative way to distribute content. Disney’s recent decision to make shows via the web could just as easily be an agreement to make shows downloadable to Tivo, with an agreement from Tivo that the commercials could not be skipped.

Our frustration with Tivo, something I voiced in my post titled “Tivo Should be Sold” is that the company doesn’t appear to be pursuing either outcome. There has been little in the way of innovative hardware, software, or business models from Tivo in recent months that would indicate a move in either direction. The pursuit of the current business model of selling hardware DVR’s on retail shelves implies a future move to scenario two- the high risk/high reward strategy. However, the lack of any announced partnerships, as well as the vaporware Netflix agreement would indicate it isn’t being pursued aggressively enough.

If the company is not driven strongly in one of these two directions, it should be sold to a company that will. Some market and technical leadership needs to emerge from Tivo in the near term, because the market has priced in what we feel is a very reasonable 600M-800M acquisition value, based on continued pursuit of their original business model.

Tivo 6 Month Chart


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  1. Without DirecTV spending massive amounts of money on free TiVo advertising this deal doesn’t represent as much value as investors seem to feel. Depending upon how much Echostar ends up having to pay, this deal may end up being sweeter for DirecTV then for TiVo in the long run. Furthermore one could make an argument that TiVo may have been better off losing 80% of their DirecTV subscribers, if they could have convinced 20% of those customers to migrate to the significantly more profitable stand alone boxes. Saying that TiVo would be better off without DirecTV might be a bit of a stretch, but before this announcement I had already assumed that the loss of the relationship would have less then a 5% impact on revenue. Don’t get me wrong getting $40 million a year in high margin fees are nice, but even if TiVo lost 100% of the DirecTV subscribers, it still would have only represented a 10% decline in revenue for the company.

    What this new DirecTV deal does contain is the potential for TiVo to advertise to DTV subscribers. From the initial press release it appears that TiVo will be able to begin advertising to the 2.5 million DTV subscribers that they have. In the past, DTV has been adamently opposed to letting TiVo advertise on the service. While advertising revenues are only a small part of TiVo’s revenue today, I expect that in the future, advertising will become even more significant then service revenues as their business model evolves.

    Business Week published an article last night on some of TiVo’s ad initives begining in May and while I view these upcoming features to still be in the experiemental phase, I have high expectations for the company when the Comcast system is rolled out and when the Fall TV shows start up.

    Interactive advertising is still in it’s infancy and there are a lot of ways that you can tie TiVo’s ads to other services, but if TiVo did something as simple as enabling their customers to buy a monthly Yahoo MP3 account through their service, the deal alone could produce $1 per month in commissions for each subscriber that signs up. As TiVo integrates couch commerce into therer advertising relationships, it will give TiVo access to powerful commission generated revenue that could potentially be worth a lot more then $1 per month.

    I still see a lot of risk for a company like TiVo and with Hollywood increasingly adopting the VOD business model, this will be a huge issue for the company going forward, but with the extension of their agreement with DTV, it removes one more objection by the TiVo bears who like to say that TiVo is on a death watch, despite having limited debt, substantial assets, high margin recurrable revenue and being positioned in one of the hottest growth industries in the market right now. TiVo may not end up capturing 100% of the PVR market, but Apple only picked up 5% of the PC market and they’ve done just fine.

    Posted by Davis Freeberg | April 12, 2006, 11:25 AM
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