| BULL CASE | BEAR CASE | ||
|---|---|---|---|
| The increase in digitization, connectedness and openness has created strong demand for user-generated and online video content; | The industry is relatively crowded, and the company faces many competitors with greater resources. | ||
| DIVX was an early successful mover in the digital video space with their coding/compression products; | DIVX derives the bulk of its revenue from technology licensing, and its customers are heavily concentrated; | ||
| DIVX is expanding into content production and recently launched its own online video sharing site; | Outsized valuation | ||
Shares of video compression software maker DivX, Inc. (DIVX) nearly doubled to $31.89 following its initial public offering in late September, and are currently up about 52% to date, amid voracious demand for user-generated and professional online videos. Despite the company's rapid growth, however, the current outlook is clouded by serious risk factors.
Based in San Diego, DivX develops technologies that compresses digital video into relatively small movie files, making them easier to transport across the Internet while maintaining high visual quality. The company's video software has been download more than 200 million times since it was founded in 1999, according to its own estimates. It also has been expanding into content production and recently launched its own online video sharing site, Stage6.
DivX is benefiting from growth in digital media and converging digital technology. In the third quarter, its revenue rose to $15.4 million from $8.4 million - an 83% increase year/year. The company also posted a profit of $3.1 million, or $0.10 per share, compared with $763,000, or $0.02 per share, in the year ago period.
Despite its promising results, DivX carries some substantial risks. The company faces fierce competition from Adobe Systems (ADBE), Apple Computer (AAPL), Google (GOOG), Microsoft (MSFT), and RealNetworks (RNWK), which offer competing video formats, as well as News Corp. (NWS), which is making a strong push in the digital media space and has greater resources at its disposal.
DivX also generates the majority of its revenue from licensing its technology to consumer electronics manufacturers. About 80% of the company's total sales in the third quarter came from licenses to hardware device makers, such as Philips Electronics and Samsung, and software vendors. Furthermore, its customers are highly concentrated, with ten licensees accounting for nearly half of revenue. The company's deal with Google alone accounts for approximately 20% of its total revenues.
While DivX is building its own user-generated video site, Stage6, the company appears to be outclassed when it comes to building a leading video sharing community. The market is already crowded, with heavyweights like YouTube, MySpace, Microsoft, and Yahoo (YHOO) all looking to profit from growing online video consumption.
Although DivX stands to benefit from increasing demand for digital media and overall industry growth factors, its stock is not cheap considering the various risks. Shares of the company are trading at roughly 55x this year's projected earnings and about 13x sales. Given the company's high product and customer concentration, growing competitive pressures, and lofty valuation, we believe the current risk reward does not warrant an investment at this time.
(Disclosure: Briefing.com has a business relationship with Google and Yahoo.)
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