Archive for category SA

Did Motorola Get Caught With A Smoking Gun? TiVo Demands Source Code Access To Secret DVRs

TiVo’s Motion To Compel Source Code

(Above you’ll find a copy of a motion to compel that TiVo filed against Motorola on July 22nd, 2011. On July 25th, the judge in the case gave Motorola 14 days to comply with the order or to explain their actions to the court. To view all of the exhibits, associated with the complaint, you may click on the following links: Declaration By TiVo’s Attorney, Court order requiring production of all source code, Motorola dodging TiVo’s phone calls, TiVo’s initial patent complaint against Verizon.) As a friendly reminder, I am both a TiVo customer and shareholder.

TiVo’s love quarrel with Echostar may have just come to an end, but they still have two more elephants lined up in the crosshairs of their gun and while I always hate to read too much into the legal tea leaves, recent action on one of the dockets, suggests that they may have just stunned one of them with a tranquilizer dart.

As part of their patent lawsuit against Verizon, TiVo had initially requested access to Verizon’s source code on their FIOS DVR. This kind of data makes it easier for TiVo to identify any potential infringement and would certainly be a key piece of evidence towards proving any patent violations. Now there are many reasons why Verizon might not want to turn over this kind of data, but where things start to get weird is that instead of objecting to the request, Verizon claimed they weren’t able to comply with it because Motorola was the one that developed their DVR. This seems fair enough, so in good faith TiVo began working with Motorola to obtain the data.

Fast forward through three months of stalling and Motorola finally turns over two different copies of their database to TiVo. The problem with this is that once TiVo started going over all the documents that they collected, they discovered that Motorola had actually developed “many more versions” of the source code using secret codes names like Burbank, Carlsbad, Del Mar and Cardiff. In total, TiVo believes that there are over 30 different models that Motorola has out there and after being stung with delay after delay over “software modifications” in their trial against Dish, it’s easy to understand why TiVo would want to exercise extreme due diligence on this one.

Once TiVo realized that Motorola was trying to pull off the old fumblerooskie play on them, they dragged Verizon and Motorola back into court and clarified that they wanted all of the source code data on their DVRs. The judge agreed and in March of this year, he ordered Motorola to release “without limitation all Deployed versions of Motorola’s Del Mar source code and all Deployed versions of any predecessor to the Del Mar source code, as well as associated Broadcom code.” [Note: Emphasis added by me]

After the subpoena, one would have really thought that this would be the end of it, but instead Motorola continued to try and string TiVo along. In the attached exhibits, TiVo demonstrated that they contacted Motorola numerous times to discuss the deficiency, yet Motorola seemed only willing to reply whenever TiVo threatened to flex their legal muscle in the case. At one point, Motorola even set up a conference call to deter TiVo from filing this motion to compel, but then opted to ditch out on the call (without even having the courtesy to cancel.)

While these sorts of petty issues won’t actually impact the case, they can still provide us with insight into the case. Motorola’s lack of responsiveness suggests a certain squirreliness on their part. Instead of portraying a company that is confident in their legal position, the attachments paint a portrait of a company that is desperately trying to do anything to avoid turning over this evidence. The very way that Motorola has treated TiVo over the last 8 months could be a primer on how to maximize passive aggressiveness by only using your caller ID. After considering TiVo’s frustration with moving the case forward and the lack of any real justifications for the delays, the judge gave Motorola a final deadline of 14 days to turn over the evidence in question or to demonstrate why they seem to feel that they don’t need to comply with the court’s instructions.

The Next Big Big Thing In Advertising

Clear Channel

I managed to get stuck in traffic during the middle of the day today and had the opportunity to listen to old people talk radio while I waited. There was some cranky guy on who was clearly worried about his own job in media. During the program he bemoaned Facebook’s $50 billion valuation, the demise of newspaper circulations and the end of the good old days when we used to have to pay travel agents $100′s of dollars to buy tickets for us.

Even though I didn’t agree with his bleak sentiments, it did make me reflect on how technology has managed to eviscerate one industry after another. Some of these trends caught on like wildfire, while other ideas were forced to lay dormant for years while the rest of the world caught up. Whether you’re talking about landlines, photo processing booths or Blockbuster Video, sooner or later good ideas have a way of replacing yesterday’s technology.

Normally, I expect to see new innovators challenging the status quo, but one industry that is experiencing it’s own “life changing” moment right now, is actually being led by the incumbents. Most people think of billboards are being somewhat of an eyesore. If you’re located in an area where you spend a lot of time, then you know what it’s like to have to look at the same old ad for months and months. By the time they do update the ad, the old one is usually halfway peeled off. Advertisers may be able to reach millions of people with a campaign, but it limits the value when they have to plan their campaign months in advance and when the presentation makes their brand look so tattered.

Over the last year, there have been two improvements in the signage industry that have impressed me a lot. The first has been how effective Lamar Advertising has been at using their digital signage portfolio to make a splash in social media. When Ashton Kutcher was trying to hit 1 million followers on Twitter, the company cashed in by giving away free exposure to @aplusk. When the goons at NBC butchered the Tonight Show by bringing Leno back, Lamar used outrage over the incident to reach the heart and souls of TeamCoco fans. While neither of these examples netted the company any serious cash, what they did prove was how much the internet/media/consumers will freak out over billboards that mention current buzz. With most companies clueless about ways to drum up buzz, Lamar’s portfolio offers an easy way for their customers to inject themselves instantly into any social conversation. Even if the sign is only up for a day, it will live forever online. With the TV advertising industry ready to pop, there will be a lot of money available to businesses that can provide this kind of immediate reach and response.

The other signage company that has really caught my attention is Clear Channel Communications. The company may be a dinosaur and burdened with way too much debt, but over the next 2 years, they plan on deploying 300 interactive displays that can only be described as life sized iPads. So far the displays have been a huge hit at San Francisco bus stops and I think that they are the real deal. Before the holidays, Digital Signage Insights posted a comprehensive behind the scenes view into how they work and their capabilities,

“The content management system, graphics processing unit, and real-time measurement application built into each digital bus shelter are capable of producing 3D graphics and immersive content the likes of which have not been seen in the digital out-of-home media sector. Clear Channel and its partners have just begun to scratch the surface of what these systems are capable of. The “Yahoo Bus Stop Derby” is a crowning example of what can be achieved at the convergence point of creativity and technology. San Francisco’s interactive bus shelters have been built with the future in mind. Owing to Clear Channel’s and Obscura Digital’s views on the expansion of the web into real world environments, the units allow for seamless scalability and back-end cloud networking. From supporting cinema-level 3D graphics, processing interactive 3D visualizations, to offloading real-time rendering to the cloud, San Francisco’s new bus shelters can do everything short of driving you to the office. On top of that, the shelters have been equipped with a real-time user-metrics collection system that provides advertisers with actionable intelligence throughout their interactive campaigns. The granular behavioral data that the units capture can be used to optimize applications in real-time, so to achieve the highest level of user engagement.”

The outdoor signage industry may seem as quaint as using your spare change for the payphone, but there’s no doubt in my mind that the industry is evolving. Whether either of these companies have the balance sheet or wherewithal to move past their debt issues is another story entirely, but I certainly can’t fault them for creating new and innovative ways where advertisers and consumers can connect on a more emotional level.

Blockbuster’s Latest Drama Is Political Thriller

Political ThrillerThey say that a good captain will go down with their ship, but what can you say about the guy who climbs on-board after the ship has begun taking on water? Over the last few years, Blockbuster Video has hit iceberg after iceberg and while they’ve avoided capsizing this long, a $300 million looming debt payment may be the final torpedo that sinks the historic brand. Over the last few months, Blockbuster has seen board members flee like rats off of a sinking ship, but at least one shareholder wants to fight to save the company.

Last week, Greg Meyer fired the first shot in a proxy war by submitting paperwork to have his name considered for a position on Blockbuster’s board of directors. To win, he’ll need to take on board of director incumbent, James Crystal. In the proxy filing, Meyer makes a strong case that he is the more qualified candidate for the position.

-In 2001 Meyer started a DVD kiosk business at a time when most thought the idea was crazy. Eventually, DVDXpress was sold to Coinstar and later merged with Redbox. Mr. Crystal on the other hand has spent his career running an insurance company and doesn’t have any DVD industry experience.

-Over the last year, Meyer has put his own money on the line by purchasing over 600,000 Blockbuster shares on the open market, Crystal on the other hand has less than $50,000 worth of Blockbuster’s stock and only because it was given to him for serving on the board of directors.

-While Crystal’s full time job is his insurance business, he also serves on 7 other boards for various insurance companies. Meyer’s only other board position is with a non-profit that uses movies to help reach young kids.

-Perhaps most damaging of all though, is the related transaction between Mr. Crystal and Blockbuster. Last October, Blockbuster made Frank Crystal & Company their exclusive insurance broker for the company. At the same time, Mr. Crystal, who sits on the compensation committee, was helping to award over $1.5 million in bonuses to Blockbuster executives in a year where Blockbuster lost over a half a billion dollars. Given that Blockbuster CEO James Keyes was awarded $400,000 of that bonus, perhaps it isn’t all that surprising to see him come out against Meyer’s nomination.

In a press release, Keyes rejected the idea of adding Meyer to the board and wrote,

“While we have an appreciation for Mr. Gregory Meyer’s investment and interest in the company, those are not sufficient reasons for his candidacy for the board. We are disappointed Mr. Meyer is pursuing a costly and disruptive proxy contest. A proxy contest can only serve as a distraction to the company when attention and resources would be better used in creating value for stakeholders by implementing our strategic plan. We assure all of our constituencies that we remain committed, as always, to doing what is right for our shareholders, debt holders, employees, and customers,”

Distraction or not, it’s understandable that Blockbuster’s shareholders would be disappointed in the current board of directors. Since bringing on Keyes, Blockbuster has seen their stock fall from $4.46 to $0.29 per share. During that time, they’ve seen Netflix and Redbox take market share from them, while they were concentrating on trying to figure out a way to save Circuit City from bankruptcy. Instead of focusing on offering an all you can eat streaming service, Blockbuster spent their operating income on redesigning their stores. Meanwhile, they’ve continued to lose the confidence of both the stock and bond market.

Given that there aren’t many people who’d be willing to run into a burning building in order to save a video store, I reached out to Mr. Meyers to help better understand what he hopes to accomplish with his proxy run. Below is a transcript from our interview.

Davis: I guess the biggest question on my mind is that with Blockbuster clearly hurting pretty bad right now, why you would even want to get involved with the company. You’ve already proven that you can build a DVD business from scratch, what is it about the challenge of turning the company around that appeals to you, instead of using your time and capital to create another new business?

Meyer: When our team was building the DVDXpress business early on, we spent years struggling to make customers aware of the fact that it was possible to rent DVDs from a kiosk and encouraging them to do so. Blockbuster was such a dominant force at the time that we felt like we were constantly swimming upstream against this 900lb gorilla.

Fast forward to today and the tables have turned so that many people say ‘Why would I ever go to Blockbuster?’ I think the pendulum has swung too far and believe there is an enormous amount of intrinsic value within Blockbuster that can be realized with proper guidance and forward-thinking strategic insight. Love ‘em or hate ‘em, everyone knows that Blockbuster means movies, and having such widespread brand awareness is extremely valuable.

Davis: Having served on the front lines of the bond market, what insights does this give you into how the banks and hedge funds might be thinking about Blockbuster’s debt right now? Specifically, what sorts of things do you think that they’d like to see in order to be amenable to restructuring overtures?

Meyer: The perception in the market is that Blockbuster’s subordinated notes will be equitized at the expense of shareholders. I believe there are some intelligent steps that management can take to avoid this outcome, which would obviously be advantageous for shareholders- and I have recently apprised them of one such structure. The Company and its legal and financial advisors need to be thinking about creative solutions to bring the company back to health and not take the easy way out by converting sub debt
to equity unnecessarily. My impression is that the Company and its advisors are looking at this as a zero sum game instead of trying to figure out how to creatively increase the size of the pie for all constituents, which I think is doable. That’s why I think it’s so important to have at least one shareholder advocate on the board.

Davis: You also mentioned in your filing that you’d like to pursue a solution that results in the lowest possible dilution, if any, of shareholders. Given the burden of having to service almost a billion dollars worth of debt, can Blockbuster be competitive in an industry whose competition is cutthroat right now? Can you share any thoughts on your rescue plan for Blockbuster and what it might take to save the company?

Meyer: Blockbuster has some incredibly valuable assets and competitive advantages. In addition to huge brand awareness, the Company has very strong relationships with the Hollywood studios. These studio relationships have become more apparent in the last few months with the Warner, Fox, and Sony supply deals providing Blockbuster with day-and-date availability of new release titles vs. the 28-day delay for other channels. This is a huge advantage relative to Netflix and kiosks competitors, and it’s one that Blockbuster has never had in the past. I think the company has done a reasonable job of communicating this advantage to customers with the recent release of ‘The Blindside’ and ‘Sherlock Holmes’.

The studios are smart- they realize it is in their best interest to have a healthy Blockbuster. Blockbuster spends more money on DVD inventory each year than Netflix and the kiosk operators combined, so they’re a very important source of revenue for the studios. And Blockbuster’s a la carte rental pricing is not viewed to cannibalize sales like some of the other distribution channels. So I view Blockbuster’s relationships with the studios remaining strong over time and think the Company needs to continue to leverage these relationships going forward, particularly as digital delivery replaces physical distribution. Keep in mind that the First Sale Doctrine does not apply in the same way to the digital world as it does to the physical world, so having strong relationships with the studios becomes even more important down the road as the studios have stronger control over who gets their content.

For now, having closed many of its underperforming stores already and amid a significant reduction in overall brick-and-mortar industry capacity, Blockbuster’s physical stores represent a true asset if managed properly that can generate significant cash flow for years to come and act as a bridge to its various future distribution channels rather than an impediment.

Davis: Blockbuster released a press release urging shareholders to reject your advances, saying that they were disappointed that you were pursuing a “costly and disruptive proxy contest” at a time when their efforts should be focused on executing their existing turnaround plan. Do you feel that it’s appropriate for Blockbuster management to publicly respond this way and do you have any concerns that your actions could have any negative consequences by trying to shake up the status quo?

Meyer: The reality is that Blockbuster’s management is making the decision to perpetuate a proxy contest. I find it unconscionable that management would be willing to waste shareholders money to fight a full blown proxy contest to keep a qualified, industry relevant and highly motivated individual off the Board. If James W. Crystal is as valuable as James W. Keyes suggests then I would be happy to serve constructively with him on the board. This does not have to be mutually exclusive. Keep in mind the size of the board has shrunk from 9 to 7 over the past few months due to several departures, so having both of us as directors would actually return the board to a more normal size. But this is a decision that Jim Keyes and the Board has to make as it is out of my hands.

Davis: Beyond the finance side of the equation, is there anything that you feel Blockbuster should be doing to make their product more relevant to consumers?

Meyer: Yes, I think the value proposition to customers can be significantly improved. Look at the smart things that smaller brick-and-mortar video competitors like Family Video (rental) and MovieStop (retail) are doing. These companies have been growing rapidly over the past several years as they’ve figured out how to remain relevant with consumers despite growing competition from Netflix and the kiosk operators. These companies offer a variety of real services to their customers. As one small example, both of these chains offer a ‘Notification Service’ by which they will call or email their customers when a movie or game becomes available for rental or sale, either new or used. This builds goodwill and drives customer traffic. Sometimes a lot of small improvements at the margin add up to a much better experience.

Additionally, these chains have figured out intelligent pricing structures that appeal to the widest possible audience in a manner that still generates profits for the retailer. There is a lot that can be done with pricing to improve both customer satisfaction and profitability.

And of course there are many innovative steps the company can take to serve customers digitally, some of which they’ve started to take with Blockbuster On Demand. The combination of near ubiquitous brand awareness and strong studio relationships has the potential to make Blockbuster a dominant player in digital delivery going forward, but this path needs to be navigated intelligently to ensure success.

Davis: Finally, Carl Ichan previously spent a lot of time and money trying to win board seats and concessions from Blockbuster management. While he ultimately won, his actions haven’t seemed to help the company all that much. Even if you were to win a seat, do you think that you’d have enough influence to create the kind of change that Blockbuster needs in order to save their business?

Meyer: All I can ask for is the opportunity to have my informed opinions heard at the board level and hope that the other directors would act in a rational and objective manner in the best interests of the shareholders.

Since I’m not a Blockbuster shareholder, my vote won’t count in this contest, but I am interested in what other shareholders think, so feel free to share your thoughts in the comments. Will you be voting for Meyer? For Crystal or do you plan to kick all the bums out? While fighting a proxy war can be a distraction and could potentially interfere with Blockbuster’s efforts to restructure their debt, it can also bring hope to a weary shareholder base at a time when things seem hopeless. I don’t think that Meyer can turn the company around single handedly, but as Johann Wolfgang Von Goethe once wrote, “in all things it’s better to hope than to despair.”

Update – In an open letter to shareholders, Meyer calls out James Keyes for perpetuating the proxy contest and reveals that he encouraged Blockbuster to adopt DVD kiosk technology over five years ago. At that time he also pointed out that Blockbuster could have saved $140 million per year by cutting their store hours by three hours per day.

TiVo Awarded Patent For Closed Captions On A DVR

The Hash Tag Patent

TiVo doesn’t know whether or not their injunction against Dish’s DVR will hold up yet, but that hasn’t stopped them from adding to their patent portfolio in the meantime. In a remarkable filing with the USPTO, TiVo appears to have now won an important patent for displaying closed caption information to DVR customers.

In addition to covering this important feature, TiVo’s latest addition to their portfolio, also appears to encompass enhanced TV services, including a “clip and sling” type technology, that could eventually allow TiVo users to automatically remove commercials from time shifted programs.

According to patent 7,661,121, TiVo now owns the right to use existing closed caption and Enhanced Television (ETV) signaling data to create an interactive experience for their customers. ETV data is metadata that content owners have started to embed into their programming. It’s been used by Cablelabs and is part of the fundamental architecture behind big cable’s sinking “Canoe” DVR advertising venture. While I would suspect that the cable companies also have patents related to how ETV data can be used, it will undoubtedly be another series of rapids that the long delayed project will have to maneuver through.

While the abstract for TiVo’s latest patent is a little vague, if you delve into the details, you start to understand why TiVo would try to seize this particular piece of intellectual property. Essentially, the patent allows TiVo to sync closed caption information (and metadata) from broadcast programs recorded on a DVR and then display that data in an interactive format. This data can be as simple as a menu or closed captioned text or can be as advanced as digital video and sound effects.

From the patent,

“A multimedia device may use closed-caption data patterns to recognize and synchronize to multimedia content streams. The types of data patterns available in closed-caption data are numerous. For instance, distinct data patterns may exist within the actual closed-caption text, the closed-caption control data, as well as well as any other event defined by the closed-caption data. By recognizing distinct patterns within the closed-caption data, a DVR may identify events within the multimedia content stream. One way of recognizing patterns within closed-caption data is by computing hash values representing closed-caption text and identifying patterns of hash value sequences. Thus, according to one embodiment, at a multimedia device, such as a DVR or server, the closed-caption data is parsed and hash values are generated corresponding to the closed-caption data. The hash values are then compiled into hash value sequences associated with particular video programs or segments, and further combined with metadata defining command and control information for processing at multimedia devices. These hash sequences and metadata are provided to multimedia devices such as DVRs in the form of hash value sequence data. The multimedia devices use the hash value sequence data for recognizing and synchronizing to closed-caption data. A matching algorithm is used by the multimedia device to sequentially compare generated hash values from the closed caption data with multiple hash sequences that the multimedia device has stored locally. According to one embodiment, the matching algorithm is implemented through a state machine that processes the generated hash values and reports whether or not a match has occurred with a hash sequence identified by the hash value sequence data. ”

While the patent was only awarded on February 9th, TiVo actually implemented part of this technology years ago. Not only do they already offer a number of different ways to view closed caption data, but if you’ve ever watched a commercial on TiVo from one of their corporate partners, you’ve probably noticed a thumbs up icon that lets you easily subscribe to a show or order more product information.

While TiVo’s current implementation of this technology is admittedly pretty limited, the patent hints that there may be more powerful features going forward.

“”A user can mark off sections of a multimedia program or place points of interest relating to content within the multimedia program. For example, a user may want to mark the best plays of a recording of a football game. Once the user marks the plays, he can send the resulting hash sequences to a friend’s DVR.” [Bold added by me]

One of the reasons why Dish was never able to launch their clip and sling technology was because the content owners threw a hissy fit and threatened to sue the bejesus out them, if they made it easy for consumers to share content. While I don’t know the technical details behind what Sling was trying to accomplish, my sense of the project was that they wanted to let users edit other people’s content and then redistribute digital copies of those clips. The genius behind TiVo’s method is that their method wouldn’t allow anyone to “share content” that wasn’t entirely owned by the customer or TiVo.

“DVR users can distribute their own sets of points of interest for programs to other users. Users can further attach metadata to each point of interest that may cause the DVR to display text to the viewer, e.g., “Isn’t this a great action scene?” The user may also attach metadata to a point of interest that tells the DVR to skip x seconds into the program from that point of interest or display x seconds of the program before skipping to the next point of interest. This allows users to create their own condensed versions of a program that they can distribute to their friends, family, classmates, students, interest group, etc.”

While TiVo uses the example of a clipping highlights from a football game in their patent filing, I’m much more interested in how TiVo customers could potentially use this technology to remove commercials from YOUR programs. If both you and I have already recorded a particular show, there is no copyright violation because we’re both recording content that we already own. By allowing their users to create hash tag data, TiVo would technically own that data and would have the right to distributed that hash tag data to other DVRs without having to worry about content owners accusing them of stealing.

This would make it easy for me (or more likely someone else since I time shift everything ;) ) to easily tag all the commercials in a program and TiVo would then know to auto-skip past the content (commercials) when it saw the tags. TiVo could also use this as a way for live subscribers to tag the end of football and basketball games, so that they wouldn’t get cut off if the game went to overtime.

Another interesting embodiment of this patent would be the combination of live information with time shifted programming. Whenever I watch something a few months old, I always see commercials for upcoming TV shows or movies that are way past their expiration date. Instead of advertisers wasting their money on DVR subscribers, they could use sponsored hash tags to replace an old ad with something more current. Alternatively, if you were time shifting the news, TiVo could use your internet connection to create a live scrolling ticker that could update you on any new developments in the story.

Other potential uses that appear to be covered by the patent would include shows that have choose your own adventure type storylines. Upset about Chuck and Sarah not hooking up? the producers could give fans an alternate storyline to explore and allow viewers to vote on how they want to see the story move forward or TiVo could use this patent to create Blind Date type pop-ups around recorded television. While I tend to prefer my TV clutter free, for events like the state of the union, I can see why people would be interested in having fun facts pop up, addressing the issues that are being discussed.

While we haven’t seen any of these implementations take place today, the mere fact that TiVo was thinking about these options when they filed the patent would seem to suggest that they’ve been quietly innovating behind the scenes. This new patent award won’t necessarily help them in their case against Verizon or AT&T, but it could offer the telcos yet another reason to settle their dispute with TiVo, instead of being forced to place limits on the future of TV.

25 Stocks Under $250 Million

House Of The Rising Sun*Disclaimer – This post should not be construed as investment advice or a recommendation to buy or sell any of the securities mentioned. Small cap stocks in general tend to be much more dangerous than larger companies and investors are highly encouraged to speak with their own financial adviser and to perform their own due diligence before considering an investment in any of the companies mentioned. Full Disclosure, I currently own shares of Calamos and Lojack.

Many investors tend to focus on large well established companies, but I’ve always had a penchant for small cap stocks. It could be my masochistic tendencies, but I prefer the risk/reward of a long shot, over companies who already dominate their market. Typically, my investment style has been to seek out strong brands that have fallen out of favor with the market and then wait for their fortunes to improve. Sometimes this involves waiting for years, sometimes it involves taking a complete loss and sometimes I get lucky and other firms step in and buy them out or bid up the price. Since a few of my readers have inquired about what sorts of things I look for in an investment, I thought I’d present a list of 25 small cap stocks that I currently have my eye on. Most of the data has been taken from Yahoo! finance as of 1/26/2010, so it’s probably a good idea to double check the numbers.

1-800-Flowers (Market Cap = $136.47 million Ticker: FLWS) – Every since United Online purchased FTD, 1-800-Flowers seems to have lost market share, but despite their wilting fortunes, they represent a strong brand in a market with limited competition. After cutting operating expenses by $50 million in the second half of 09 and with Valentine’s day just around the corner, I wouldn’t count this one down and out.

Audiovox (Market Cap = $151.26 million Ticker: VOXX) – Despite having booked over a half a billion in consumer electronic sales over the last year, Audiovox doesn’t seem to get a lot of respect outside of the consumer electronic’s industry. With $361 million in shareholder equity, the firm is trading at half of their book value. While the company has lost over $50 million in the last 12 months, these losses are largely attributed to one time charges. With the firm having hit profitability in the last 3 quarters, a turnaround may be in sight for patient investors.

Bank Of The Internet (Market Cap = $87.61 million Ticker: BOFI) – While many local California banks made some pretty terrible loans during the housing boom, BofI was considerably more conservative with their assets. The market may have discounted them along with the rest of the financial community, but a closer look at their balance sheet suggests that this may be a hidden gem in all the rubble. With a charter that allows them to operate in every US state, there is a lot of potential for this little known company. With some of the highest interest rates on cash deposits, they’ve been able to attract deposits during a period where most banks have seen their customer base contract. For fiscal year 2007, they had revenue of $45.7 million, in 08′ they booked $64.8 and in 09′ they had $81.1 million. While I’m no longer a customer of the bank, from past experience I can personally attest, that they have the best customer service of any financial institution that I’ve ever worked with.

Big Band Networks (Market Cap = $205.92 million Ticker: BBND) – Since it’s debut in 2007, this content delivery network has seen their stock price fluctuate between $3 a share to $20.44. The company did lose $11 million in the last quarter, but had they not been investing in research and development they would have generated a small profit. While they do owe approximately $70 million in debt, with $161 million in cash and short term investments, they should have the stamina to make it through the market’s bust. Sitting at the epicenter of online video movement, there’s a lot of potential for this Silicon Valley company.

Calamos (Market Cap = $237.42 Ticker: CLMS) – When it comes to convertible bond investing, Calamos has set the gold standard for fund managers. While revenue is down over 20% since the market collapsed in 2008, I don’t believe that this is proper justification for trading at less than 1 times their trailing 12 month sales. With a strong management team, a fantastic brand and their recent return to profitability, I think that the company is undervalued. With their latest dividend reflecting a 2.4% yield, I’m willing to wait for their turnaround.

ClickSoftware Technologies (Market Cap = $200.88 million Ticker: CKSW) – ClickSoftware helps companies better manage their workforce. Since the beginning of 2009, they’ve seen their stock rise almost 400%, so they’re not exactly a secret. Nonetheless, this Israeli company has demonstrated some pretty impressive metrics. In fiscal 06′ they had $32.4 million in revenue, in 07′ this rose to $40 million. In 08′ they recorded $52.3 million in sales and for 2009, they are expected to report approximately $61 million. With the company having made three small acquisitions in the past year and realizing 67% gross margins, it would appear that they have a bright future ahead of them. With $48.6 million in current assets and only $22.2 liabilities, they should be able to survive for a very long time, especially if the continue to remain profitable.

DivX Inc. (Market Cap = $180.25 Million Ticker: DivX) – After making a huge splash in 07′ and hitting a billion dollar market cap following their IPO, DivX has been a huge disappointment for many investors. While there are long term questions about their business model and management has given no indication that revenues won’t continue to drop, with $139 million in cash and short term investments and only $25.6 million in liabilities, the stock is certainly priced at a bargain. Given their unique position in the digital media space, I can think of a number of large competitors who wouldn’t mind taking advantage of the market’s short-sightedness.

Double-Take Software (Market Cap $216.34 million Ticker: DBTK) – Even before cloud computing was a buzz word, Double-Take was working towards building remote solutions for businesses. After seeing their revenues rise over 50% between 2006 – 2008, the company experience some turbulence in 09′. For the first 9 months of the year, they recorded revenue of $60.4 million, compared to $71.3 million for the similar time period in 08′. Nonetheless, when you consider that they are still booking a gross profit of 89%, there is a lot here to like. With financial and insurance companies representing some of their biggest customers, it may take time for them to return to their highs, but with nearly 4 times as many assets as they have liabilities, the company should have no problem surviving.

Geek.net (Market Cap = $77.41 million Ticker: LNUX) – As a self professed Geek I may be a bit biased on this one, but with the company trading at just $10 million above their book value, I think that this could be an extremely attractive acquisition for the right partner. Through sites like Slashdot, Sourceforge and ThinkGeek, they’ve been able to build an audience of over 40 million unique visitors each month. When you consider that their core audience tends to be primarily male developers with a lot of disposable income, I’m not surprised that their revenue has grown despite a collapse in the online ad markets. Recent insider selling and the lack of profitability may be cause for concern, but I believe that their core brands are too valuable to be trading at such a steep discount.

IncrediMail (Market Cap = $77 million Ticker: MAIL) – Since hitting their bottom in late 2008, IncrediMail’s stock before has been nothing short of incredible. With the stock up over 400%, there’s room for it to take a breather, but based on their most recent dividend, investors are earning an approximate 10% yield. While it’s always possible that they could quit paying back returns to their shareholders, with revenues up 25% for the first 9 months of 09, the trend is headed in the right direction.

Jackson Hewitt (Market Cap = $101.27 million Ticker: JTX) – They say nothing is certain in life except death and taxes and given Jackson Hewitt’s past sins, it’s fair to say that both may still be in store for this company’s future, but with the stock trading at 10% of past valuations, there’s also room for an impressive “dead cat bounce”. After getting busted for issuing problematic refund anticipation loans there’s an unknown liability that hangs over this firm, but with the company trading at 0.40 times their 12 months sales, the risk/reward is attractive for the troubled tax preparer.

Internap (Market Cap = $247.71 million Ticker: INAP) – Like many of the CDN players, Internap has seen their stock price hit with a buzzsaw as investors re-evaluated the long term potential of internet delivery. While Akamai may have a firm grasp on this market, I believe that there’s a lot of untapped value in this company. With over $250 million in revenue over the past year and over a billion dollars worth of tax losses, this small little video provider is ripe for consolidation.

Lasercard (Market Cap = $75.85 million Ticker: LCRD) – After a history of losses, this Silicon Valley security company appears to have turned the corner with their business model. During 2009, they blew through their net operating losses and have once again begun paying taxes on their profits. While their revenue tends to be concentrated with a few customers, recent contract wins with the governments of Hungary and Angola should provide some much needed diversification over the next year. Their leverage is a little bit higher than I’d like to see, but with a successful underwriting early last year and a bright future for the global security market, they should be OK over the near term.

Lojack (Market Cap $74.57 million Ticker: LOJN) – Caught between the wrong end of a patent lawsuit and the collapse of the auto market, Lojack has been absolutely hammered over the last few years. With the stock down more than 80% from their all-time high, it would be easy to write this one off as a tax loss. Despite the challenges that they’ve faced though, I believe that their unique technology and brand can easily be ported into other industries and that their recent losses will only prove to be temporary. With sticky contracts with law enforcement agencies and the potential to once again realize strong earnings, I think the company has been undervalued by investors.

Motorcar Parts of America (Market Cap = $68.22 million Ticker: MPAA) – Despite their ticker symbol, MPAA doesn’t have anything to do with the entertainment industry. They’re a small firm that sells plain old boring alternators and starters for small trucks. While the auto industry has seen new car sales eviscerated over the last few years, it should provide an opportunity for companies who build replacement parts. With their current liabilities exceeding their current assets, it may be wise to wait until they raise more money before proceeding, but with the company trading at approximately half of their trailing 12 month sales, the market seems to have priced in the doom and gloom already.

OpenTV (Market Cap = $162.92 million Ticker: OPTV) – With the Kudelski group having already agreed to pay $1.55 per share, you won’t get rich off of investing in this set top box manufacturer, but there could be an arbitrage opportunity for those looking for a short term investment. Assuming that it takes them another 1 – 3 months to close the transaction, investors could expect an annualized yield of 10.75% – 3.22% respectively. While these transactions always carry the risk that something could derail them, I’d be surprised if the deal doesn’t get completed in the first quarter.

Primedia (Market Cap = $126.26 million Ticker: PRM) – From a high of $175 per share during the .com heyday, to it’s current price under $3 a share, it’s fair to say that the last decade hasn’t been very kind to Primedia investors. Despite their past performance though (and huge question marks about the ad market), there’s still life in this old dog yet. Over the last 12 months, they’ve been able to pull in approximately $270 million in ad revenue and while this is less than what they earned in 2008, it does suggest that their revenues are starting to stabilize. With an impressive portfolio of .com properties, once the ad market returns, Primedia is an a better position to recover than most.

Rentrak (Market Cap = $167.97 million Ticker: Rent) – DVD sales may be in a freefall, but Rentrak has done a good job of managing this decline. The company not only helps to distribute packaged media, but also sells industry data to the major studios. While on one hand, the current business trends would appear to be working against the firm, the decline in disc based media also makes that intelligence even more valuable. With the company trading at less than 2 times sales, it wouldn’t surprise me to see a firm like Nielsen try to buy them in an attempt to bolster their own portfolio.

Rocky Mountain Chocolate Factory
(Market Cap = $51.65 million Ticker: RMCF) – While this pick violates a rule I have about never investing in restaurants, I’m willing to make an exception when it comes to chocolate :) With $17.8 million in assets and only $3.7 million in debt, this small specialty retailer has a remarkably clean balance sheet. Sales may be down year over year, but thanks to a partnership with Cold Stone Creamery, there is potential for growth. Given the strength of their brand name, I could think of quite a few companies who would mind owning their brand.

Smith and Wesson (Market Cap = $235.94 million Ticker: SWHC) – Over the past two years Smith and Wesson investors probably feel like they’ve been shot in the gut. Despite revenue going through the roof, they’ve been sidelined by one blunder after another. With a messy balance sheet and company officials facing charges of bribery, this one may be dead on arrival, but with over $300 million in revenue and a terrific brand name I wouldn’t hesitate to take a second look once things get straightened out.

Sonic Solutions (Market Cap =$232.46 million Ticker: SNIC) – For a long time, Sonic seemed to be the little engine that just couldn’t. With a number of software products focused on digital media, success always seemed like it was just over the horizon, but delays from studio partners and the decline in demand for their DVD services put a crimp in their stock’s performance. After seeing a rebound of over 400% in 2009, investors may be setting themselves up for another disappointment, but recent agreements with Blockbuster Video and a successful stock underwriting late last year, have removed concerns about their near term future. While I still have doubts about their ability to execute, there’s no denying that the Roxio and CinemaNow brands have value.

SORL Auto Parts
(Market Cap = $205.64 million Ticker: SORL) – Chinese companies always make me a bit nervous because it’s hard to trust their financials, but given China’s investment in infrastructure, there’s a lot of upside to the industry that SORL operates in. As a supplier of auto parts for Chinese trucks and buses, they’ve been immune to the issues facing the US auto sector. With assets representing more than 4 times their debt, they should be well positioned to capitalize on China’s own stimulus plan.

Spark Networks (Market Cap = $62.77 million Ticker: LOV) – Every since I made a bundle when IAC bought out UDate, I’ve been looking for an internet dating site to court. While I may have missed the bottom when it comes to Spark Networks, I’m still attracted to their business model. Revenue, net income and their member base have both been heading the wrong direction, but if their new Spark.com domain can take off, there’s still a lot to love.

SRS Labs (Market Cap = $98.73 million Ticker: SRSL) – Compared to heavyweights like Dolby, SRS is a 98 pound weakling in the audio technology industry, but don’t let their size fool you about the quality of their technology. Recently the company announced that their partners have shipped over 30 million certified TruVolume devices. Perhaps even more impressive though is that the company operates at 99% gross margins. With their technology able to prevent the sound fluctuations between your programs and commercial breaks, I see a bright future ahead. When you also consider that the company has over $50 million in assets and less than $3.5 million in debt, I think it’s a steal at their current valuation.

Stamps.com (Market Cap = $140.77 million Ticker: STMP) – Over the last few years, Stamps.com’s revenue has been more or less stagnant, but with limited competitors they should be able to maintain a pretty good hold on their niche market. With the recent growth in home based businesses, the company is poised to capitalize on FedEx’s losses. With a balance sheet heavy on assets and light on liabilities all it would take is a dividend or a share buyback to make this stock attractive.

How To Save Blockbuster

SuperBlockbuster

Ten years ago, Blockbuster video was on top of the world. They didn’t know it at the time, but it was the golden age for the video store. After years of reminders to be kind and rewind, consumers were adopting DVD players en masse and needed a source for their entertainment needs. For better or worse that source was Blockbuster.

With the internet buzz hitting a fevered pitch, Blockbuster was already hard at work creating a digital strategy. Given their dominate position in the video store industry, they even flirted with the idea of buying a small internet start up named Netflix for a mere $50 million.

With the entertainment world seemingly in the palm of their hand, Blockbuster was positioned to make the jump to digital better than anyone, but over the last decade they’ve made a series of blunders that now threatens to bankrupt them today.

Yet, in looking at their rise and fall, it’s easy to make the quick assumption that their problems were a result of technological innovation, but the truth of the matter is that they have no one but themselves to blame for the weak position that they find themselves in today.

Of all their missteps, the biggest blunder was assuming $1 billion in debt, so that Viacom could collect an obscene dividend payment when they sold the company to a naive public. That debt now hangs over them like an albatross across their their neck and has caused them to lose pace with their unencumbered competitors.

With revenues in steep decline, it will only get harder and harder for Blockbuster to continue to meet their obligations under this debt. Without the firepower to compete on a level playing field, their situation will only get worse

With the precariousness of their position becoming increasingly clear, Blockbuster has done everything from paying a high price to refinance their debt to hiring a bankruptcy specialist to help salvage what is left of their business.

Yet, despite the clear and present danger of their situation, Blockbuster has continued to keep their head buried in the sand. Over the years, I’ve offered my fair share of suggestions criticism for how they could improve their business model, but we’re now at a point where a tourniquet won’t save them, they must do massive surgery and Stat!

In an effort to try and preserve a dying part of the entertainment industry, I present to you, my plan to save Blockbuster.

With the future looking pretty bleak for just about any video store, how can a company like Blockbuster save themselves? By sacrificing their media business in exchange for an opportunity to reinvent their retail business.

What I’m proposing would be tricky and the devil really would be in the details, but with the right execution, Blockbuster could shed their legacy of debt, future proof their business and position themselves to take market share, instead of losing it.

Essentially what they’d need to do is create a “good Blockbuster” and a “bad Blockbuster” to isolate their problems.

On one side you would have their DVD by mail program, their DVD kiosks and their digital business. On the other side, you would have Blockbuster’s traditional video store business that so many are quick to write off.

Together, the two businesses are slowly strangling Blockbuster, but split apart, they could free them from the impact of years of stagnation and ineptitude on their part. What I’m proposing is that they spin off their good assets and use that money to pay off their debt.

In the past, Blockbuster tried to launch an aggressive initiative to boost their DVD by mail program, but by doing so, they only ended up cannibalizing their in store customers. As a result, they’ve all but abandoned the program and have allowed their future to slip away.

If an independent Blockbuster.com doesn’t have to worry about that cannibalization, they could focus on going head to head against Netflix. They could create a subscription program for their kiosks that could offer value that Redbox couldn’t match. They could be price competitive without having to worry about their legacy stores. The result would be a smaller Blockbuster with less meaningful revenue, but it would represent profitable revenue instead of losses.

Neither Netflix nor Redbox would be able to offer DVD exchanges at the kiosk level and through the mail, but Blockbuster could capitalize on both strengths. Yes, the company would be a mere sapling in the larger entertainment industry, but Netflix was once a sapling and they’ve been able to grow into a very large oak.

From the video store side of the equation, Blockbuster could focus on what they do best, maximize cash flow while transitioning their stores into a new business. Whether that means turning their stores into modern day Starbucks or a replacement for the now defunct Circuit City, there are still plenty of opportunities for smart and nimble retailers.

To date, Blockbuster CEO Jim Keyes has made this transition a priority for the company, but when they are forced to forgo tens of millions in capital expenditures, just so that they can service their debt, it limits how quickly they can make this jump. As a result, they continue to face pressure to close stores instead of turning them into cash flow producing machines.

Given all of the negative media attention, it may be hard to believe, but Blockbuster still does a ton of business. For the first 9 months of 2009, Blockbuster brought in over $1.9 BILLION in revenue. By comparison, Netflix brought in $1.22 billion during the same period. Yet, when you look at the differences in market capitalization, Netflix is over 20 times more valuable than Blockbuster.

Perhaps even more surprising is that Blockbuster would have turned a profit of $38.4 million during that 9 month period, had they been able to ignore their debt. Instead, that $38.4 million profit turned into a loss of $131.6 million for the company. Now you don’t need to have a Phd in math to know that losing over $100+ million per year starts to get expensive fast and perhaps even more damaging than the loss of the cash is the effect that these interest payments are having on their competitive ability.

Instead of being able to invest in their future, they’ve been forced to make cut backs. Instead of retrofitting their stores, they’ve been closing them instead. Instead of stepping up the marketing, they’ve been forced to dial back. The result is that more revenue shifts to Redbox and Netflix and their cost to acquire customers has plummeted. If this trend continues, you don’t need Dr. Doom to tell you that it will be curtains for Blockbuster. They must stop the bleeding and they must stop it now.

Now I know what you are thinking, if Blockbuster is a penny stock today, how are they going to come up with $1.6 billion to pay off their long and short term debt. Part of it comes from the assets that they are holding today. With $980 million in current assets, they should be able to keep a good chunk of their leverage in check. The remaining $620 million worth of debt would be paid off by spinning off their new media divisions.

According to the most recent data, Blockbuster currently has 1.6 million online subscribers. As of last September, they had deployed 1,000 kiosks, but were anticipating that they would have over 10,000 deployed by the end of 2010. While Blockbuster doesn’t break down their digital revenues, I think that it’s reasonable to suggest that this division would be worth anywhere between $25 – $75 million based on their market position and intellectual assets.

If you look at Netflix’s current valuation, it works out to be approximately $255 per subscriber. Assuming that you discount Blockbuster subscribers by 30%, it would value Blockbuster’s DVD by mail business at $285 million.

In February of 09′ Coinstar completed their purchase of Redbox at a valuation of approximately $350 million. At the time, Redbox had 12,500 kiosks suggesting a value of approximately $28,000 per kiosk. Assuming that Blockbuster can get to 10,000 kiosks, even at a 50% discount to what Coinstar paid at the bottom of the market, one could assume that this stake would be worth approximately $140 million without Blockbuster’s legacy stores or debt.

What these numbers suggest is that if Blockbuster were to do a spinoff, it’s easily conceivable that they could raise at least $500 million in the offering. Assuming that they start to market their DVD by mail and get it up to 2.5 million subscribers, it would value their new media business at approximately $660 million.

If they did the spin off in the form of a convertible bond, I believe that this number goes even higher, because bond investors could be given the option to return to their current position, if the spin off flopped.

While this sort of transaction would create a new competitor for Blockbuster Video, by getting rid of their debt, it would enable their stores to become profitable once again, which in turn would make it easier for Mr. Keyes to raise money for the marketing and store improvements that Blockbuster so desperately needs.

While I believe that this rescue plan could make Blockbuster competitive again, I don’t believe that their current management is willing to sell off their future, even if it means saving themselves. Despite all evidence of a dying industry, Keyes continues to insist that the video store is the cornerstone of what they do and has consistently defined Blockbuster’s competitive advantage as being able to offer entertainment across multiple channels. While it’s easy to point to Netflix and Redbox as the source of Blockbuster’s kryptonite, I believe that it is their own unwillingness to let go of the past that is preventing them from being a video superhero of the future. Only time will tell how indestructible they really are, but if they continue down the same path, they’ll end up as a mere footnote in the history of the entertainment industry.

Coming Soon To A Store Near You

Hollywood DivXI know that I’ve been critical of DivX’s efforts to woo Hollywood in the past, but I’ve also got to give them credit for a win when I see one and I think they knocked it out of the park when it comes to Paramount.

Recently, Paramount announced that they were going to be distributing content on USB sticks. At the time, they didn’t say what format it would be in and even on DivX’s conference call there was no mention of this realization of their strategic vision, but Electric Pig is reporting that the Paramount movies will in fact be encoded in DivX.

With only 20,000 memory sticks for sale and at a price of approximately $33 US, Paramount is still clearly in the testing phase, but the fact that they choose DivX demonstrates the clear advantage that DivX has over all of their other digital competitors. They have the only real solution for brick and mortar retailers.

If Paramount tried to do this with a proprietary solution, it wouldn’t work because it wouldn’t give them a way to get that movie to the television. They could try to do it with Apple, but Apple doesn’t have the same reach to the TV, especially in Europe where this is being launched.

To date, most of my thoughts on DivX’s courtship of Hollywood have centered on the futility of trying to win enough support, so that online retailers could adopt their technology for digital distribution. If you can’t get a Disney or UMG to license DivX’s format, it makes it tough for someone like Netflix or Blockbuster to use their codec even with the other 80% of the content owners on board.

The beauty of the USB distribution strategy is that they won’t need 100% industry support in order to move their plans forward. Shelf space is limited as is, all they need is for a single studio to want to take advantage of this and there will be more than enough titles to tempt you with while you are waiting in line at the cash register.

Now I know what many of you are thinking, movies on USB are pretty lame. When Paramount made their announcement, there were more than a few commenters who zinged them for being out of touch with current trends. While there’s no doubt that the world will go digital, I also realize that the major studios aren’t going to abandon the retail partners that deliver the majority of their profits each and every year. It may end up becoming super easy to buy movies straight from your home, but if you have millions of consumers visiting a store each day, you can bet that the studios will want to reach those customers where they are hanging out. The shelf space is too valuable to be abandoned.

DivX on USB also opens up new business models for the studios. Instead of selling three DVDs, they could package all the Godfather films on one stick to justify a higher price tag or they could offer an entire season of television on an 8GB stick instead. If a retailer can sell something for twice the price, they will take smaller margins from the studios for the larger transaction. With the studios under pressure to develop new revenue streams, this will be too tempting for them not to exploit.

There’s no doubt that DVD is moving to Blu-Ray, but DivX memory sticks allow their Hollywood partners to reach consumers who may not have upgraded to high def just yet. With the industry in a state of flux, being able to sell a device that can be read by any computer and over 200 million devices gives DivX broad reach when it comes to the world of disconnected playback.

Paramount may be approaching this market cautiously, but I think people have greatly underestimated the size and the impact that USB films will have. It may not be cutting edge technology, but there are too many powerful companies who need it to succeed for it to fail. At the birth of this industry, it’s encouraging to see Paramount actively supporting their partnership with DivX, instead of just taking a licensing payment and then ignoring what their technology can offer.

USB movies won’t necessarily solve DivX problems with their shifting business model, but it does underscore the significance of the platform that DivX has built. As much as DivX is threatened by the obsolescence of the DVD, they can also benefit from the format shift. So far, they haven’t done a very good job of managing this transition, but this deal proves that even an old dog can learn new tricks. If retailers start asking for DivX as a weapon against Blockbuster and Netflix, other studios might also understand the benefits of using open and popular technology to make more money.

Blockbuster Bleeding DVD-By-Mail Subscribers

not-blockbusterPhoto by C-Bunny.

Just in case you think Blockbuster’s problems are isolated to a declining video store industry, I’d encourage you to take a closer look at their latest 10-Q filing. Despite there being clear growth in the DVD by mail category, Blockbuster is hemorrhaging subscribers. In fact, the percentage of people giving up on their by mail service is almost as high as the percentage of people giving up on their video stores. According to their 10-Q,

“Rental revenues decreased mainly as a result of: a $76.3 million decrease in by-mail revenues driven by a 30% average decline in by-mail subscribers, which was more than offset by related cost reductions described below under “Domestic—Gross profit;”

At one point in early 2007, Blockbuster had the pedal on the metal and was boasting of having close to 3 million subscribers. Since then, they’ve been understandably quiet, but I had no idea things were this bad until I read their most recent filing.

After piecing through other filings, I was able to come up with an estimate of 1 – 1.25 million current subs.

Here’s the math for those playing at home.

At the end of 2006, Blockbuster had 2.2 million subscribers and had brought in approximately $250 million in revenue. By the end of 07′, they were flirting with 3 million subs and had $525 million in DVD-by-mail revenue.

From a historical standpoint, this tells us that Blockbuster’s subscribers tend to average between $9.49 – $14.60 per month, but these figures are a bit skewed by their total access efforts. Since most of their subscriber gains were added at the end of 06′ and the beginning of 07′, it pushes both numbers to an extreme. Their actual monthly average is probably closer to somewhere in the middle.

By comparison, Netflix subscribers were averaging $12.84 per month as of their most recent quarter.

The information that Blockbuster discloses doesn’t allow us to get at an exact figure, but if we also dig through past filings, there is more than enough info to extrapolate a reasonable estimate for their current number of subs.

In December of 2006, they had just passed 2.2 million subscribers. Two months later, they were predicting that they’d be at 3 million subscribers by March 07′

A year later the first sign of trouble shows up when they disclosed that they saw “significant” subscriber losses after pulling total access in 07′. If we assume that 20% of their subscribers left after they cancelled the free in-store exchanges, it would bring you to an estimate of 2.4 million subscribers for midway through 07′.

By Oct 08′, Blockbuster admits that their by mail revenues decreased another 21.5%, so if you subtract another 500,000 subs you get a total of 1.9 million from 9 months ago.

Since we know that they’ve lost 30% of their subscribers over the last 12 months, it gives us an estimate of 1.3 million subscribers today. With some of these number being moving targets, I wanted to check to my math to see how reasonable this guess was and I actually think it’s a tad high. If you take a look at their most recent by-mail revenue number, it suggests that the total is slightly lower.

Since Blockbuster has plans that range from $9 – $17 per month, it gives us a range to consider. If a decline of $76 million represents 30%, it would suggest that they are currently earning $14.8 million per month from by mail subscribers.

If we assume that 100% of them were $9 per months subs, it would mean that the maximum number of subscribers that they could have at this point would be 1.64 million and if 100% of the subscribers were paying $17 per month, it would peg the minimum size of their subscriber base at 870,000.

Since $12 – $14 is a more reasonable estimate for what the average Blockbuster by mail subscriber pays each month, it gives us a ball park range of 1 – 1.25 million current subscribers.

I wasn’t surprised to see a drop in subscribers right after Blockbuster abandoned their total access plans, but to see them drop below TA levels has to be concerning for Blockbuster Execs. This is the one part of the company that should be firing on all cylinders, but clearly Netflix’s Watch Now service has been poaching their members.

Blockbuster may have put up a good fight in the DVD wars, but with nearly 10 times the number subscribers, Netflix is now threatening to do to them, what they did to Wal-mart’s DVD by mail program.

The smaller membership gets, the harder and harder it will become for Blockbuster to run their by-mail program at a profit. They could always raise prices, but that would only lead to additional defections. With Blockbuster on the ropes, don’t be surprised to see Netflix maintain the price war for another 12 months while they wait for Blockbuster’s bond owners to take control of the company.

In the meantime, this data only highlights the fact that Blockbuster’s problems aren’t because of a lack of opportunities, it’s an issue with their execution.

Judge Denies Further Extensions, DivX/UMG To Be Resolved By Christmas

You Win Some You Lose Some

Additional ruling
3 good transcripts with background on case to date (1 , 2 , 3 )

It’s been nearly two years since DivX filed their “pre-emptive” lawsuit against Universal music group and so far, there really hasn’t been much to talk about. DivX’s original lawsuit was thrown out after UMG removed the overhanging legal threat against Stage6 by actually filing a suit alleging copyright infringement.

Given the hurry that DivX was in to have this case resolved, one would have thought that consumers would have had a digital betamax decision by now, but once DivX abandoned Stage6, their strategy towards the case took a 180.

With DivX seeking Hollywood approval, I’ve no doubt that they would like nothing more than to sign a content deal and settle the matter with a small token of goodwill. Last November, they tried to reach a settlement with UMG, but UMG seems out for blood on this one. If they were to actually get the $300 million in damages that they are seeking, it would not only bankrupt DivX but would give UMG control over their technology.

While it may still be in UMG’s best interest, not to establish a legal precedent on the DMCA safe harbors, there’s no doubt in my mind, that they’ll try to extract more than a pound of flesh, before they let DivX off the hook on this one.

Over the last year and a half, the case has largely been hung up over petty issues related to discovery. With DivX in stall mode, they tried to ask for a mountain of documentation from UMG. Specifically, they wanted the entire chain of copyright documents for all 2,600 allegations of infringement.

With some songs requiring over 500 pages of contracts, UMG was reluctant to help DivX on a fishing expedition, especially when they have “certificates” that certify their ownership of the works in question.

Meanwhile, UMG wanted to use Audible Magic, in order to detect every instance of copyright infringement on Stage6. DivX understandably wanted to make this harder for them. DivX argued that since UMG failed to use their voodoo technology, while the site was up, they shouldn’t be compelled to power all 750,000 videos back up.

Eventually, they gave UMG an index that let them search for the name of a video and then request a copy from DivX for review.

Of course the problem with this approach is that as anyone who used Stage6 knows, the studio files were never labeled with the proper titles. Search on Stage6 was always pretty terrible and this was made even worse by members trying to hide themselves underground.

Rather then using search, browsing through tags was a much more efficient way to find content ;) Since most visitors were coming from link aggregation sites anyway, it wasn’t all that necessary for the movies to show up in search.

Most of these differences could have been worked out pretty easily, but with DivX trying to let YouTube set the precedent, and with UMG trying to go after the lower hanging Veoh fruit instead, neither party has been very incentivized to move this case forward.

In fact, just last week, both UMG and DivX asked the judge to add on an extra 60 days before they would have to do battle, specifically so Veoh could go first. The judge, who has clearly been frustrated by the petty antics of both parties, finally put his foot down and denied the extension despite both parties being in agreement. Now, Veoh’s case has been pushed back while they wait to see if DivX walks away a free entity or facing an executioner.

Like a man on a mission, the judge has followed up his denial with two rulings, that settle a laundry list of squabbles and should make the rules of engagement crystal clear.

At one point, DivX may have been able to convince the judge to let them have wider access to the copyright records, but after failing to cite a single “widely distributed” modern act, he put an end to this discovery requirement.

Because a healthy part of the legal paperwork is obscured by sealed records, it’s not exactly clear what happened with audible magic, but from the way I read it, it looks like DivX was able to limit UMG to finding the content the same way that users had to. The judge did give UMG access to the search terms, (which will enable them to use the tags in order to find more potential violations), but he didn’t require DivX to turnover the metadata on the files.

DivX wasn’t able to get emails of record label employees, but did get an order for “actual or prospective policies or practices from January 1, 200o to the present.”

As part of their defense, DivX is trying to assert that they put in measures to help prevent copyright abuse. Specifically, they used technology that would prevent the same video from being uploaded, if it had already been subjected to a DMCA notice.

UMG is trying to argue that the copyright violations on Stage6 were so blatant that DivX would have had to have known that infringement was occurring (even if UMG didn’t complain about it first.)

The key issue here, will be whether or not the technology that DivX employed, was considered an “industry standard” for preventing infringement. If they can show that UMG had previously endorsed the technology that they were using, it would make it hard for them to argue that DivX wasn’t taking reasonable steps to prevent pirates from ransacking Stage6.

With the legal maneuvering, finally out of the way, the biggest obstacles to a trial have been removed and we should have a resolution before Christmas.

Of course, if you’re hoping that DivX is going to make a stand for consumers by establishing the legality of video sharing for a site that is all but dead to them, I wouldn’t get your hopes up too high.

DivX and UMG may have failed to reach an agreement last November, but they’ve “tentatively” agreed to go in for couples counseling and have a mediation date scheduled for Sept. 21st.

I don’t know that DivX will be willing to write a big enough check to satisfy the music conglomerate’s greed, but if UMG begins to doubt their case, it wouldn’t be hard to get a little bit of money and a passive admission that they can enforce whatever rule of law they want.

If we do get a trial, it will be a fun one to watch. Here is an estimated schedule based upon the most recent developments in the case.

August 17th – Non-expert discover cutoff/last day to conduct settlement conference
August 18th – 25th – UMG begins depositions of DivX employees and witnesses
Sept 29 – Last day to hear motions
October 26th – witness list is due
Nov 24th – Trial Begins
Dec 10th – Jury reaches verdict

Whether or not DivX will stick to their guns remains a question, but there is finally light (or darkness) at the end of the tunnel. We don’t know how this will get resolved, but it shouldn’t take much longer to find out.

Rhapsody And The Art Of The Up-Sell

RealPhoto by Thomas Hawk

One of my very first jobs was working behind a concession counter for a big multi-plex cinema. It isn’t the sort of place where one would expect to learn a life skill, but early on I learned an important lesson in business, the art of the up-sell.

You see, movie theaters make very little from the box office receipts, so the concessions counter is the lifeblood of the industry. The setup is pretty much the same at every theater, but most people don’t tend to think about it. Because the actual cost of the popcorn and soda is so low, the theaters reap big profits from selling captive customers overpriced snacks and beverages.

One of the problems that theaters face, is that there are a ton of people who tend to order small sizes. It could be that they are trying to save money or that they don’t need oversized portions, but because the containers cost the theater more than the actual popcorn or soda, going from a small to a larger size, tends to be pure profit for the theater.

To help “encourage” movie goers to pay the max, theaters will price their small popcorns at ridiculously expensive levels and then have a minor jump in price from small to medium and medium to large. If you were to price the popcorn by ounce, a small would cost four times as much as a large, but because of the high cost at the small level, it makes it easier to convince consumers to pay a little bit extra for a lot more food.

When I sold concessions, the sales pitch would typically go “hey did you know you can get a large for only 50 cents extra?” That was all it took and at least 75% of the customers would go big.

In thinking about why my theater was so effective at up-selling, two things jump out at me. The first has to do with the way the pricing was set. Consumers got tremendously more value at the higher levels, then the lower ones. It might be tough convincing someone to spend $5 on a bucket of popcorn to begin with, but once they made that purchase, an extra 10% for 200% more, seems small. Secondly though, they had an actual human explain this value to the customer. Concession employees were expected to upsell or suggestive sell on every single transaction. It could be subtle, but management made sure that every employee was at least presenting more options to the customers.

What made me take this trip down memory lane is a recent experience with Real’s Rhapsody music service. Before the internet, napster, and digitization, I used to collect music with a passion. Records, Tapes, CDs, it didn’t matter. I would scour local garage sales and thrift stores looking for bargains, (not to mention all of the BMG and Columbia House memberships.)

When the internet first started to take off, my collecting habits intensified. I’d surf Ebay for favorite artists. I didn’t care about the singles or the greatest hits, I was after the rare B-sides that were released internationally. There is something amazing about listening to an artist’s entire discography in order, but back then, it took a lot of money to buy every single song that an artist produced.

Once MP3′s took off, I abandoned physical playback and spent many late nights digitizing my music. As time has gone on though, I’ve realized what a hassle it is trying to maintain a large digital library. Computers have a way of freaking out once you go over a certain limit, there are countless hard drive failures involving added expenses and I don’t even want to think about the amount of time I’ve spent dealing with buffer overrun errors while backing up my music. The bottom line is that if you’re trying to collect a couple hundred thousand Mp3′s, it’s not only cheaper to rent then it is to buy, it’s cheaper just to store it.

Because I had such a large music collection, I never gave Rhapsody a chance, but as one hard drive failure after another has taken large chunks out of my music library, I’ve found myself turning to the internet for specific artists or songs that I’m now missing.

Over the last year, I’ve signed up for Rhapsody three different times to listen to music that’s disappeared over time. Thanks to their free trial offers, I’ve been able to hear a lot of great music, but never kept my membership for longer than a month.

What surprised me so much about the experience was how much I enjoyed it. Not only can I get the latest top hits for a fraction of what I used to spend, but I also get access to the expensive b-sides that were never in wide circulation. The first time I logged onto the service, I was estactic after discovering an entire album’s worth of material from my favorite artist.

Given how much enjoyment I’ve gotten out of the service, one would think that it would be a no brainer for me to spend a modest amount of money for access to more music then you can even think about, but when it came down to becoming a paying member, Real Networks lost me on the up-sell.

You see, as a streaming internet music service, Rhapsody really is an amazing product, but its lack of a robust download solution, means that if you want to take your music on the go, customers have limited options. Since Real realizes that not every consumer wants downloadable functionality, they price their service in two tiers.

The first is the standard all you can eat streaming music of just about any song or artist you can think of (we’re talking stuff not even on Bit Torrent.) For $2 more though, you can download songs to “approved devices” and rock out using a portable device that doesn’t need to be connected to the net.

As an internet streaming service, I would have been happy to pay their monthly fee for all of the music that they provide, but by offering a download “upgrade”, it makes me keenly aware of a significant limitation to the service. As is, I can listen to Pandora via the internet now, so a streaming only service makes me second guess how much value Rhapsody really has. I wouldn’t even mind paying the $2 more per month just for streaming access, but don’t see enough value in the $2 upgrade to justify signing up for the downloading tier.

Part of this is because I’m not able to download a DRM free MP3. Even if you download your music, you still have to “refresh” your approved device once a month or your songs get disabled. You’re also limited in the number of devices you can play your Real files on.

As much as I prefer downloading over streaming, it simply isn’t worth an extra $24 per year for a weaksauce version of the real thing. Having to connect my cell phone to the net once a month is obnoxious and I’m not particularly fond of downloading music that I can’t play on all the electronic gadgets that I own.

If they eliminated the download tier, I’d probably be a customer right now, but by making me choose, they’ve persuaded me not to sign up for either package.

Not everyone purchased an up-sell when I sold concessions, but during my entire time behind the counter, I never had a single customer walk away without at least buying the small popcorn that they originally asked for. When it comes to Rhapsody though, the different pricing tiers have cost them at least one customer who would have paid, if he didn’t have to choose between streaming only or weaksauce downloading.

I don’t know if Real does consumer surveys, but I bet that I’m not the only one to agonize over this distinction. Instead of using the price difference to highlight their weaknesses, Real would be better off by either raising the price $2 on everyone and then including their downloading solutions with the service or eliminate the downloading tier entirely and focus on being an amazing and comprehensive streaming service only. By trying to straddle between streaming and downloading, they are only confusing customers and highlighting the limitations to their service.