Another yummy S-1 appeared late last week from DivX, a provider of software that allows compression-decompression of DVDs and movies. This S-1 interests me because DivX is a bubble-era company that initially gained prominence by its software that allowed the compression and decompression of illegal copies of movies floating around the internet. Previous to companies like DivX, movie files were too large to be transmitted over the internet. After DivX, all you needed was a fat broadband connection and your buddy could connect to you via firewire or transmission could even be possible over instant messaging networks. For those of you who have always wondered how companies who give away their product for free eventually make money, here in DivX is a good example. After gaining popularity, DivX has started supplying OEMs allowing consumers to buy machines with the software pre-loaded.
The DivX filing is significant to me because it is yet again another IPO filing from a tech-bubble era company funded in 2000 that survived the meltdown and has achieved profitability. Since the meltdown, there have been countless articles written about venture capital overhang. While the popular press has worried about unused capital commitments, I’ve never really felt this was a real problem. The problem since the meltdown has been a tight IPO market with few liquidity channels available. Consequently, when VCs can’t achieve liquidity, their portfolios become larger and they are hesitant to put new money to work. When this happens, uncalled capital commitments build up and management fees accumulate and thus overall returns are dragged down a bit.
When liquidity channels are tight, venture investors must hold onto their companies longer. VCs won’t invest as readily in this environment. People think this is primarily because VCs don’t want too big of portfolios at one time and that they want to be able to manage risk in their portfolio by seeing if early bets will pay off. While the latter is partially true, the real detriment to having tight liquidity markets is that industries do not mature and evolve well without exposure to the public markets. VCs need their companies to go public so they can get a return on their investment as well as to see those markets mature and evolve. Industries do not change as rapidly until several companies are public. Several things are allowed to happen when tapping the public markets – increased merger activity, new ventures, consolidations, and products related to economics of scale.
The DivX filing is a clear sign that things are heating up. There is a feeling in the venture community that now is a great time to take those companies public that they have been holding onto. If you take a look at next week’s anticipated offerings, you will see Interwest Partners actually has two companies slated to go public, QuatRx and Novacea. In their defense, those companies are both out of Interwest VIII, which is a huge fund, so it is probably a coincidence. While I am happy for all of my venture brethren to get liquidity and turn those ROIs around, I am also a bit worried. I know of several companies that are contemplating their S-1 filings. Some are ready for the public markets, some are not. If you notice the SEC filing activity, you will find that the quality of companies has declined a bit and 3 to 5 quarters of profitability is not required. In addition to the poorer quality of companies, I am also noticing that management and shareholder teams have lots of 30-year olds on board. Not that I have anything against young people, but this trend reminds me of years past.
So before I forget, let's be students of the S-1 on the DivX filing:
Principal Shareholders: R. Jordan Greenhall (CEO), Zone Venture Fund, WI Harper Group, Insight Holdings.
Company Story: Started in tech-bubble 2000 initially providing video compression software, now including a media player, selling to OEMs now.
Leadership: Management team of several 30 something year olds, including CEO R. Jordan Greenhall, a 34 year old who had a brief stint at MP3.com before starting DivX. He’s a Harvard law grad. Interestingly, two of their managers hold the “CXO” title, which I have never seen on an offering memorandum. However, I am obviously getting a kick out of it as I have adopted that term for my own VC firm. Another interesting thing about their filing is their note to investors which eerily reads a bit like the introduction to the Google filing.
Financials: Expanding revenues of 8 mm in 2003, 16 mm in 2004, 30 mm in 2005 with 2 mm of profitability last year.
Final Assessment: This is a company that has survived the tech meltdown and appears to have momentum. No valuation is listed in their offering, but they have about 33 mm shares outstanding so I would estimate a 250 mm to 350 mm valuation which is around 10x 2005 revenue. This is an intensely competitive sector but this is a young management team that has survived some difficult times. It will be interesting to see how well received the offering will be.
Friday, May 12, 2006
IPO Report: What Is DivX Worth?
So that no one is left guessing, by looking at the closest comparable public company, DivX, which has filed its S-1 with the SEC, is worth about $160 million. The whole company. The IPO is to raise as much as $135 million.
DivX's businesses are very close to the businesses that RealNetworks are in. Real's (NASD:RNWK) revenue last year was $325 million. It's market capitalization is $1.59 billion according to Yahoo!Finance. The DivX S-1 says its revenue in 2005 was $33 million. That's the math.
One could make the argument for several reasons that Real should have a higher multiple than DivX. Real has $700 million in cash on its balance sheet. That's nearly half its market cap. Real's distribution, and, more important, use on PC's, cellphones, and consumer electronics devices is probably much greater than DivX's. Real's Helix media server system is almost certainly more widely deployed than DivX's servers and the amount of content on the internet played back in the RealPlayer is also almost certainly greater. Real also has a well developed subscription service that includes it's Rhapsody and SuperPass products. Real, because of its size and recent settlement of antitrust claims with Microsoft is in a better position to compete with the Windows Media Player platform than DivX is. And, Real's digital rights management software, to protect content from piracy, is almost certainly more widely deployed and used that DivX's.
Perhaps the most important issue is mentioned in the DivX S-1. That is DivX has "entered into a license agreement with MPEG LA pursuant to which we have acquired rights to use in our technologies and products certain MPEG-4 intellectual property licensed to MPEG LA. Our licensing agreement with MPEG LA grants us a sublicense only to the rights in MPEG-4 intellectual property licensed to MPEG LA." And, a bit later on in the document: "we have been contacted by third parties regarding the licensing of certain patents characterized by such parties as being essential to the MPEG-4 visual standard. In this regard, AT&T has offered to license us certain patents it claims are essential to MPEG-4 and our products". Having AT%T looking at patents on the technology you use is not a good thing.
Unlike RealNetworks, DivX must license some of its core technology from the MPEG patent pool (www.mpegla.com), and the current version licensed by DivX is a bit long in the tooth. So, DivX faces competing with companies like Real and Microsoft (NASD:MSFT) who have their own core technology, developed in house, while DivX must rely on an outside provider that has to be paid annually for the license to its patents.
A couple of other ratios worth review are revenue per share and revenue per employee. The DivX filing lists full dilutes share at 49.4 million. So, their revenue is $.668 per share. RealNetworks has 176.9 million shares. That puts revenue per share at $1.81, or 2.7 times the DivX figure. Turning to employees, DivX has 189, so revenue yield per employee is about $175,000. Real has 915 employees, so revenue yield there is $355,000, or over two times DivX.
DivX will almost certainly have to show first quarter, and, perhaps, first half numbers before the IPO goes to market. It should be telling. The company's cash position is about $25 million. It made $3.1 million on $33 million in revenue in 2005.
It will require some extremely big numbers in early 2006 to convince those looking at the IPO that it should trade at a premium to RealNetworks. At this point, there are simply not enough compelling reasons. And, raising $135 million on a rational market valuation for the whole enterprise of $160 million would be a very big stretch indeed.
Douglas A. McIntyre is the former Editor-in-Chief and Publisher of Financial World Magazine. He is also the former president of Switchboard.com, which was the 10th most visited site in the world at the time, according to MediaMetrix. He has been chief executive of FutureSource LLC and On2 Technologies, Inc. and has served on the boards of TheStreet.com and Edgar Online. He does not own securities in companies he writes about. He can be reached at douglasamcintyre@gmail.com.
Posted by: douglas mcintyre | May 13, 2006 at 07:40 AM