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An Under-The-Radar Way To Play The Rally In Cable Stocks

Monday, March 10, 2014 - 8:30am

Many corporate executives place a lot of faith in the rational behavior of the markets.

If they deliver on the promises they've set out for investors, the market should reward them with a sufficiently higher share price. But sometimes, the market fails to respond, even when management delivers.

The executives at DVR pioneer TiVo (Nasdaq: TIVO) have surely done what they promised, yet shares remain remarkably undervalued. Roughly two years ago, I laid out a series of catalysts that would help boost this stock by 50%.

Shares have risen 40% since then, but that's cold comfort for investors who have seen the S&P 500 rise 52% in that time. Shares of cable TV companies have more than doubled in that time, making TiVo a relative loser in this industry. But if you are looking to apply fresh money to this industry now, forget the cable giants. It's simply hard to see any more upside for them. Instead, refocus your sights on TiVo, which holds appeal to both value and growth investors.

Let's start with the value part of the equation.

In my late 2011 profile of the company, I noted that TiVo stood to greatly gain from a series of upcoming legal verdicts. TiVo eventually prevailed in its legal fights with AT&T (NYSE: T), Verizon (NYSE: VZ) and others, as I noted in September 2012.

And though the defendants are spreading their payments out over a number of years, you can already see the windfall on the balance sheet. At the end of fiscal (January 2011), TiVo had $209 million in cash. That figure has now swelled to more than $1 billion. And another $330 million is expected in future payments from the recently resolved litigation. The company's entire market value is just $1.63 billion. Some of that cash is being applied toward share buybacks, with $100 million in shares likely to be repurchased in the current quarter.

The Growth Reversal
When I looked at TiVo back in 2011, the company had lost its footing as the number of subscribers to its service had steadily fallen over the prior five years. I saw signs of a reversal, and predicted that "Tivo's subscriber base appears to have bottomed out at 1.9 million this past July, but could rebound to 4 million by the end of 2012."

Flickr/Jamie McCaffrey
If you are looking to apply fresh money to this industry now, forget the cable giants. It's simply hard to see any more upside for them. Instead, refocus your sights on TiVo, which holds appeal to both value and growth investors.

That forecast was too aggressive. TiVo was slow to add new subs, and only exceeded the 4 million threshold in the most recent quarter, more than a year later than I had anticipated. Still, the fact that the subscriber base is up 34% from a year ago shows that the company is regaining its footing in the DVR segment. Mark Argento, who covers TiVo for Lake Street Capital, is "encouraged by the progress TiVo is making on its MSO business and believe it is the key driver of long-term value creation." (MSO is the industry term for cable companies.)

Still, the analyst think TiVo remains a "show me" stock, as reflected by his $15 price target. "For the stock to work significantly higher from here, management will need to demonstrate scale on its MSO deployments," he predicts.

Rich Tullo, director of research at banking firm Albert Fried, sees a catalyst that will take this stock to $23. He notes that Comcast (Nasdaq: CMCSA), which will be the runaway industry giant once its deal to acquire Time Warner Cable (NYSE: TWC) is consummated, is likely to be great source of growth.

Comcast currently carries TiVO's basic DVR technology, but a recent decision to incorporate Netflix's (Nasdaq: NFLX) streaming into a set-top box (STB), means that many Comcast users will choose to upgrade to TiVo's Roamio cloud-based DVR, which is better equipped for internet video streaming. "Currently TIVO is the only STB platform which streams NFLX and we think it's logical that TIVO will be the CMCSA STB that streams Neflix too," he writes.

Why does Tullo see shares rising to $23? He thinks projected revenue growth in excess of 50% this year justifies a target price-to-cash flow ratio of 17. "Owing to TIVO's strong patent estate, 40% AOCF (adjusted operating cash flow) growth CAGR through FY2017, substantial AOCF upside beyond our model, and TIVO's value as a takeover target, the multiple we use is justified in our view," he concludes. His target price represents 70% upside.

Risks to Consider: TiVo must remain one-step ahead of the competition in terms of set-top box technology, which it has managed to do thus far. The company is spending a considerable amount on R&D to try to maintain that leadership.

Action to Take --> The balance sheet alone is reason enough to consider this stock as a deep bargain. Though the company continues to add subscribers at a slower pace than Wall Street would like, growth momentum appears to be building. Higher uptake from Comcast subscribers stands as the strongest catalyst for this stock.

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David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of T in one or more of its “real money” portfolios.