This week’s bond review focuses on a technology company that enables the creation of audio and video by companies around the globe. Avid Technology is on the cusp of completing a transformation – it has transitioned to a recurring revenue business model, diligently reduced operating expenses, and has set up strategic alliances with large media providers, and just recently announced its intention to use cloud computing to host its suite of creative tools. Moving to the cloud represents a significant shift in the way media is produced and distributed – multiple people can work on the same project from anywhere in the world, at any time. Its most recent financial results attest to the effects of these changes.
2016 operating income increased over 8x over 2015 levels.
Net income in 2016 increased over 18x as compared to 2015 levels.
Avid has amassed an impressive $429 million revenue backlog.
For Q4 2016, the company boasted interest coverage of 2.4x.
Avid’s 2020 convertible bonds, couponed at 2% and with a current yield-to-maturity of 10% are convertible to Avid common stock at a strike price of $21.94. For investors, this presents an additional opportunity for increased return as Avid continues to complete its transformation in 2017 and beyond. In consideration of these factors, these high-yielding bonds make a sound addition to both our FX1 and FX2 managed income portfolios.
About the Issuer
Avid creates the digital audio and video technology used to make the most listened to, most watched, and most loved media in the world. Through the company’s vision of Avid Everywhere™, Avid Technology delivers the most open and efficient media platform, connecting content creation with collaboration, asset protection, distribution and consumption. Avid’s preeminent customer community uses Avid’s comprehensive tools and workflow solutions to create, distribute and monetize both video and audio media all over the world—from prestigious and award-winning feature films, to popular television shows, news programs and televised sporting events, and celebrated music recordings and live concerts.
Recent Q4 and Full Year 2016 Results
Avid recently reported its Q4 2016 and full year 2016 results. Here are some of the highlights:
For Q4 2016, gross margin was 60.3%, up 1.2 percentage points year-over-year.
Operating income for full year 2016 was $64.0 million versus $7.0 million for full year 2015, representing an increase of over 8x.
Net income for full year 2016 totaled $48.2 million as compared to $2.5 million in 2015. This represents an astounding increase over 18x.
Avid has an astounding $429.3 million in revenue backlog.
At the end of 2016, more than 42,700 enterprise users were utilizing Avid’s MediaCentral platform, a 29% increase from the beginning of the year.
Added more than 10,700 paying subscribers in Q4, representing a 21% sequential quarterly increase, the largest paying subscriber increase in Avid’s history.
Digital bookings increased 45% in 2016 over 2015 levels.
Total operating expenses in Q4 totaled $58.5 million as compared to $82.3 million in Q4 2015, a reduction of 29%. Operating expenses for full year 2016 were down 10.8% over 2015 levels. Avid has worked diligently over the past few years to decrease its ongoing operating costs.
(Source: Avid Investor Presentation, April 23,2017)
Louis Hernandez, Chairman and CEO of Avid Technologies, commented on the company’s banner performance in Q4: “Thanks to strong execution in key focus areas, we met or exceeded quarterly guidance for all of our metrics and delivered positive adjusted free cash flow.” In addition to the company’s strong results for Q4 and 2016, Avid is creating alliances to ensure long-term revenue stability and growth.
Creating Strategic Alliances for Growth
Since the beginning of the year, Avid has announced three major strategic alliances with companies that will drive its vision towards a sustainable, recurring revenue model. These three alliances are with Al Jazeera, Beijing Jetsen Technology, and Microsoft.
Avid had already been working with Al Jazeera on a long-term Avid Everywhere strategy for an open and integrated news workflow using its MediaCentral platform for its global news network. This infrastructure will be supported by a new agreement signed earlier this year. This multi-year Global Services Agreement includes the supply of advanced services like system support, software maintenance and additional professional services tailored to Al Jazeera’s specific needs. Also included in the agreement are staff training and access to Avid Labs.
In January 2017, Avid signed a “go-to-market” commercial partnership with Beijing Jetsen Technology, a long-time channel partner of Avid in China. The agreement makes Jetsen the exclusive distributor in China of Avid’s products and Jetsen will take over responsibility for Avid’s operations in the greater China region. The total contract represents a value of $75 million (USD) for the initial three years. As part of the agreement, Jetsen will also invest $18.1 million in Avid in return for a minority stake in the company. China is a very lucrative market for Avid. The broadcast and post-production market segments in greater China represent a $1.5 billion (USD) market opportunity that is anticipated to grow 15% per year through 2020.
Finally, in April Avid forged a strategic cloud alliance with Microsoft. This agreement means that Avid and Microsoft will cooperatively develop and market cloud-based solutions and services targeted at the media and entertainment industry. Using Avid’s creative tool and Microsoft’s Azure cloud platform, the agreement creates a multi-year alliance between Avid and Microsoft in which both companies will make significant mutual commitments and investments in technology, product development, as well as go-to market efforts. This alliance represents Avid’s major play towards moving to cloud based tools for the entertainment and media industry.
Moving to the Cloud
In late April, Avid announced that it is taking its entire suite of applications and media toolset to the cloud. This represents a culmination of a four-year effort to advance the company’s Avid Everywhere vision that allows for collaborative media workflows. This gives content creators and distributors the ability to produce, manage, deliver and monetize media from any place at any time. The cloud represents a centralized location where creators can exchange information and creativity, wherever they are, anywhere in the world and on any device. This move has been facilitated by the company’s recent agreement with Microsoft under which Microsoft Azure will become Avid’s cloud platform of choice.
Growth and Change in the Entertainment and Media Industry
The US’ $1.7 trillion global Entertainment and Media industry is projected to grow at a compound annual growth rate of 4.4% through 2020. Globally, Entertainment and Media is steadily shifting from publishing businesses to video and internet businesses, specifically, those that provide over-the-top, or OTT services (this term is used to describe the delivery of film and TV content via the internet, without requiring users to subscribe to a traditional cable or satellite TV service). Indeed, the delivery of content is what will challenge most Entertainment and Media companies. According to Strategy&PwC, “the expansion of digital technology, manifested in more ubiquitous fixed and wireless network connectivity enabling growing numbers of connected devices and new routes to the user, is altering the industry’s structure, driving new ways to produce, distribute, and monetize content across its landscape”. This changing landscape is exactly what Avid Everywhere is designed to address. Companies that can rapidly digitize various forms of media (music and video) for an on-demand consumer, will reap the benefits in the new Entertainment and Media economy. The following graphic illustrates the rapidly growing revenues for streaming services.
For bondholders, a company’s ability to pay interest on its debt is paramount. When considering Avid’s 2020 bonds, the company’s latest quarterly results show extremely healthy interest coverage. For Q4 2016, Avid registered operating income of $10.95 million and interest expense of $4.62 million. This calculates to an interest coverage ratio of 2.4x.
The default risk for these bonds rests on whether Avid can complete the company’s transformation to a recurring revenue model. Over the past several years, this has been a main focus for the management team. From its latest financial results, it does appear that Avid is performing well, adding a record number of subscribers in Q4 and more than doubling the number of subscribers during 2016 as compared to 2015 levels. Operating expenses have come down, while operating income and net income have seen outstanding increases. Based on these and other factors discussed here, it does appear that the outstanding 10% yield on these 36-month bonds outweighs the risks identified.
Bonds have interest rate risk (as interest rates rise bond prices usually fall); the risk of issuer default; and inflation risk. In general, the bond market is volatile, bond prices rise when interest rates fall and vice versa. This effect is usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Bonds involve a high degree of risk and are not suitable for all investors.
Summary and Conclusion
As the landscape of media and entertainment continues to evolve, companies wanting to survive and thrive in this rapidly changing environment will need to have flexibility in the creation, distribution and monetization of their audio and video content. Avid Technology’s tools accomplish this task. In addition, with its recent move to cloud-based computing, the digital media workflow has become more accessible and scalable for both content creators and those looking to capitalize on it. Avid is in the final stages of transforming the company to reflect a recurring revenue model and the benefits of this transformation are already evident. Avid’s 2020 convertible bonds have a fantastic current yield to maturity of 10%. Investors looking to add some diversification from the technology / entertainment sectors to their income portfolios might consider adding Avid bonds. In addition, if the company performs well, there could be an additional opportunity to make addition return if the stock reaches and exceeds its strike price. These 36-month convertible bonds have been marked for addition to both our FX1 and FX2 managed income portfolios.
Issuer: Avid Technology Inc
Conversion Price: 21.94/share
Yield to Maturity: ~10.04%
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Disclosure: Durig Capital and certain clients may have positions in Avid Technologies June 2020 Convertible bonds.
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