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Tivo – Barron’s Reports

This weeks Barrons has a short article ($$$ link) on Tivo (TIVO) that highlights the acquisition option as well as the need to pursue Cablecos for licensing deals. No new analysis beyond what I’ve written over the last few days, but the article is getting media attention so I thought an excerpt was in order.

With a name that’s become a verb, plus great software, TiVo could be acquisition bait. But its share of DVRs is on course to be eclipsed this year by Scientific-Atlanta (SFA) and Motorola (MOT), the two largest cable set-top makers.

Most of its subscribers come from a deal with DirecTV (DTV), the satellite operator, which pays TiVo $1.15 a subscriber, and accounts for nearly 70% of TiVo’s users and 20% of its revenue. DirecTV last week extended the deal to 2010. It won’t market TiVo’s service, but the deal prevents TiVo from losing existing customers.

Last week’s jury verdict may boost TiVo’s chances to sign up cable operators other than Comcast (CMCSA), with which it already has a deal. Cable guys will find it difficult to work around TiVo’s patents, says Terence Clark, a lawyer who heads the national intellectual property practice at Greenberg Traurig. That could force Time Warner Cable and Cablevision (CVC) into licensing deals.

But the case doesn’t solve TiVo’s most pressing long-term problem. It still has a long road ahead as it tries to win over cable operators with its patent claims.

A buyout may in fact be the best exit strategy for TiVo. In the meantime, selling on Thursday’s pop in TiVo shares may be the best exit for investors. What lies ahead are many years of knocking on cable operators doors, a long, long story with no fast-forward button in sight.

Hat Tip – Seeking Alpha

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