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Could Rentrak Supplant Nielsen TV Ratings?

Mar. 23, 2015 6:30 AM ET | 1 comment | About: Rentrak Corporation (RENT)

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)

Summary

Shares of Rentrak fell significantly in early February after a downbeat earnings report and a slew of sell-side downgrades. We think the sell-off is overdone.
The company has a monopoly position in two of its three segments while the third (TV) is the growth driver for the company.
The company has an extremely visible ramp in revenue on the TV side as they consistently add new local and national channels to their platform.
Rentrak (NASDAQ:RENT) is a media measurement and information company that is being billed as the next Nielsen. The company has seen the stock chopped by one-third since the start of February on the prospects of slower growth. Nielsen has been the TV ratings authority for half a century but Rentrak is starting to threaten its previous dominance using a Big Data approach. Couple that with the problems that Nielsen has been experiencing over the last year and the opportunity for Rentrak to zoom to the forefront of the industry.

Business Model Provides Monopolies and Growth Driver

Rentrak bills itself as the entertainment industry's premier source for knowing- every day, every second, everywhere- who is going to the movies and who is watching TV or video across every screen. The company's proprietary technology allows it to measure the box office take at the "census-level around the globe and merger viewing information from millions of televisions with actual consumer behavior information."

The company has two business segments: Advanced Media and Information (AMI) which operates the media measurement services along with the Home Entertainment division (HE) which leases and services the measured results activity on film product from traditional brick-and-mortar, online, and kiosk retailers. Revenue is broken down into four distinct operating units: TV Everywhere, Movies Everywhere, OnDemand Everywhere, and Other. We believe that Rentrak has a competitive advantage in both Movies Everywhere and OnDemand Everywhere, while the TV Everywhere continues to be their growth driver.

TV Everywhere is the largest unit by revenue accounting for 41% of fiscal 2014 (fiscal year end is March 31). This business generated zero revenue just five years ago and represents the key growth driver for the firm going forward. We think as the firm adds more local TV stations around the country, TV Everywhere revenue will continue to grow at an exceptional rate. Currently, they measure approximately 430 of the nearly 2,000 local TV stations in the US. The average contract is between two and six years with strong renewal rates in the low 90% area. However, they often start as one-year 'trial deals' in order to entice the customer with the cost at a steep discount to Nielsen's price point. But once the client is 'hooked', they typically sign multi-year deals with significant price increases embedded into them.

On the national TV side, they continue to add the smaller channels providing the only measure of these outlets as Nielsen currently only measures the largest 100 channels. Management has noted that they have the goal of reaching 400 channels (no timetable has been given).

Between the local and national TV station adds, we think the company will see a significant ramp in revenue over the next two to three years as they expand their customer relationships with more broadcast operations. On the local side, they are adding upwards of fifty new stations per quarter, and thus have a nearly eight-year ramp of adding more local stations (to get to all 2,000). Management has guided an 80% revenue growth rate through fiscal 2016 (ending next March). We see continued success in their TV Everywhere business as they have a clear path to ramp up revenue before any pricing power is considered.

Even attaining the 2,000 station figure, we think they will still have strong pricing power to push through moderate-to-high price increases offsetting the slowdown (or cessation) of new station adds. At that point, they will be the 600-pound gorilla with significant clout in the industry.

The Monopoly Businesses Provide Stable Recurring Revenue Streams

The Movies Everywhere business (35.1% of revenues) measures nearly all of the movie screens in the US and approximately 95% of all movie screens worldwide, totaling roughly 100K theater screens. They provide real-time ticket sales information, allowing film studios to modify their advertising direction immediately. The business has no real competitor for the product after they bought Nielsen EDI for $15 million in 2010. As part of the transaction, Nielsen signed a long-term data license agreement with Rentrak for continued access to certain box office sales information for a select group of its existing products.

Currently, the company only has a few of the larger US studios signed up to receive the information along with a small footprint of small studios and some overseas. There is a considerable potential path to much higher revenue should they scale this business by signing many more studios. The renewal rate is an astounding 99% thus we think there is significant pricing power in the brand given the satisfaction with the product and lack of competition. Management has forecasted a 12% CAGR in revenue through the next two years.

The other monopoly business is OnDemand Everywhere (17% of 2013 revenues) which is the only company that collects and measures all video-on-demand television viewing information in the US from the 100+ million set-top-boxes from every operator or telecom company. This is a high margin business with decent, stable high-teens growth. Management has laid out a path to 20% growth over the next two years.

We believe these businesses will continue to grow steadily as more studios, operators, etc. want the information to make better advertising rate decisions or to target select demographics for their ads.

Recent Sell-Off A Buying Opportunity

We would argue that the shares were significantly ahead of themselves when they crested $80 per share just six weeks ago. The market was embedding very strong growth far into the future, which we believed was unsustainable and unrealistic. This was recently reiterated on the fiscal third quarter conference call where management noted that "80% TV Everywhere top line advances are now unsustainable."

Following the call, a slew of sell-side analysts downgraded the shares and significantly lowered their price targets with Wunderlich Securities going to $60 from $93 on significantly lower revenues and EBITDA estimates. We think the sentiment is now sufficiently negative and the expectations significantly re-rated that the market is now overshooting to the downside.

The margins inherent in the business allow for substantial scale with extremely high incremental margins after they sign a new relationship. We think some of the loss of momentum in the fiscal third quarter was due to gross margins falling 300 bps yoy. We would note that the decline was likely all due to integrating DirecTv and Cox into their TV Everywhere product. The fixed costs associated with such an integration are likely to extend for a few quarters but as revenue ramps will eventually offset those costs and gross margins should re-expand back out.

While TV Everywhere revenue growth did decline, the 76% yoy growth is still exceptional. As we suggested above, the TV segment is the growth driver of the business as the OnDemand and Movies segments are growing more slowly (although more steadily) between 10% and 20% per annum. Some of the sell-off is likely due to the TV segment slowing from 26.7% qoq to the current 11.1% qoq. We would counter that the segment is now likely to see more lumpiness in their results and that expectations for sustained 25%-35% qoq growth (80+% yoy growth) are not realistic. We think looking out on a longer-term timeline helps smooth out the lumpiness in new signings and provides a better look-through. While the top line did slow, it was not egregious. The 76% yoy increase was only slightly lower than the 84% yoy increase from the third quarter 2013 over the same quarter in 2012.

While the operating income (loss) was much larger than expected at $2.4 million, compared to a $1.8 million loss last year, adjusting for stock-based compensation and one-time costs associated with their iTVX acquisition in August of 2013 (including $600K of acquisition costs and $350K in reorganization expense), adjusted EBITDA actually jumped by 1.5 times to $3.6 million. The stock-based compensation expense was substantially higher but is due to their recent acquisition. According to their 10-K, the acquisition of iTVX in 2013 included contingent considerations (options), which pay out to employees when the price of the stock is above $21.80 per share. As the share price rose in the last year, the consideration increased as the fair value of the options rose.

Valuation

We think the difficulty in valuing a company that is on the cusp of breaking-out from a zero bound in earnings is creating volatility in the price. But that volatility is allowing the possibility of a great entry point at owning the shares. The growth initiatives are excellent and extremely visible for the company with strong barriers to entry preventing erosion of pricing power. We believe the new client add should remain fairly consistent even if revenue growth is lumpy.

The company's incremental margins are strong with management suggesting operating expenses will grow 20% yoy on average. The Movies Everywhere and OnDemand businesses have gross margins above 75% with EBIT margins around 25% for Movies and 45% for OnDemand. As they continue to grow these businesses, we think EBIT margins will eclipse 30% and 50% respectively in the next year and higher beyond. This provides quite the tailwind to their overall high growth profile.

We think the company can easily achieve $35-$40 million in EBITDA in fiscal 2017, and much more should they choke off the operating expense growth. Still, we think there is substantial leverage available in the system over the next two years. The potential growth is extremely compelling and that even though they are realizing outsized growth in operating expenses as they invest in new projects and expand their empire. Our work shows that the likely scenario is that EBITDA expands out to $39 million in fiscal 2016 (ending next March) and then approximately $66 million in fiscal 2017. Using a 20x multiple to that figure and adding in the net cash position of $85 million (no debt is on the balance sheet), equates to an intrinsic value of roughly $87, 60% upside from here.

But again, we think the path to that level will be volatile and non-linear, which is typically the case in companies that are fast-growing and just starting to earn a profit. We think investors can use weakness to accumulate shares and provide themselves a margin of safety.

(Source: Author's Calculation)

Conclusion

Rentrak's Big Data analysis uses second by second information with proprietary analytic tools to provide more useful information to advertisers. Just this past January, Nielsen started to feel the change in the wind when CNBC said it would no longer use its service believing that it was not adequately gauging their daytime audience. We believe Rentrak's broader reaching methods including census data and emphasis on specific information about consumer engagement have provided a compelling alternative. We like the more diverse business model with a stable, but growing Movies and OnDemand Everywhere businesses while they ramp fast the TV business. We think the sell-off last month is overdone and the company warrants a hard look by investors.
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