Wednesday, April 02, 2008

MacroStar: Vision or Hallucination?

This morning Macrovision (MVSN) reported it has completed the divestiture of its software business, including the FLEXnet and InstallShield product lines, raising $200M. With the previously announced sale of its games unit to RealNetworks (RNWK), Macrovision is well on its way to completely transforming its business. What remains is to consummate the merger with Gemstar/TV Guide (GMST).

The company believes that with the cash raised from these recent sales, it has reduced the amount of debt needed to finance the Gemstar purchase by nearly 20%, to just $650M. Expect to see a good portion of this remaining debt retired early, as Macrovision spins off non-strategic portions of Gemstar once it's folded in--notably the TV Guide print business, which I believe is orthogonal to MVSN's core strategy. This could significantly shorten the loan payback on the purchase from the 2011 date CFO James Budge originally estimated.

That all assumes, of course, that the deal goes through. Many Gemstar shareholders were none too happy when the merger was first announced in December. Ditto many Macrovision investors, who either did not understand or did not believe the vision management articulated. I would argue Budge and CEO Fred Amoroso did a poor job of explaining it at the time, using lots of effusive, scripted prose but leaving behind what felt like a distinctive snake oil residue.

However, there is a method in the madness here, a bit more visible now that extraneous bits have been spun out. The key is to understand Macrovision's three key constituencies: Hollywood studios, consumer electronics manufacturers, and cable companies (MSOs). Traditionally, the studios paid for copy protection, manufacturers licensed the tech for VCRs and DVD players, and MSOs paid to ensure compatibility between studio copy protection and their headend gear. Great high-margin cash business. All good.

But a year or so ago, Macrovision acquired Mediabolic, which gives it technology to enable (copy-protected) video transfer between PCs and multiple devices within the home. Say, to cable set-top boxes. They have already signed Scientific Atlanta (CSCO) as a customer, and I believe either Motorola or NDS is also on board.

Next, they bought All Media Guide, which provides metadata for video and music. By acquiring Gemstar, Macrovision gains television guide info--again, metadata. MVSN can now license both algorithms and information to device manufacturers and cable companies, while helping Hollywood protect its content wherever it is transferred. In the bargain, consumers would get a seamless home video capability.

Your existing set-top box becomes a media hub. Can you say "AppleTV"? I knew you could.

Arguably, Macrovision has made some missteps with its strategy in the past. The software business had low margins relative to MVSN's licensing unit, and games was pretty much a bust. But unlike many firms, it has been fairly quick to recognize errors and dispose of losing businesses. And this vision, however poorly spelled out by management, feels right.

Based on April 1 closing prices, and assuming no change in the original terms, the Gemstar deal is now valued at about $2.22B, 21% below the original $2.8B figure but slightly above the current market cap. This compares to a 9% drop in the S&P500 over the same period, and largely reflects the poor reaction of traders to both sides of the deal. The SEC just declared the S-4 effective and proxies are being mailed out. As both boards are already signed up (including Rupert Murdoch, with 41% ownership), it looks like the merger will go through.

Given the margin expansion that will follow the spin out of the poorer performing Software and Games units, Macrovision may be somewhat undervalued, even allowing for the anticipated share dilution. But for Gemstar investors who believe this vision could become reality, there's substantial upside post-merger if the firm can execute properly.

Disclosure: Author holds no positions in either Macrovision or Gemstar.


Anonymous said...

This is not for publication.

Scott, I was very interested to read your take on the GMST-MVSN merger. As a long-suffering GMST holder, I had thought I was starting to see the light. Beginning with the now-obvious mistake of initiating a position in GMST in the low 20s, I averaged down enough sub-3 to finally make it a profitable situation at about current levels. I was/is a big Rich Battista fan, and I think he was really going to be able to put GMST into the kind of position that Henry Yuen only dreamed of. However, Battista's "boss" (no other way to really describe it) Rupert Murdoch up and bought the Wall Street Journal and he wants to clean up his holdings and raise some cash. So, the imperative came down to Battista to put GMST up for sale and he did.

All they got was the MVSN offer. Now, I'm not too familiar with MVSN, but I'm trying to get up to speed. Your comments about Amoroso & Co. "poorly" explaining the rationale for the merger are too kind. In listening to a couple of MVSN CCs, Amoroso and Budge come across as....well, stupid. I know that it may be a mistake to judge someone by their poor verbal skills, so that's why I'm reaching out in whatever direction I can to either confirm or deny this hypothesis.

In the beginning, I viewed the MVSN deal as stealing GMST. Now, I am coming around to the idea that MVSN has been exposed by this deal. Their current mainstay DRM seems to have a limited lifespan, so they are spending their currency now on a stable lifeboat to the future. Once upon a recent time, it would have been laughable to characterize GMST as a lifeboat, but MVSN looks to be in serious trouble if its only bread and butter is an aging DRM technology that might be roadkill within 2 years.

What do you think?

Scott Berry said...

I received a personal communication from "Anonymous", and would love to answer your questions, but you didn't leave a contact email. Please leave another comment with a way I can reach you. Thanks.