Today’s buy idea is a company with a $1.8 billion market cap that makes streaming video technology. The stock’s price is depressed following a disappointing earnings announcement, but Fidelity Investor Editor Taesik Yoon thinks this reaction was short-sighted and presents a buying opportunity. The Fidelity Investor excerpt is followed by two sell alerts.
Rovi Corp. (ROVI)
from Fidelity Investor
With the ever-increasing focus on near-term results, investors often lose sight of the bigger picture. That’s why it’s not unusual to see shares of a company that misses quarterly estimates or reduces near-term guidance sell-off even if the reason stems from the negative impact of actions expected to improve growth and profitability in future periods.
This is what happened to Rovi Corporation. [Rovi] reduced its revenue projection by $15 million to $585-600 million and lowered its adjusted earnings per share guidance by 10 cents to $1.70-$2.00. The primary reason for the reduced outlook stems from Rovi’s strategic decision to not sacrifice profitability for volume as it negotiates terms on ongoing licensing opportunities for its over-the-top (OTT) products, which enable the delivery of entertainment media content by third-party providers (such as Hulu Plus) using broadband Internet Protocol packets. This has prolonged the time it is taking to close on deals currently being negotiated.
Nevertheless, Rovi was able to renew 25 product agreements with cable operators in North and South America during the quarter, which provides greater revenue stability going forward. Other positive developments over the past several months include the introduction of the industry’s first HTML5-based, cloud-powered electronic programming guide in Japan, which is expected to help integrate Internet-based content and broadcast TV as the nation’s broadcast system migrates to a new service called Hybridcast; a multi-year agreement for the licensing of Rovi Video and Rovi Music metadata solutions by Nuance Communications; and a collaboration with STMicroelectronics (ST) to deliver an end-to end solution for the creation, secure delivery and playback of High Efficiency Video Codec (HEVC) on ST’s System-on- Chip (SoC) products used to power set-top boxes.
Furthermore, we are encouraged by the recently announced actions Rovi will take to enhance shareholder value. This includes exploring strategic options for its DivX business, which could result in its sale; a voluntary debt pre-payment in the current quarter that should help reduce interest expense; and the leveraging of its strong balance sheet to repurchase shares under a newly authorized $250 million stock buyback program.
We also want to note that the lack of deal closings doesn’t imply that no progress has been made. In fact, Rovi stated that it has wrapped up patent validity and infringement discussions and has moved on to negotiating business terms on these deals. In one specific situation, the delay is due to the service provider expressing interest in expanding the scope of its agreement to include the utilization of discovery products in the areas of set-top boxes, cloud-based guides and metadata, which ultimately would result in a larger contract.
So despite the negative impact on near-term results, we continue to believe that Rovi’s decision to get appropriate value for its licensing deals is the right one. As these are long- term contracts, compromising on price would have a negative impact on profitability for multiple years. It would also diminish the company’s negotiating leverage on similar deals with other partners. Once completed, they should help ROVI enjoy a meaningful rebound in revenue and earnings growth in 2014. Thus, the additional sell-off that occurred after its Q3 earnings report only served to make the stock more attractive from a long-term standpoint in our view.
Taesik Yoon, Forbes Investor, tyoon@forbes.com, 212-206-5518, November 2013