DivX: After the IPO

DivX, the company that distributes and licenses its video encoding technology through various media channels, IPO'ed September of 2006 at around $16/share. It is currently floating at around $20, half a year after its IPO, peaking at around $31.89 late Dec of '06.

If anything is to be said about IPOs, it is that the first few months of a stock's birth should always be avoided by long-term growth investors. The hype of a tech IPO plus the preferential treatment of institutional investors getting first dibs on initial stock issuance almost always results in individual investors picking up the new stock at a price premium outweighing the underlying company's actual earnings potential.

DivX is no different, but it seems that the transient is gradually dying out. As seen below, its 1-month moving average (middle trend line) is bottoming out after taking a downward dive since peaking in Dec '06. This seems to be corroborated by the narrowing of the Bollinger bands, signaling lesser volatility.

Does this minima signal an entry point opportunity for those patient investors? Lets dig deeper...

Fundamentals

The bulk of its business lies in licensing of its codec technology to other video apps and consumer electronic makers (80% of its revenue) and the rest coming from media distribution services of its player, advertising on its website and community portals.

Profit margins look strong at around 33% and its remaining $61m in cash flow from the IPO will probably be used to acquire new technology and personnel, as has been reported that it plans to increase its workforce by 30%.

Spending on Product Development has been steadily increasing by 40-50% each year, while revenue has kept up with the pace over the last 4 years.

Long-Term Growth prospects
DivX recently hired 2 veterans from consumer electronics giant, Sony and digital document company, Adobe Systems, to strengthen their customer focus, further increasing investor confidence that DivX is investing for long-term growth and competitiveness.

This recruitment drive reflects DivX's need to reorgnize its development teams to be more consumer focused and thus innovate for future customer expectations, a factor in long-term growth of a public company. These are early steps in the right direction after getting past the hype of an IPO.

One of the first uses of the $108m in IPO funds was to buy Corporate Green, an online community platform to furnish the nascent online DivX community with more tools. This further solidifies DivX resolve to establish a strong community of tech followers, in very much the same way the mp3 format has been built up to be accepted as an industry standard.

As an online video sharing platform, it lags behind frontrunners like myspace, and youtube. However, being a younger company, its vision is to provide its growing community with fast and high quality video downloads to differentiate itself from its competition which would work if the online community is willing to download the DivX encoding software for their video uploads.

Thus its future growth hinges on the mass insertion of the DivX codec into new digital media hardware where consumer hardware makers will pay licensing fees to DivX and also DivX's new Stage6 online video portal, a potential source of advertising revenue. Is this a viable strategy given its competition?

Its technology does place it at the forefront of video encoding techniques. And whether its belief that it can generate greater exposure to its technology through online communities is grounded can be evaluated by the $1.6b Google paid for youtube and the $580m News corp paid for myspace.

Anti-DivX Sentiment
The main sources of DivX revenue in 2006 lies in the packaging of its media player to the Google Toolbar and in the licensing of its encoding techniques to DVDs and compatible players. This revenue stream comprises of only a couple of major players most notably Google. This stream can dry up if Google decides not to bundle the DivX player with its toolbar once the license agreement expires.

To work with DivX video, the user has to download a codec software or buy players with special hardware that decodes DivX-formatted media.

DivX has set its sights as being recognized as the industry standard in video compression and thus, hope to increase licensing revenue by achieving mass market acceptance. However, its competition are mostly owned by larger media or tech companies that can synergize their video sharing sites with other product offerings.

MySpace owned by News Corp is able to freely present its media content produced by its Fox movie and TV business and form community groups hosted on MySpace for various Fox programs. YouTube owned by Google could be packaged with other Google web applications to create a powerful all-in-one online portal. These possible factors are be leveraged to isolate DivX's Stage6 video sharing/community space.

Outlook

DivX though starting out slow, is making steady. Its earnings growth has increased by 500% in 06 from 05 and from negative earnings the year before. These numbers are startling in their own right, but lags behind big tech movers like Akamai. Overall, with sound and experienced management cultured for many years in the internet media industry, DivX is a sound long-term growth investment.