Tivo: Respectable Q but unrespectable guidance.

Tivo reported the earning after the market close on Wednesday. Heading into the earning, I thought the company had manageable expectation that had a fair chance of being exceeded. Hence I thought the stock was a trading buy.

(see http://www.investorhives.com/msgd.php?msg_...)

From the today's stock action, this turned out to be a blown call. Let us fast-rewind the tape and review what has occurred. As expectedly, Tivo delivered respectable top-line and bottom-line performance. The revenue came in at $65.7 mil, slightly ahead of the consensus estimate. EPS loss was at 12 cents, 3 cents better than the consensus loss estimate. Operating margin was ahead of some analysts' expectation, coming in at -18.7% versus ~ -25% expected. Tivo also announced DVR software deployment deal for Cablevision Mexico with 500K subscribers in the middle of 07. These headlines alone would have caused the shares to trade slightly higher, which it did just after the earning was released.

Then the investors took the notice of the next Q guidance. Although heading into the earning with low expectation, the company still managed to disappoint the investors with the next Q sales guidance. As the Christmas holidays are the seasonally the strongest time of the year for Tivo sub adds, the investors wanted to hear that the company will be aggressively accumulating as many as subs as possible (even at the expense of significantly higher marketing cost). This was also my expectation but it was not the case. Tivo guided for subdued sub add outlook. Yet the company was still guiding for the significantly higher operating expenses. This aspect may have been very puzzling for investors. The investors wanted to hear more aggressive sub add efforts at higher marketing expense. Or they could have been also happy with more profitability with less marketing expense. Somehow, Tivo seemed to have done something that is not very intuitive: less sub add with more operating expense. This was the source of the investors' disappointment and the stock tanked by nearly 10% today.

What may have happened was management's attempt to kill the two birds with a stone, a strategy which backfired on the stock price performance today but is not completely unreasonable. Tivo is fighting with two major uncertainties: timing of the network-wide Comcast deployment and resolution of the litigation against Dish. Tivo needs to ensure that Comcast relationship can generate meaningful sub adds for the company to expand its sub-base large enough for more effective ad opportunity. However, the timing of this event is rather uncertain. First, Comcast will have go through testing phase of Tivo software till early 07. Even after Comcast start marketing Tivo software by the middle of 07, it may take some additional time for the subscribers to readily accept Tivo product and Tivo software to gain momentum within Comcast subs. Cox deployment may even take longer than Comcast. Till then Tivo will continue to burn the cash and as such the company may want to minimize as much cash burn as possible.

Yet at the same time, the company may want to add respectable number of standalone sub adds (since it has the highest profitability) during the seasonally the strongest time of the year. So it is still spending fair amount of money to entirely subsidize the single tuner Tivo box (predicting loss of 30 ~ 35 mil and the company has slightly greater than 106 mil in cash). In a way, it is preferentially clearing out the old inventory as people will clearly have more inclination for the single tuner version with no hardware cost. Notice Tivo is raising upfront cost for the dual tuner DVR to $69 with higher monthly fee. However, longer term commitment (3 years) will yield significantly lower monthly fee (slightly less than $9 and is actually cheaper than $10 that the most cable providers are charging). So if people still opt for dual tuner this holiday season, all the revenue will be the upside surprise: the company thinks most of the hardware sales will be the single tuner because of no hardware cost (entire amount given back in the form of rebate). This is company's attempt to still experiment with the pricing plan to understand the consumer preference for more effective marketing and at the same time to yield respectable standalone sub adds during the holiday season.
So the company is trying to limit cash burn while adding reasonable number of new subs and in the process ended up guiding more subdue sub add outlook with higher operating expenses. Am I really disappointed? Well with the stock price movement Yes�� But with respect to what the company is doing, I can care less. This is because in order for Tivo to become a viable and thriving entity, the company must see two events with favorable outcomes: patent litigation against Dish and Comcast deployment. Yesterday's earning outcome and subsequent stock movement will be a noise compared to that you will see as a result of the litigation and effectiveness of Comcast deployment. These are two events that investors must pay attention. If none of these events pan out favorably for Tivo, I am going to bail out of the stock. Until then I am going to continue to speculate on Tivo on the long side.

Due to tremendous technological leadership in the DVR space and synergy with the advertisement product, in the worst case, Tivo will be bought out and become a division of Comcast. Even in this case, I believe that there could be a fair amount premium from the current share price (given how well Comcast share price is doing these days). In the best case of successful litigation outcome and rapid sub add growth from the MSO deals, the shares could be trading significantly above the current level. I am hoping that it would be the latter case. But so far investors are betting that it will be the former.