Last week Avid announced that it was postponing its fourth quarter 2012 earnings release "to provide additional time for the Company to evaluate its current and historical accounting treatment related to bug fixes, upgrades and enhancements to certain products which the Company has provided to certain customers". This came just a day after productions using its products cleaned up at the Academy Awards.
These two stories highlight the strange nature of the company. On the one hand, it offers great products that are loved by award winning customers. On the other hand, it's consistently struggling to turn a profit. Avid's accounting problems provide a good backdrop to look at its financial situation, some of the structural challenges it faces, and some of the more extreme options that could be on the table if the accounting problems at Avid run deep or the losses continue.
A Management Shakeup?
First a bit of background. The decision to postpone results isn't the only recent bit of unsettling news. In case you missed it, on February 11th, Avid's board announced that it had replaced Gary Greenfield as CEO with long-time board member, Louis Hernandez. This was done without warning, and would tend to indicate that there was some internal unhappiness with the results that Greenfield had delivered.
While Hernandez has a solid resume, he doesn't look like the breath of fresh air that the company could really use. The board highlighted his experience at Avid as proof of his credentials, saying that:
As lead director, he spent years developing a deep familiarity with Avid's customers, markets, and products that will allow him to quickly make a positive impact as chief executive.
But that could be the problem. If you want wholesale change, is it wise to replace the CEO with the "lead director" who's blessings, if not fingerprints, should have been on the corporate strategy that got them where they are in the first place? He has had a front row seat to the years of decline.
Perhaps the management shakeup was an opportunistic change. Hernandez, suddenly became available, after selling Open Solutions, the provider of tech solutions for financial institutions where he was CEO, in a transaction valued at close to $1 billion. The experience with operations and innovation gained while growing a startup and navigating it into a successful exit may have been appealing to the rest of the board.
If the desire for change is strong, or the accounting problems run deep, then Avid may be forced to look at some more radical options. What are some of the options that could be on the table? As I see it, the alternatives include more restructuring, an investment in innovative products, a private equity buyout, an outright sale of the company, or a breakup of the company. What is the likelihood that each of these options will happen? Read on to find out.
Avid's Problems - It's Hard to Turn Back the Clock
Avid's days as a growth story look to be well behind it. The company was hard hit by the shift from hardware-based video editing solutions, to software only solutions. Avid has posted a net loss every year since 2005.
As you can see, there was a reduction in net losses in 2010, and 2011. This was accomplished by managing cost of revenues and operating expenses, rather than through revenue growth, which has proven harder to find. Forays into consumer and pro-sumer video and audio editing markets have ended badly.
The large revenue decreases of 2008 and 2009 seem to have stabilized, but the recent divestiture of its consumer business will impact revenue in 2013 (the divested product lines contributed approximately $91 million of Avid’s 2011 revenue of $677 million). It's unclear where Avid will find significant new drivers of growth.
The challenge that Avid faces is that it operates at the high-end of niche markets that are experiencing modest growth. For example, in the post production segment, its high-end solutions are great for winning Oscars and building a reputation for excellence, but the market growth (at the top-end) is relatively slow. The dynamic in the professional audio segment is similar.
In spite of limited growth, these markets are fiercely competitive and suffer from price competition. In the professional editing market, Apple's decision to cut the price of Final Cut Pro from $1000 down to $300 has hurt Avid, as has Adobe's bundled pricing strategy for Premiere Pro (basically everyone who uses CS6 has access to Premiere Pro, whether they need it or not). Even though it may be shipping more units of Media Composer than in recent years, cross grade promotional pricing must hurt profitability. The software is essentially becoming a loss leader that brings people in the door so that Avid can sell them storage, collaborative workflow products, and professional services.
Relatively slow growth and pricing pressures are compounded by the fact that Avid customers across all segments are extremely demanding. Customers come to Avid for cutting edge solutions to difficult problems such as designing collaborative workflows. Serving this audience means that Avid must continue spending on R&D. This is a client base that demands constant innovation. Milking its existing product lines is not a long-term option.
Given the structure of the market, and Avid's positioning, it's difficult to see how Hernandez can turn back the clock to Avid's glory days.
One strategic option for Avid, and the route I'm sure it's most likely to take, is to continue restructuring to drive improved operating performance by focusing on its Media Enterprise and Post & Professional customers.
Avid has tried this many times before. The most recent restructuring plan was introduced in July 2012, when it announced that it would divest its consumer audio and video lines in order to focus the company on professional customers. This decision was reached after the market for its consumer software essentially collapsed. Prior to this plan, Avid launched separate restructuring plans in 2008, 2010, and 2011.
The problem with restructuring is that there are limits to what can be done. At some point, it's hard to cut your way to growth. Avid cut 20% of it's workforce and sold off its consumer services in the summer, so I'm not sure how much fat is left. Only time will tell on this one.
Invest in Innovation and New Product Categories
Avid could try to invest in significant new product development and new product categories. I think efforts to do this could be hampered by the following:
It has limited cash to invest in new product development.
The time horizon for incubating new products in-house is relatively long.
It has limited financial resources to make acquisitions that would deliver material results quickly.
With this strategy, my first thought was that Avid could round out its suite of editing tools. However, professional video editing only represented 11% of revenue in 2011 (down from 13% in 2010). By contrast, storage and workflow solutions represented 21% of revenue in 2011, up from 16% in 2009. Given the growth in this segment, I suspect that Avid would be more likely to invest in shared storage, collaboration and asset management than anywhere else.
An Outright Sale of Avid
I think this is a pretty big long-shot.
The big problem with finding a buyer is that Avid's product suite is relatively diffuse. I can't think of a single company that would be a natural home for the pro-audio business, the pro-video business, and the support and professional services business. All three segments are major contributors to revenue.
The only thing that I think would push Avid towards a sale would be financial distress. Right now, it still has some cash on hand, and a guaranteed credit facility, so it should be good continuing along at its current burn rate for awhile. However, if Avid can't eventually turn a profit, or if there is a big surprise in the accounting treatments, then perhaps that could push the company towards a sale.
Right now, its stock price is nowhere near the distress level where I think this would happen. When Avid announced the filing delay, the stock traded down approximately 8% and hit new 52 week lows. I suspect the stock would have to fall by another 10-20% before opportunistic buyers start knocking on the door.
Unlikely Acquisition Candidates: Apple & Adobe
Key competitors Apple and Adobe aren't likely buyers. Even if Avid were to be broken up, it's hard to see either one of these companies being interested in the parts.
Apple is aiming at more of a mass audience with Final Cut Pro and is interested in shifting to a new editing paradigm, so there wouldn't be a fit for any of Avid's editing solutions. The broadcast and storage solutions wouldn't be a fit for Apple as it has moved out of the server and storage markets. Apple has pro-audio covered off with Logic. Given that its commitment to this market has been questioned, I can't see it wanting to acquire Pro Tools.
On the editing front, Adobe has enough momentum that there would also be little to gain. In fact, with the impending launch of Adobe Anywhere, it's set to further encroach on Avid's territory. Although Adobe has designs on serving the entire media creation and distribution workflow, I can't see it wanting to complicate its business by moving into hardware sales and support. Pro Tools software could have a fit in the Creative Cloud portfolio, but I can't see Adobe doing much to make this happen, as there are probably cheaper ways to beef up its pro-audio tools.
I could see Autodesk being interested in Avid's software and support assets, but not any of it's hardware solutions for editing, storage, or pro-audio.
Autodesk has a strong balance sheet, great cash flows, and high margins. Media and entertainment accounts for approximately 8% ($194 million) of AutoDesk's net revenue, and it is an important strategic area for the company (witness the launch of Smoke 2013). The company has done several acquisitions, and has proven that it can successfully integrate them. In fact, Autodesk acquired Softimage from Avid at a fire-sale price back in 2008.
The big barrier here is that the company would only be interested in pieces of Avid rather than the whole company.
This is an interesting transaction to consider. Unlike most other potential suitors, Blackmagic understands selling hardware and software.
Blackmagic also has a history of acquiring struggling companies (Davinci, Cintel, EchoLab). Even the acquisitions of Teranex, which had a large patent portfolio and was termed "a strategic acquisition" by Grant Petty, was probably not done at an outrageous premium given that it never really found a home in the portfolios of its 4 previous owners.
Blackmagic looks like a disciplined and opportunistic buyer, not a company that pays huge multiples with the hope of achieving "synergies" somewhere down the line. As such, I can really only see it being interested in an acquisition at a bargain basement price. Even then, I suspect it would need substantial support from institutional investors to raise the necessary funds.
A challenge with acquiring Avid is that Blackmagic is good at disrupting in terms of price / performance ratios. It cut prices after acquiring Davinci, and it followed a similar play-book with Teranex. It is now disrupting the camera market with the Blackmagic Cinema Camera. I'm not sure that the same opportunities to cut prices and grow the market exist with Avid's product lines.
Management Buyout with Private Equity
These days, management buyouts seem to be a popular course of action for struggling tech companies. Michael Dell is in the process of doing this with his namesake company, Richard Schulze, founder of Best Buy is looking to do the same (although it looks like he didn't get the funding), and now Barnes & Noble pioneer Leonard Riggio wants to preserve his legacy.
I doubt this is in the cards for Avid. First, there isn't a founder or management team that is personally invested in the company's success like Dell, Schulze, and Riggio. These transactions are being driven by founders with large fortunes, big egos, and personal legacies that are bound to the success of the companies that they founded.
Avid's founder Bill Warner looks happy with his legacy of taking Avid public, selling Wildfire Communications to Orange, and mentoring entrepreneurs at TechStars and several other organizations. Given Greenfield's less than stellar financial track record, I can't see people lining up to behind him in a bid to take Avid private. Same goes with Hernandez.
Another strike against this option is that the best targets for leveraged buyouts are undervalued public companies with strong underlying cash flow. The standard play-book is to: 1) fund the buyout with debt; 2) cut costs and restructure the company while outside the glare of the public spotlight; and 3) exit the investment through a sale of the company or an IPO. Avid doesn't have the cash flow necessary to take on large amounts of debt and service it during a restructuring.
With this type of transaction, the management team must quickly unlock new sources of growth or cut costs substantially. With Avid's track record and the structural challenges that it faces, I don't think Avid is a great candidate for this.
The bottom line is that unless Avid's financial situation takes a drastic turn for the worse, I would expect to see it continue along its current trajectory at the helm of Hernandez.