Asymmetrical Information

Translation:

"We are dead meat on a stick."

Not that there's anything wrong with that...

I bought TiVo at $4.31. I sold it last month at $12.78.

Woo hoo!

Of course, I'll be crying if it makes it back to $80 as it once was.

As I write this, TiVo is trading at $8.75 and trending slightly downward.

I spotted this in an article the other day:

TiVo (TIVO) has cachet, but could be reduced to being a niche player in the digital video recorder market, says Barron's. Subscribers to its recording service are at 703,000 and expected to grow, Barron's says, and that's where company is basing its future, as opposed to hardware licensing. One caution in the Barron's article is that Rupert Murdoch's expected purchase of DirecTV will put him in control of a key TiVo partner, even though his News Corp. also owns a DVR competitor, NDS (NNDS). That could jeopardize the connection to 38 percent of TiVo customers from the DirecTV pool of 10 million subscribers. Another threat could surface if Barron's is correct about rumors that AOL Time Warner and other entertainment giants are working on ways to archive all their content for video on demand, which could compete with the storage feature of TiVo.

Personally, I love TiVo, both the device and the company. It's a very risky investment right now, however. Potential upside is huge, but so is the down. I wouldn't put any money into this that I couldn't afford to lose (which is of course true of ANY investment, but especially one like this).

"Struck on iceberg. Water coming over gunwales in bow. All lifeboats away. Please ask orchestra to play "Nearer My God to Thee."

I find the phrase "net revenue" a little confusing, but the numbers look good. Ignoring the fiscal year shift, it works out to:

2002: 96.0 million net revenue
2001: 19.4 million
2000: (1.5) million

Now this isn't profit. This is total income (revenue) less something (commissions?), though having negative revenue in 2000 is really puzzling.

So is Tivo making any money? Short answer, NO. I found this on Yahoo's financial site: http://biz.yahoo.com/fin/l/t/tivo.html. The "net revenue" mentioned above is here called "gross profit". But look at "operating profit"; even the really good quarter they had last spring (May-July 2002) ended in a loss of over a million. Other quarters are much worse. And then there's interest expense.

My assessment is that Tivo owes more than they have and are still losing money. So the value of the company comes down to intangibles. Can they grow enough to start showing a profit? Can they change their expenses and income enough to start coming out ahead? Would another company pay enough for them that shareholders would get something (the first $500 million would have to go to pay off their debt).

I guess I would look into that "Cost of revenue" line. If that could be cut sharply, the company could show an operating profit at least. (Of course, if it could be cut sharply, why hasn't it been already?)

There are around 65 million shares outstanding, so the current price of $8.63 gives a market cap of $563 million. So if you're looking for a buyout, somebody would have to be willing to pay around $1.1 billion for the company (debt plus current market cap); then you'd get your money back. You'd need a higher buyout figure to show a profit on your investment.

Well, that's the problem with speculative stocks, now, isn't it?

I'd look at TiVo's business model, figure out if it's even remotely possible to get enough people to buy the monthly service for the company to actually make a profit.

If I thought "yes", I'd do some back of the envelope math to figure out how much money they could earn, and discount it appropriately.

Since I think, "no flippin' way", I don't buy the damn stock.

Next question?

I have no real idea what it means, but it makes me glad I did not pay the $250 fee for "lifetime usage"

speed, 100 kots... anlge 90 degrees down.. altitude.. 8000, 7000, 6000, 5000.... lets just hope they're over death valley so we can get out soon

I think the paragraph you quoted is pretty easy to understand. "Accumulated deficit" is an entry in Shareholder's Equity. TiVo has raised ~$522mm in equity offerings but has lost ~$545mm so far, meaning that the difference between the equity financing and actual losses have been made up for by either debt (only $7mm -- not the massive $500m mentioned above by PJ/Maryland) or "deferred revenue" (which revenue which TiVo anticipates it will receive but which has not arrived yet).

Net revenue is not very puzzling either. The 2003 fiscal year saw TiVo give about $10mm in rebates to customers. These rebates are deducted from gross revenue to come to Net revenue. This is standard accounting practice. A firm that gives you a promised rebate of $0.10 on a $1.00 purchase counts the entire $1.00 purchase in its gross revenue but deducts that rebate to arrive at Net revenue.

Having said that, the most important financial statement is the Cash Flow Statement. That shows that TiVo lost $33mm in 2003 (fiscal year) (it's Cash flow from operations line). So they had revenues of $96mm and lost $33mm. Their Free Cash Flow was a bit lower than the $33mm but let's leave that aside.

None of this is going to tell you clearly how much the company is worth, of course. To do that, you have to see the future and predict the eventual consumer penetration rate of the TiVo and what each of those customers is going to be worth. (I believe TiVo had about 1mm customers when they last reported.) Personally, the TiVo device could foster a revolution in consumer electronics, one centered on that most lucrative and dominant piece of consumer electronics in the average home, the TV set. $500mm for such a company? You betcha.

But again, determining the proper stock value for such a company involves relying not on the data in a 10-K or 10-Q but accurate prognostication of consumer trends.

The question was not about the evaluation of the stock, but rather if the accumulated losses were considered debt.

I am in a debate with someone who says that technically these losses never need to be paid back and can keep racking up losses, as long as they keep making payroll and paying creditors. I say sure they do, and that until they achieve positive cash flow and start paying back this debt the company will either be bought out or go under.

So I wasn't really asking stock advice, as I know this is a risky stock and bought it pretty cheap.

So when are accumulated losses not debt? The person I am in the debate with is adamant about it not being debt at all. I don't get it... if I owe money to the bank, I consider that to be a debt. No matter if it might be long term or not.

Accumulated losses are 'paid' out of stockholders equity. Provided the company has equity from either what the original investors paid into it or raised by stock sales then net losses are indeed not debt that has to be paid back to a creditor. The losers are the stockholders who never have to get paid back anything.

There is a limit to how much the company can lose however. Eventually it will run out of equity and become insolvent. Assuming that the company cannot convince people to put more capital into it, that will be the end and it will either have to go under, get sold or turn around.

One problem with TiVo is that a PC with a $150 video capture card and a few Gb of hard drive space can do what TiVo can do ... without monthly fees.

I'd be very wary of TiVo. Cable operators are offering digital cable boxes/services that have TiVo-like capabilities. A few of my friends have them.

Untrue, because the amount of programming involved to have the PC figure out what I might like to watch, and update schedule and chanel line up automatically would far exceed the $12.95 per month I pay to have TiVo do that for me.

Crystal: I agree with Boonton. Jane's question did ask about the valuation of the stock, BTW.

While I'm an economic idiot, I might have some good input.
I have Comcast cable. I just got DVR at $10/month. It's tivo without needing tivo and I get picture in picture with it. I can record two shows and watch a recorded show or record one show and watch another. I can also set it up to record the same show each week or, well you get the idea. Comcast brought me a new cable box for it. I can save 30-50 hours of programming. It sounds a lot like tivo to me so maybe it's time to get out.

JT- Yes... Jane's question did ask about the evaluation of the stock, but being the person who originally presented her with the question about Tivo, I wanted to clarify this was not what my inquiry was.

My read between the lines on the statement is "if we grow fast enough we can get enough customers make it cheaper for a cable operator to buy us than to kill us off then we'll be ok. If not, insert fork here."

How should the readers interpret that information from the 10-k? Well, they should only interpret it as a small part of the rest of the annual report. Context is key.

And to the person who inquired earlier, net revenue is equal to gross revenue less cost of goods sold.

Guessing on the future market penetration of Tivo is speculation, not investing. I'd stay away until they have more predictable future earnings.

It would be nice to see the first sentence of the paragraph in question in full context. I wonder if it could possibly imply that revenues were low because conservative revenue recognition practices were applied. So for instance, maybe many users have signed long-term contracts, but Tivo hasn't recorded the full value yet as revenue. I don't know because I don't follow the company. Or maybe they just mean recognized as in "received".

I always tell my clients that if you take that money to Vegas and blow it, they will comp you tickets to the show. What will your broker do for you? will he call you in the morning tell you he loves you and that you were great?

Sean:

Umm, no.

Net revenue is total revenue less sales returns & allowances (including stuff like discounts and rebates).

Net revenue less cost of goods sold is gross margin on sales, or gross profit.

Crystal and Jane,

In English, that stuff means "There be dragons here!"

Crystal,

Accumulated losses are never debt since they will technically be paid out of stockholder equity. There are however other way of financiang a loss you can for example borrow from your suppliers in which case the loss would be paid out of stockholders equity from an accounting point of view but also give rise a accounts receivable debt. You can also regard accumulated losses as an asset since they will enable you not to pay taxes on future profits. This however is not eactly advocated by accountants!

As to the value of the stock it is pure speculation and I refer you to the greater fool theory.

Businesspundit: "Guessing on the future market penetration of Tivo is speculation, not investing. I'd stay away until they have more predictable future earnings."

It is most certainly investing. No one is denying that TiVo is a risky stock and hasn't made any money yet. Microsoft and Amgen were in the same condition once, as were many companies that have gone belly-up that we've never heard of. Calling any such investment "speculation" on the basis of historical financials is simply foolish, IMHO.

(1) I agree w/ JT. Projecting future market penetration most certainly is investing.

We all recognize that making forecasts is a guessing game, but an investor's job is to find companies where it makes sense to project where the business might be in 3-5 years. Good investors will be the first ones to tell you that this is easier to do for some companies (Coke) than others (Tivo); and they will often give this as a rational for choosing to avoid stocks like Tivo -- making a reasonably accurate long-term prediction is just too hard for that kind of company.

In the case of Tivo, the section of the annual that Jane quotes makes it clear that the company is growing fast -- 395% from 2002 to 2003. That's an important takeaway.

Such high annual growth is great, but it is also characteristic of businesses that are far from full penetration or long-term stability in their markets. Early markets offer great growth, but also the potential for upheavals related to competition, changing consumer tastes, etc.

Tivo is certainly facing competitive pressure that suggests that even if personal video recorders become huge hits and every American household owns one, Tivo itself may not end up being the company to benefit.

On a qualititative basis, I'd be wary, and look into competition with much more detail before buying the stock (some of the concerns re: Direct TV mentioned above look pretty significant).

(2) Accumulated deficit is not debt. Think of accumulated deficit as a record of past spending, not an indication of future obligations.

That's why it is in the "Stockholders Equity" section of the balance sheet and not the "Liabilities" section.

In Tivo's case, as of their most recent quarter (the one right after that annual report was filed), there is $9m in long-term debt and no short-term debt.

Nine million is a small number given that Tivo also has over $39 million in cash. And that $9m is long-term debt which means it can be paid over time.

BUT, the picture gets dimmer because Tivo has other, non-debt obligations. Like accounts payable (ie. bills from vendors) of about $29m. Accounts receivable (invoices sent to customers) is only at $7m so you have net $22m that has to be paid out, separate from Tivo's debt. Take that out of Tivo's $39m in cash and you're left with $17m.

The main value of the statement Jane quotes is that it tells you that Tivo lost a lot of money in the past and is still losing money (they "have substantial negative cash flow"). So, you have to ask yourself: how long does Tivo's $17m in cash last?

The statement in the annual is valuable because it turns your thoughts in that direction.

JT mentioned that Tivo's cash flow statement showed a cash usage of $33m last year -- suggesting that the company has enough net cash ($17m after paying its bills) to last it for six months. Then Tivo must either raises new money (debt or equity), go out of business, or become profitable.

What will happen? Well, Tivo raised $27m in June, so add that cash to its total. More breathing room. That money was raised after its last quarterly report was filed, so you won't see it in the annual or the 10Q.

Also, on July 1st Tivo filed to sell up to $100m worth of debt and equity, suggesting that they plan to raise much more money.

What does all this mean for valuing the company? Just that it's a process that takes one heck of a long comment to explain.

The new money that Tivo raised (and hopes to raise) can be thought of as bad for existing shareholders. It's better than going out of business, sure, but it's much worse than getting profitable without having to raise new money.

Why? Because new debt is an obligation that Tivo has to pay ahead of its obligations to shareholders, and new equity creates a larger pool of shares which dilutes the value of Tivo's existing shares. (ie. I own 3/10th of Tivo, until Tivo issues $50m in new equity, increasing its share count, meaning that I now own only 2/10ths of the company).

So, whatever you are paying for Tivo today, you should mentally inflate that price, in order to account for the impact of the $27m financing and the future impact of up to $100m more. Of course, you also figure in the cash that Tivo takes in from these deals, but since the company is not profitable, that cash will decrease over time until profitability is achieved.

So is Tivo worth its $550m market cap (+ the new shares issued for the $27m financing, + the future financing cost)?

It is perfectly possible that, given the $27m they just took in and the ability to raise more money, that Tivo becomes profitable before they run out of cash. So it might not go out of business. Then what?

Then you have to forecast/project/imagine what Tivo's business will look like in the future. What will its products be? (New audience measurement products for advertisers are being rolled out, for example). What will the pricing, costs, and margins be? (mostly a function of competition's impact on pricing, I think). How large could the company be? (A Tivo in every household? Well, a Tivo-like device, with some portion of the market being actual Tivos and the rest taken by competitors).

To justify $550m - $600m in valuation you need annual profits of, say, $20 - $25 million and enough growth still expected in those profits to justify a P/E of 25 or so. Say 25% annual growth. Some consider a 25 P/E aggressive, even for this kind of growth, but let's go with it. So: 25 P/E x $20m - $25m in profits = $500m - $625m in value.

Tivo is growing a lot quicker than 25% per year now, but by the time it is profitable that will have changed.

How plausible is it that Tivo can generate the $20 - $25 million in net income needed to be worth about $600m?

My back of the envelope numbers suggest that for Tivo to make enough profits to justify a $550m - $600m market cap (about its current price given the new money it raised) revenue would have to TRIPLE, gross profit margin would have to DOUBLE, and operating margin would have to improve by about 30%.

All of this is actually possible for a fast-growing business. Even reasonably likely.

The problem is that this good performance doesn't get you a good return -- it just means Tivo would then actually be worth roughly what it is trading at TODAY.

In other words, it's wildly overvalued.

That doesn't mean the stock won't go up -- anyone who lived through the late 90s should be sure of that. But I would call Tivo stock a speculative play, not an investment.

For the curious, my numbers:
Today revenues are at $114m. Triple them and you have $342m.

Today the gross margin is at 20%. Let's be generous and say it doubles to 40%. Doubling gross profit from 20% to 40% gives us $137m in gross profit.

Below the gross margin line, Tivo has about $50m in operating costs (44% of revenues). Let's say that these drop to 29% of revenues in our rosy future. This is $100m given our new revenue figure of $342m.

Take our $100m in operating costs out of our $137m in gross proft and we are left with operating profit of $37m. Take out 38% in taxes and you have net income of $23m. Give that a P/E of 25 and you have TIVO worth $570m.

That's a lot of improvement just to get to today's value.

Also, this is a *very* rough way of figuring things. For example, one value of Tivo's accumulated deficit is that it actually means the company can avoid paying taxes for a LONG time. I assumed a 38% tax rate up there, which is probably what Tivo will eventually pay -- but not until it has made gobs and gobs of tax-free profits. Even so, I wouldn't touch the stock except as speculative gambling.

** Sorry, this is a short one **

A better understanding of accumulated losses:

These are costs that have already been paid.

They are often paid in two ways: by spending down the cash that the company has on its balance sheet, and by using debt to pay for them.

If debt is used, then there will be a separate line on the balance sheet which shows how much debt the company has. This line is all you should consider as an obligation.

Since its possible that debt was not used, and that the spending that created the accumulated deficit was paid for out of cash, there's no reason to consider the accumulated deficit line as a future obligation.

It is merely a record of past history.

To the extent that a company *didn't* have cash to pay for its spending, then a high accumulated deficit is often *correlated* with high debt. But all you should do is look for debt on the balance sheet to see if that's the case.

** OK, end simple part **

One other complication is that instead of debt, a company may have raised cash in the past to pay for its spending by issuing stock. Some of this stock may not be plain old common stock but rather preferred stock with special terms.

The existence of preferred stock can mean bad things for holders of common, so if I saw a large accumulated deficit I would then look not just for debt but for evidence of preferred stock having been sold in the past.

But in general, again, the losses are old spending that has been paid for (somehow). If that spending resulted in a continuing obligation, that obligation is most likely to be debt, which you can easily find on a balance sheet -- or, it may be preferred stock, which is a pain to figure out.

JT and Jim,
I don't mean that guessing future market penetration is speculation in all cases, just in Tivo's case. In Coke's case it makes sense, and can be done with a fair amount of accuracy.

I guess I lean too much to the Buffett/Graham view of investing:What do we mean by "investor"? Throughout this book the term will be used in contradistinction to "speculator." As far back as 1934, in our textbook Security Analysis, we attempted a precise formulation of the difference between the two, as follows: "An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."(from The Intelligent Investor)

I agree that Microsoft and Amgen went through the same thing - most companies do, but until you can see what they will become, I think of it as speculation.

OK Businesspundit. For me, speculation has a more pejorative meaning, but TiVo certainly conforms to the definition you provide.

JT,
I think our difference is semantic. I agree that investment in Tivo is not akin to gambling, but I think you will agree that there is a good deal of uncertainty in their future, and they don't have a monopoly on their idea.

Comparing Tivio to Microsoft or Amazon is misleading.

Their business is based on selling a physical gadget. In particular, an electronic gadget.

This means that at any given time they have a fixed incremental cost of goods sold for each new customer they add. This COGS can theoretically go down (manufacturing efficiencies for large production runs) but in practice may not do so to any great degree (parts go out of availability quickly, re-engineering is required, the company has to pay, in one way or another, for inventory of parts and inventory of finished product that isn't sold yet).

Net result? Unless they could somehow gain a lot of new sales of services only, they are unlikely to mimic the growth into profitability of startups like Microsoft.

Apple Computer is probably a better parallel.

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