DivX Looks Outside The Codec For The Future Of Web Video
May 7th, 2008 Davis
DivX reported their 1st quarter earnings on Monday and while I’m still waiting to read the actual 10k before digging too far into the numbers, I did want to comment on what I see as a significant shift in strategy. Over the last 7 years, DivX has done an impressive job of building an eco-system around a single file format. The first time that I came across a DivX file, I actually thought that it was some kind of a virus. It took me two weeks before I worked up the courage to download the DivX media player so that I could play the movie, but once I did, I realized that my fears were unfounded. The file not only offered a superior video experience, but it was a lot smaller than the MPEG files that I was used to downloading. Since I was on a dial-up connection at the time, every little byte made a big difference.
As the P2P networks developed, DivX and it’s open source cousin XviD, became an important resource for file sharers. Initially, my own interest in DivX was driven by it’s technological advantages over other video formats, as well as the wide availability of DivX content on the grey market, but as compression technology has evolved, my reasons for using DivX have changed as well. Since I’m no longer on a dial-up network, compression is less important then what I can actually do with my videos.
As DivX gained in popularity, they were able to forge agreements with consumer electronic manufacturers that allowed you to play DivX files on a wide range of devices. Even though, H.264 is a superior standard for internet video, I still prefer DivX files because I know that I’ll be able to play them on the hardware devices that I own.
By creating an eco-system that supports portability, DivX has been able to lock me into their format in the same way that Apple has been able to use iTunes to keep their customers buying iPods instead of mp3 players.
As H.264, Microsoft, Apple and Adobe all continue to creep into DivX’s territory, there has been a lot of concern over how DivX would respond to these competing threats. Microsoft’s approach has been to batten down the hatches by developing their proprietary Silverlight codec. By retaining full control over the video format, they are able to convince people to buy as many Microsoft supported products as possible. These extra restrictions increase the appeal of Silverlight for DRM hungry Hollywood studios, but it also frustrates their customers in the process. Incompatible file formats are the reason why services like Netflix’s Watch Now doesn’t get along with Apple. Since Microsoft (and Apple) refuse to open up their codecs, it gives them a monopoly on the hardware that is allowed to support their video files.
Apple has at least opened up their system a little bit by adding support for the H.264 format, but they’ve still chosen to wrap their h.264 files inside of the Quicktime container. This prevents other companies from supporting Apple H.264 content, without obtaining a license for Quicktime first. This helps to open up Apple’s eco-system to alternative video formats, but still gives Apple control over the companies that are allowed to play nice with their your media.
Similarly, Adobe has also forged agreements to support H.264 inside of flash, but if you want to take your Flash H.264 files portable, you’ll need a device that can support the Flash format. To their credit, Adobe has done a good job of building momentum for downloadable flash by supporting open source initiatives, a new DRM system, and by removing license fees for mobile providers, but despite their early traction with these efforts, there are still very few hardware devices that are actually capable of playing portable flash content.
With so many companies pursuing proprietary video strategies, one would expect DivX to be focusing on locking consumers into the DivX format, but like most things having to do with DivX, their strategy for dealing with the next generation of codecs is also built on a system of openness.
We got our first real glimpse of this strategy last November when DivX announced that they had acquired Mainconcept for $22 - $28 million. The Mainconcept acquisition gave DivX an immediate footprint in the H.264 space, but it also raised some important questions about how DivX could maintain a monopoly on their community, while supporting a format that is widely available to competitors.
Interestingly enough, while discussing H.264 on their latest conference call, DivX CEO Kevin Hell pointed out that the current state of H.264 really isn’t all that different from the MPEG-4 standard that DivX was built on.
“Looking forward, a real opportunity exists for DivX to emerge as the consumer face of H.264, serving as a trusted brand for users who don’t want to concern themselves with underlying formats or technologies. In fact, the current H.264 market resembles in many ways the early stages of MPEG-4 market.
When DivX first emerged seven years ago there were number of different and incompatible MPEG-4 implementations available. Through our strong consumer adoption and the creation of the DivX certification program, we were able to simplify the experience for consumers and provide a solution that just works across any device. We plan to repeat that strategy by incorporating broad H.264 support into both our software and consumer electronics offerings under the DivX brand. We are on track to release a new version of our software in 2008 that supports H.264 and then extend that support to consumer electronic devices that are likely to hit the market in 2009. We believe that this development will help move the DivX brand beyond one single format and toward promise of support for any video content, on any device.”
DivX’s evolution towards H.264 won’t be a clean and easy transition, but it is the right direction for the company. If they can successfully integrate H.264 into their certification program, it will reduce the threat of their codec becoming obsolete and will highlight their certification process as being the real value added for consumer device manufacturers.
Instead of trying to educate consumers on the differences between MPEG-4 Part 2 vs. MPEG-4 AVC (H.264), CE manufacturers can slap the DivX label onto their devices and consumers will know that it will support their digital video libraries without complications. In fact, during the Q&A section of their conference call, DivX discussed the possibility of pushing this envelope even further by adding Flash support to their certification program.
“In terms of how we think about Flash more broadly, the vast majority of content that is downloaded today is in DivX format or variations of the DivX format, so we don’t see that as being a threat in terms of the use case that we’re really providing, which is high quality content delivered through the internet and then played back on a variety of devices. To the extent that Flash starts to get traction in terms of files that are downloaded at high quality and based on the terms, it would be something that we could actually extend into and offer into our certification program as well and that’s what we’d be looking to do.”
Part of what makes DivX such a difficult company to pin down, is their ability to take competitors and turn them into partners. On one hand, Microsoft is one of the biggest threats to DivX, but if they can get them to extend DivX support to the Xbox, they could become an important customer.
Adobe is currently using Mainconcept to power their H.264 support, but they are also trying to establish their own format as the new standard for internet delivered video. These complex relationships are enough to make anyone’s head spin, but DivX has a way of getting their partners to look at the glass half full side of the equation.
On one hand, It’s hard for me to believe that Adobe would be all that enthusiastic about giving up control over their flash content, but on the other hand, a DivX partnership would create a powerful competitor to Apple and Microsoft’s closed systems.
Adobe would gain access to an established community of video fans and would have one more platform that could drive demand for Flash content. Instead of having to worry about the lack of downloadable flash content, they could leverage DivX’s popularity, while slowly introducing their own standard for web video. While I doubt that older DivX devices would be able to support Flash with a firmware update, any new DivX devices would be able to support their content.
For DivX, they would be able to increase the appeal of their brand by offering support for the next generation of internet video. They could also use Adobe DRM as a way of bypassing studio approval for DivX content. While DivX did mention plans to update their DRM later this year, getting in through Adobe’s backdoor could be a lot easier than buying off the studios. According to DivX’s 4th quarter 10k filing, they paid Sony $1.5 million and gave them 100,000 warrants at a strike price of $16.14, in order to get the studio to bless the DivX format. While it’s possible that DivX plans on buying off all of the studios, this could get expensive really quick, if DivX is serious about going legit.
For consumers, it would be the biggest win of all. Instead of being locked into a single file format, they would have the flexiblity to adopt alternative standards without having to abandon their current media libraries. This would pressure Microsoft and Apple to open up their hardware, instead of maintaining data silos.
It’s hard to judge how serious DivX is about adopting flash support from just a few comments, but even beyond flash, having support for multi-formats adds real value to their brand. As new forms of digital transmission unfold, DivX is in a position to attach their brand to a much larger category of web video.
Some of the niche video formats don’t have the ability to negotiate partnerships with the device manufacturers directly, but through DivX could gain access to a much larger audience. If DivX certification suddenly meant that Matroska containers could play on DivX devices, it would open up another community that DivX could tap into and it would change how Matroska fans think about the DivX brand.
Bringing other formats into the DivX program, would add to DivX’s cost of revenue, but it would make DivX certification more valuable to their CE partners. I may enjoy dissecting the nuances between the various competing video formats, but most consumers don’t want to think about it. They want to be able to play whatever file they have without converting it into a single format. By focusing on supporting as many formats as possible, DivX may end up competing with their own eco-system, but they’ll also expand their reach in the process. By taking DivX beyond the codec, it allows their community to move forward with the future, while hanging onto the treasures from the past.
Disclosure - I own shares of Netflix
Posted in Technology, DivX, SA, TV, VOD, Disclosure - I own stock in co. mentioned, DRM, Netflix | 2 Comments »
MovieBeam Rises From The Dead - Again
May 5th, 2008 Davis
Just when you thought it was safe to salvage your Moviebeam box for spare parts, there’s new hope on the horizon that Moviebeam may once again be coming to a television screen near you. Like a zombie from a bad horror flick, Moviebeam continues to rise from the dead feasting on the rotted brains of media moguls and venture capitalists with each new incarnation.
According to the Daily Bankruptcy Review, Movie Gallery has asked for bankruptcy court approval to sell their VOD service to Dar Capital Limited at a $2.25 million price tag.
“Movie Gallery pulled the plug on its-on-demand movie service, called MovieBeam, in December as part of its restructuring under Chapter 11 protection. Dar Capital Limited has agreed to buy MovieBeam, which had about 1,800 subscribers at the time it was shut down. The service required customers to purchase a television set-top box that allowed them to order films for between $1.99 and $4.99. Movie Gallery said in court papers filed Thursday that it began shopping the MovieBeam business soon after shuttering the service and that 14 parties showed an interest in the company. Dar Capital is picking up MovieBeam’s remaining assets, which include certain trademarks and intellectual property associated with the business.”
While the resurrection of Moviebeam will be welcome news for the 1,800 customers who initially ponied up the dough for a box, the sale of the service represents another bitter defeat for Movie Gallery. Just last year, they paid $10 million for the service. Initially, they had hoped to use Moviebeam to strengthen their digital strategy, but when they couldn’t convince in store customers to invest in yet another set top box, they shuttered the money losing service and cut off the early adopters who had plunked down hard earned cash for the box.
If the courts do allow the sale to take place, I’m not convinced that Dar Capital will have much luck in performing CPR on this one. Moviebeam fatal flaw was that that it suffered from a lack of choice and I don’t see this being any less of an issue for Dar Capital. If consumers could get access to everything on demand, paying an upfront fee wouldn’t be as much of a big deal, but with a miniscule selection of movies, it’s hard to justify spending money on a box, especially when you still have to pay for the content.
Even at the heavily discounted price of $2.25 million, this still means that Dar Capital will be paying $1,250 per subscriber. At this cost, they may be better off subsidizing the cost of 2,000 boxes and starting their own service. Then again, it’s entirely possible that Dar Capital is more interested in the bandwidth agreements, then the actual customer base. Moviebeam delivers their movies by piggybacking on PBS’ bandwidth.
Last week, Sezmi launched their wunderbox with promises of a bandwidth delivery system that sounds eeriely similar to the one that Moviebeam implemented. Given the amount of bandwidth that Sezmi will need to deliver on their high definition promises, it wouldn’t surprise me if Dar Capital flips Moviebeam’s bandwidth, instead of turning the service back on. It’s still too early to know what Dar Capital’s end game will actually be, but we should know more on May 8th when Movie Gallery is due back in court.
Posted in Technology, Movies, TV, VOD | 2 Comments »
TiVo Kills In 3D
May 1st, 2008 Davis
Posted in VOD, Disclosure - I own stock in co. mentioned, TiVo | No Comments »
Stage6 Part Deux?
April 24th, 2008 Davis
Over the past few days buzz has been building over the possible launch of a Stage6 clone. According to the DivxIT.net website, a Stage6 “alternative/clone” will be revealed on April 29th. If this is true, it would be an exciting development for fans who still crave the high quality Stage6 experience.
This isn’t the first time that someone has tried to hype the launch of a Stage6 replacement. As soon as Stage6 announced their shut down, there was a flurry of fake Stage6 clone announcements. Most of those sites fizzled out before they even got started.
NewStage6.com was the first “replacement” to pop up on my radar. Initially they had a timer counting down until their launch, but today, the site is all but empty. Highlol.com was another website that tried to create buzz around the Stage6 collapse. They promised free HD DivX downloads, but there still aren’t any videos on the site today.
Having already been burned a couple of times, you can understand why I tend to be skeptical about these sorts of promises. With DivX Inc. having come out and denied any affiliation with the site, I can’t help but wonder how far they will let this get before they try to shut it down. On the other hand, because DivX benefits from having more of their content out there, maybe they are really better off ignoring it. Still, if DivxIT does gain traction, DivX might not be so happy about someone copying their site, especially when they don’t seem willing to sell it to begin with. If DivX does try to go the hostile route, I think that they may be up against more than they realize.
According to my sources, the creator of DivxIT is a part of the social revolution group, Anonymous. I wasn’t able to confirm whether DivxIT is the brainchild of a solitary fan or if it is part of the larger movement, but I do think its worth noting that Stage6 was hacked earlier this year. Whoever hacked the site posted membership information online, but I don’t know whether or not they would had access to the GUI. April 29th may still end up being a bust or just a cheap knock off, but I wouldn’t be shocked if this turns out to be an exact replica of the Stage6 website.
I was also able to learn that prior to setting his sights on web video, DivxIT’s mystery founder also created the MyVideoTab.com website. MVT looks like a great resource for anyone who is interested in learning how to play cover songs off of the internet, but its ownership is also shrouded in mystery.
Even before Stage6 shut down, there was already a Stage6 clone in China, but trying to watch videos from the US brings back terrible flashbacks of 26k dial up connections. If I was going to launch my own clone, I would have gone with the 6egats.com 
domain instead, but someone beat me to that one already. We may end up getting punked with some wacky Scientology video on the 29th, but it will be interesting to see how this ends up playing out.
Update - So much for my conspiracies about black helicopters. It looks like DivxIT and DivX have worked out a deal for the new site. DivX must have asked them to change the name to something less confusing though because the new site will now be launched at Vreel.net. The launch was also postponed until May 6. On the Vreel website they have a FAQ where they say that their “database will be built from the ground up from day one onwards.” They also thank DivX for being cool about working out a deal with them.
Posted in SA, DivX, VOD | 2 Comments »
Stage6 Moves Into Stage404
March 5th, 2008 Davis
Over the past week, I’ve spent a lot of time thinking about DivX’s decision to close down Stage6. When I first heard the news, I wasn’t sure how to feel about the decision. On one hand, I believe strongly in the free market system and when DivX choose to go public, they took on an obligation to look after their shareholder interests.
By turning to the public DivX was able to raise more than $140 million in cash from investors who believed in the future of the company. Having access to this kind of capital opened a lot of doors for DivX, but it also came with strings attached. While it’s easy to blame DivX’s insiders for pulling the plug, without their initial support, DivX never would have been able to create Stage6 to begin with. I disagree with the final decision to shut the site down, but I can at least understand the economic realities that drove the decision to remove Stage6 from the core business.
On another hand, I was a fan of DivX long before their IPO and a loyal member of the Stage6 community. Without DivX’s community, they never would have succeeded in the first place and to abandon their fans over corporate profits speaks volumes about the priorities behind the decision makers at the helm of the company. While the cold hearted capitalist in me has no moral high ground to stand on, the fan in me can’t help but be heartbroken by the realization that DivX may have lost their soul in the course of going public.
I’ve been using Stage6 from the very beginning and while its always had its fair share of eccentricities, I’ve found that it’s gotten better and better as the site has developed.
Over the last year and a half, I’ve been able to watch “web” videos on my 60″ television, I’ve been able to discover high quality original content that is more relevant to me, then anything on cable and I’ve even been able to connect directly with the artists who I’ve admired. When the history of Stage6 is finally written, it will be easy to be distracted by Stage6’s problems with piracy or the politics at the corporate level, but to see those independent artists lose this platform is the real tragedy behind the Stage6 story.
Seeing DivX shut down Stage6 has been tough, but watching the fallout from has been even more depressing. Initial reports blamed lack of traffic as the reason behind Stage6’s failure 
Silicon Valley Insider’s headline on the story read “YouTube Kills Another Rival.” In Gizmodo’s coverage of the news they write “You may only be vaguely aware of DivX’s Stage 6 video site (which probably explains why it wasn’t successful)”
The problem with this theory is that Stage6’s traffic was actually quite impressive. If anything, Stage6 was a victim of its own popularity. From the get go, DivX tried to rein in the growth of the site, but in the end, high quality downloadable video proved too compelling to stop the explosion in their traffic.
DivX first launched Stage6 in August 2006. Initially, it was intended to be a modest experiment where DivX could showcase their technology. After two months and very little marketing, traffic to the site was already in the “hundreds of thousands user range.” On DivX’s first conference call with investors, Jordan Greenhall told analysts that “in 2007 we have specifically modeled Stage6 to spend no more than $5 million, until and unless we specifically decide to do otherwise.”
Had Stage6 remained underground, DivX would likely have treated the site as a minor marketing expense, but as word about the site leaked out, it created momentum that DivX was powerless to stop.
At the time, $5 million in budgeting seemed appropriate, but even Greenhall couldn’t have anticipated how popular Stage6 would turn out to be and by the end of 2006, Stage6’s traffic was clocking in at 2.4 million unique visitors per month. By February of 07′ Stage6 hit 3 million uniques and 2 months later, traffic was at 4.3 million visitors.
By July Stage6 traffic hit 10 million visitors and it was clear that DivX had tapped into something very powerful. In the first six months of 2007, Stage6 had already burned through the $5 million that they had budgeted and expenses were continuing to climb. In order to better capitalize on their Stage6 asset, DivX announced plans to divest the business and Jordan Greenhall agreed to step down as CEO, under the guise that he would take control of the new Stage6 entity.
By the 3rd quarter of 07′, DivX was spending $4 million a quarter with about 2/3rds of the expense going towards bandwidth. To help control these costs, DivX started an aggressive campaign to remove porn and copyrighted content from their servers, but their efforts were of limited success. When they updated their web player to block certain sites from playing Stage6 content, the pirates were quick to point out that users could get around this restriction by installing older versions of the software. When they started to aggressively remove copyrighted content, people built automated uploading tools that where able to overwhelm the Stage6 staff. Their efforts did help to slow down the growth rate at the site, but by October traffic had still risen to 11.4 million visitors.
With traffic continuing to rise, DivX warned investors that they were budgeting another $6.5 - $10 million in Stage6 expenses for the 4th quarter/second half of 2008. When DivX finally pulled the plug on Stage6, they had likely spent $17 - $20 million on the “experiment” and had over 19 million unique visitors to show for it.
To help put this growth into perspective, 19 million uniques is roughly two thirds the number of US visitors that YouTube was getting when they were acquired by Google for $1.6 billion in stock.
With DivX facing the prospect of having to fund another $20 million in 08′, just to keep Stage6 running, I’m not surprised that the traffic eventually proved too bitter a pill for shareholders to swallow. From the outside, its easy to blame YouTube for Stage6’s demise, but in reality, the site was far more popular than most observers realize.
Given the growth trajectory and the size of the Stage6 community, I had expected that Stage6 would have no difficulty in raising capital to fund the venture, but in December DivX unexpectedly announced Greenhall’s resignation from the board of directors and warned that the Stage6 divestiture would not take place in the time frame given to investors.
At the time, I had a lot of trouble making heads or tales of this announcement and it wasn’t until Michael Arrington leaked the sordid details behind the breakdown of Stage6, that I realized the significance of Greenhall’s departure. According to Arrington, DivX had raised commitments for $27 million in capital at a $90 million valuation. Given that my own internal valuation had pegged the site at $85 million, it would appear to me, that this was a fair valuation for both DivX shareholders, as well as Stage6 investors. Why this deal broke down, isn’t exactly clear and the devil really is in the details, but Arrington pins the blame on massive egos getting in the way of shareholder interests.
“At a meeting in late November the DivX board was asked to approve the spinoff and venture financing. But at the last minute the board decided to cancel the spinoff and retain control of Stage6. It’s not clear why they did this - perhaps they were surprised at the valuation and wanted to keep control of the assets. Or perhaps the revenue from Stage6 was too material for them to let it go over the long run. From what we hear a massive battle of ego’s ultimately killed the deal. But when the decision was made, the key Stage6 founders resigned.”
Arrington speculates as to why DivX’s board turned down the offer, but the reasons he cites don’t really mesh with what the company was trying to do from a financial perspective. It could be that DivX’s board simply didn’t like the terms of the deal or that the financing was never really in place to begin with, but my own conspiracy theory is far more insidious.
I think that the board wanted out of DivX and engineered a coup to take over control of the company.
Greenhall always had grand visions for DivX and clearly wasn’t afraid to take risks. Starting Stage6 was both a brilliant and stupid move on his part. In a very short period of time, he created a valuable asset for the company, but it’s cost structure punished shareholders who didn’t buy into his long term vision. The very reckless nature that was crucial to his success as an entrepreneur, understandably made Wall St. more than a little nervous.
Knowing that Greenhall would never willingly cede control, the board tempted him by offering him control over the Stage6 spinoff. Stage6 was Greenhall’s brainchild to begin with and the bait proved more than he could resist, so in July 2007, he stepped aside as CEO to begin raising funds for the venture. Initially, I don’t think that the board planned on shutting down Stage6, but when financing failed to materialize, they ran out of patience and began to dismantle the team behind the community. When Greenhall found out about their plans, his emotions likely got the better of him and after cornering himself into an ultimatum, he was tricked into giving up the little remaining control that he had left.
While there is no way to know the exact details behind what really happened, amidst the backdrop of the Stage6 revolt, there were two noteworthy public filings that hinted of the trouble brewing in Shangri La.
The first was the revelation that Insight Venture Partners had unloaded their shares on the open market. The second was an amendment adopted by the board that provides significant financial incentives for management to engineer a sale of the company.
At the time, I had trouble reconciling these two filings because if DivX’s board was trying to shop the company, then it wouldn’t have made sense for Insight Ventures to bail out of the stock. Given what we now know about the Stage6 implosion, it doesn’t surprise me that Insight Ventures took the quick exit on this one.
One of the more interesting clauses buried in the change in control agreement is a provision that limits the rights of shareholders to elect new leadership at the board level. If a majority of the incumbent directors are replaced within an 18-month period, it triggers a provision that would cost DivX shareholders dearly. With 3 of the original board members having now resigned, it doesn’t surprise me that the board back dated the agreement prior to Greenhall leaving, so that Hell’s appointment to the board would count against this limit.
It’s easy to overlook this fine print as business as usual, but I think the board implemented these measures to ensure that they would remain in control, in the event that DivX’s long term shareholders objected to their short sighted decisions.
No one enjoys having their dirty laundry aired publicly and it’s easy to get distracted by the drama surrounding the closure of Stage6, but I think it’s important for investors to look past the soap opera and focus on what these decisions tell you about the priorities of DivX management. It’s hard to know the exact details behind Stage6’s failure, but there are a few facts that you can verify.
Whether intentionally or by accident, the DivX board removed Greenhall as CEO. In December DivX saw a mass exodus of their founders. Why they left may be open to interpretation, but the fact that they left together underscores how significant of an event this is. Given its traffic and growth, Stage6 had real value to the right investor, yet DivX’s board wasn’t willing to take the short term earnings hit, in order to maximize the value of the asset. During the time that Stage6 was falling apart, the board adopted an executive compensation plan that encourages management to sell the company even if it means sacrificing DivX’s long term future.
Now it’s entirely possible that I’m reading too much significance into the rift between the board and the Stage6 founders, but the only justification that I can see for the board leaving this kind of money on the table would be if they were trying to dress DivX up for an acquisition. For as much as Stage6 was potentially worth, it was just as much of a liability. Spinning off the site would have allowed DivX to maximize their investment in Stage6, but it would have involved a long legal fight that would have certainly scared off potential suitors.
Figuring out a way to monetize all that traffic would have been the best solution for Divx’s long term strategic positioning, but by closing the site, DivX choose to manipulate two important financial levers instead. Not only do Stage6’s expenses now translate directly into net income for the company, but DivX has decided to use the $20 million it would have cost to keep Stage6 running to boost the price of their stock through a share buyback program.
Normally I would be a fan of these sorts of shareholder friendly initiatives, but as a growth company, I think that DivX owes more to their investors. The company is in the middle of one of the hottest sectors of the new economy and to see them use their cash to buy back stock is a startling admission of how little conviction they have in the long term potential of their business. If DivX’s management really believes the company is undervalued, then why has there only been one insider purchase over the last six months? DivX may cite maximizing shareholder value as the rationale behind these moves, but closing down Stage6 to buyback their stock reeks of desperation. I may be misjudging the board’s motivation, but I can’t help but be suspicious that the real purpose behind the buyback announcement is to boost their stock price, so that their insiders can try to unload the business.
9 times out of 10, I’d argue that having the founders leave a company is a bad sign for investors, but in the case of DivX, I don’t think that this is true. The people who really cared about the future have abandoned ship and Wall St. now controls DivX’s destiny. For investors to react to these events by selling off the stock 25%, makes very little sense.
It’s hard to know what DivX would be worth to the right buyer, but I think that their recent sell off leaves them vulnerable to a low ball offer. If you strip out DivX’s cash, they are currently trading at an enterprise value of less than $200 million, their trailing 12 month P/E is at 18.50 and they are now trading at slightly more than 2 times book. For a company bringing in $80 million a year at 90%+ gross margins, this seem ridiculously undervalued in my opinion.
Whether DivX wasted money on Stage6 or not, their current valuation completely ignores the impact that the Stage6 savings will have on their earnings and certainly doesn’t reflect the potential that DivX’s board may be open to selling to the highest bidder. When you compare DivX’s current valuation to potential suitors, it’s easy to understand why DivX’s trojan horse into the living room, would be worth a premium to the right strategic investor.
I hope that I’m wrong and that DivX’s attempts to maximize shareholder value only represents a temporary set back for their community, but when I connect the dots I see a board that is more interested in engineering short term profitability, then in making the tough decisions necessary to ensure the long term success of the business. If the board was really in DivX for the long haul, it would have been easy for them to overlook DivX’s short term valuation while they tried to find a buyer for Stage6. If their goal was really to sell the company, then it was to their benefit to sacrifice Stage6.
Hopefully, I’m wrong about their plans and DivX will refocus on bringing innovative products to the market. Still, I can’t help but fear that the breakdown of Stage6 really represents the beginning of the end for a brand that I’ve come to love. I’m in no position to pass judgment on DivX for thinking exclusively of their investors, but as a member of their community, it’s painful to lose one of my favorite web destinations over corporate profits.
Posted in DivX, Technology, Media, VOD | 2 Comments »
Lawyers Guns & Money: Can DivX’s Safe Harbor Protect Them From Stage6 Pirates?
February 7th, 2008 Davis
DivX took a step closer to being forced to walk the plank after suffering their first legal setback in their copyright dispute with Universal Music Group. In a legal filing published late Tuesday night, Judge Dana Sabraw dismissed DivX’s request to declare Stage6 legal, ahead of their UMG piracy trial.
The dispute originally started in December 2006, when UMG notified DivX that several of their videos were showing up on their Stage6 website. In the original cease and desist letter, UMG didn’t provide DivX with a list of the infringing videos, but still demanded that DivX remove all Universal content. A month later, UMG sent a second letter, only this time identifying specific videos that they had problems with. DivX promptly removed the videos in question and didn’t hear from UMG’s legal department for another 8 months.
After this 8 month period of awkward silence, UMG approached DivX and agreed to license their content, albeit at a very steep cost. In order to atone for their past sins, UMG wanted DivX to pay them $30 million.
Sensing a shakedown, DivX balked at the deal and decided to take their chances in court. They had fully complied with all of the provisions of the DMCA and if UMG wanted to punish them, they’d need to attack the DMCA’s safe harbor provision to do it. After calling their bluff, UMG dragged their heels on filing a lawsuit, but the potential threat for conflict still created a real problem for DivX. With the company trying to spin off their Stage6 asset, these storm clouds of uncertainty cast a long shadow over the legality of their Stage6 operations.
With UMG threatening legal action against the site, DivX was forced to choose between trying to sell the asset at a discount or trying to see if they could ride this storm out. With UMG seemingly content to continue to accrue alleged damages, DivX felt compelled to ask the courts to rule on whether or not Stage6 was protected under the safe harbor provision.
DivX took a huge risk by pushing this issue. If they are right then their wager will certainly pay off. If the courts can establish the legality of their Stage6 website, it would remove a lot of the uncertainty surrounding the business and would allow potential suitors to feel more comfortable about its long term potential. If DivX is wrong though, the consequences could be severe.
Six weeks after DivX filed for declaratory relief, UMG finally made good on their threat and filed a lawsuit against DivX accusing them of piracy. By bringing DivX up on charges, they were able to successfully argue that their trial was a more appropriate venue for this question to be answered. While this does represent a set back for DivX, I doubt that the result was entirely unexpected.
Still, through legal maneuvering, UMG has been able to regain control over home court advantage and they’ve put themselves into a position where they can always settle or walk away if things start to look bad. Even if DivX sticks with the full court press, they may not end up with the declarations that they were hoping for. In the discussion section of the judgment, Sabraw sympathized with DivX, but couldn’t justify running a separate trial now that DivX is facing legal action.
“Defendants argue declaratory judgment is an incomplete remedy since this action does not include all parties to the lawsuit pending in the Central District. Furthermore, since Plaintiff cannot identify all copyrights at issue, Defendants argue the remedy in this Court is limited to adjudicating only the copyrights named.
The Court agrees with Defendants. Athough the fear of uncertain litigation may have initially justified Plaintiff in filing this action, Defendants have since filed a lawsuit in the Central District that eliminates the uncertainty. Moreover, the DCMA [sic] safe harbor analysis Plaintiff seeks here will be more completely and efficiently undertaken in the Central District, where the court will be able to determine Plaintiff’s compliance with respect to particular copyrights that Defendants identify in the course of those proceedings.”
While it may appear that DivX has lost round 1, the dismissal of this case won’t be the end of this dispute by a long shot. With the declaratory issue now out of the way, DivX will need to focus on defending themselves against UMG’s lawsuit. Even though DivX’s initial lawsuit has been dismissed, they’ll still get an opportunity to defend their website. Still, until DivX can reach some kind of resolution, the lawsuit will certainly make it more difficult for them to separate their Stage6 assets from their core business. With rising bandwidth bills, the credit crunch and legal questions surrounding this asset, it may be difficult for them to find a buyer who is willing to get involved in this kind of a dog fight.
Sensing that conditions weren’t right, DivX pulled back on their plans for Stage6 in December and in a press release announcing the resignation of Jordan Greenhall, they also warned that their Stage6 transaction wouldn’t be finished by the end of the year like they had planned. The company promised to update investors in the first quarter of 08′ and with DivX expected to report earnings soon, you can bet that Stage6 will be a hot topic on their next conference call. The plan that DivX management lays out, will be critical in determining how investors interpret their financial results.
Last quarter, investors rewarded DivX by focusing on their non-gaap growth and ignoring the Stage6 and compensation expenses. If DivX still plans on spinning off Stage6, then it’s fair for investors to ignore the rising bandwidth costs and focus on the value of the underlying asset.
If DivX’s legal battles really mean that they need to hold onto Stage6 in order to maximize its value, then investors may be in for a shock when they realize that Stage6 is really a long term investment. Facing the prospect of a drawn out legal battle, they may not take as much comfort in “one time” charges or expenses.
The answer to the Stage6 riddle isn’t an easy one, but after years of profiting from their popularity in the pirate community, it’s ironic to see DivX’s finally starting to feel some heat over the activities of their community. Even beyond the copyright liabilities, there is a significant cost for DivX to foot the bill for pirated Stage6 content and I suspect that DivX isn’t anymore enthusiastic about piracy on Stage6, than UMG is. There’s no way to know how this all will end, but I have a feeling that its going to take longer than people expect, in order to sort it all out.
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