Technology stock

Avid Technology Stock: Sell After Earnings Unwarranted (NASDAQ: AVID)

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Investment thesis

Greedy (NASDAQ: GREEDY) is a United States-based company that provides audio and video technology from editing software and compositing hardware. In 2018, the company began changing its pricing model from a perpetual to a subscription-based model. model ((SaaS)). This resulted in huge success which significantly increased its gross margin and EPS (earnings per share). The company recently released its first quarter 2022 results and the stock fell 20% as second quarter forecasts fell below analysts’ estimates. However, subscription revenue still increased by more than 30% and full-year guidance remained unchanged. I believe this is an overreaction and creates a good buying opportunity for investors.

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Data by YCharts

Introduction

Avid’s core product includes Pro Tools and Media Composer. Pro Tools is music and audio production software. On the music side, it allows artists to create beats, write songs, record vocals and instruments, and mix studio-quality music. On the audio side, it allows production teams to record, edit, mix, and produce sound for film, television, video games, and more. Media Composer is video editing software with features like remote collaboration. It allows video professionals to create movies and TV series much more efficiently. Avid also sells software-supporting hardware, such as sound mixers, storage rigs, and more.

The demand for these products has increased dramatically over the past few years and I believe the trend will continue. This is due to the continuous increase in the production of television series, films and music. The streaming war continues to escalate with the arrival of Disney, HBO, Peacock, Paramount and more. This has led to a huge increase in demand as all these companies try to produce more content to compete with each other. I believe this will continue to provide tailwinds for Avid. According to Statista, the SVoD (subscription video on demand) market is expected to grow from $82.43 billion this year to $115.90 billion in 2026, representing a CAGR of 8.9%.

The demand for music production software has also increased a lot in recent years. This is due to the growing popularity of music streaming platforms such as Spotify and Soundcloud. These platforms make it easy for independent and less famous musicians to upload their music and earn royalties, which has led to a huge increase in music output as more musicians seek to enter the industry by lowering barriers to entry.

First quarter results

In the first quarter of 2022, the company reported revenue of $100.6 million, an increase of 6% from $94.4 million a year ago. Subscription revenue increased 32.5% year-over-year, while Integrated, Perpetual and P/S revenue decreased 0.7%. Gross margins remained stable at 66.3%. Adjusted EBITDA was $19.3 million, a 9.0% year-over-year increase. Adjusted EBITDA margin was 19.2%, an increase of 50 basis points year over year. Non-GAAP EPS was $0.33 versus $0.28 a year ago, representing growth of 17.9%. It reported positive operating and free cash flow of $7.9 million and $4.7 million respectively. The company reported second-quarter revenue of $92.0 to $104 million, with adjusted EBITDA of $13.5 to $19.5 million and non-GAAP EPS of 0.19 to 0 $.32. For FY22, the company had revenue of $430-450 million, with adjusted EBITDA of $84-94, free cash flow of $60-67 million and non-compliant EPS to GAAP from $1.40 to $1.51. The weak revenue growth was in part due to global supply chain issues that caused a tight supply of several components, which impacted their ability to meet customer orders. I think this is a temporary issue that will subside over time.

Jeff Rosica, CEO, in the press release

The global supply chain continues to present challenges, which could lead to uneven quarterly performance in the near term. We currently believe these challenges to be temporary and remain confident in the growth of our subscription and maintenance business and our ability to meet our 2022 goals. We recently introduced several exciting new product enhancements for Pro Tools, Media Composer, and MediaCentral, and in April we added new pricing tiers for entry-level and high-end Pro Tools users as we continue to execute on our subscription growth strategy. .”

The company’s balance sheet also remains healthy with a cash balance of $41 million and available cash of $111 million, including an unfired revolver. The net leverage ratio (net debt / LTM adjusted EBITDA) improved from 2.6 to 2.2 this year. It’s also worth noting that the company has a stock repurchase authorization announced in September last year that allows it to repurchase $100 million worth of stock. They bought back $10.8 million in the first quarter, so $102.4 million is still in place.

Despite the market reaction, the results are certainly not bad in my opinion. If you look deeper, subscription revenue actually grew 32.5% year-over-year to $33 million, which is now about 33% of total revenue. Cloud-enabled software subscriptions (Pro Tools + Media Composer + Sibelius + MediaCentral) also saw a nice increase, subscribers now stand at 432,000 compared to 348,000 last year, a growth of 24.1 %. Profitability is growing with an adjusted EBITDA margin now at 19.2% and should continue to grow as the SaaS transition continues. In the graph below, you can see that since its transition to the SaaS model, its gross profit margin and EPS are improving rapidly. Non-GAAP EPS is expected to rise to $1.40 to $1.51 this year based on management guidance.

Chart
Data by YCharts
Chart
Data by YCharts

Evaluation

After the decline, the company is trading at a FWD PE ratio of 17.4. This is undoubtedly a compelling valuation for a company whose mid-teens results increase and subscription revenue by more than 30%. Not to mention that subscription revenue is only about 33% of its revenue, so growth should be able to continue. Another company that focuses on editing and creative software is Adobe (ADBE). As you can see from the chart below, Adobe is currently trading at a FWD PE ratio of 28.9, representing a premium of 66%. The two companies also have a similar earnings growth rate. A premium should be given to Adobe as it is much more established with much broader product offerings, however, I think the premium should be lower. XLK (Technology Select Sector SPDR ETF) groups together most technology companies and is a good benchmark for technology stocks. It currently has a PE ratio of 25.4 with an estimated 3-5 year EPS growth of 15.5%, which is similar to Avid’s growth rate. If we use XLK as a benchmark and apply its PE ratio to Avid, that gives Avid stock a 46% upside from current levels.

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Data by YCharts

Supply chain and inflation

The biggest risk right now, in my opinion, is the blockage of the supply chain. As mentioned by management, the company saw a tight supply of several components for its integrated audio solutions at the end of the first quarter. This impacted its ability to fulfill customer orders, causing first quarter revenue to be at the lower end of the forecast. However, I am optimistic that supply chain conditions will begin to ease throughout the year as the COVID situation in China improves. Inflation is less of an issue for the company as its solutions are very essential to production teams and musicians. Streaming companies will continue to increase their video production as competition increases. During Netflix’s latest earnings call, the company said it would double down on content creation.

Conclusion

In conclusion, I think this drop is overdone and it is now trading at a reduced valuation compared to similar companies like Adobe. The second quarter guidance beat analysts’ expectations, but that’s largely due to temporary supply chain issues that I believe will be resolved within the year. Guidance for the full year remains intact, showing that the management team believes the company will show a stronger performance in 2S despite a weak 1S. The transition to a SaaS model continues at full steam, with subscription revenue increasing 32.5% year-over-year and subscriber count increasing 24.1%. Cash flow and margins should improve as subscription revenue begins to represent a larger portion of total revenue. SVOD continues to provide a strong tailwind as more companies enter the streaming wars, fueling demand for content creation software. I think there is still a long growth trajectory for Avid and the current valuation is compelling, presenting a good buying opportunity for investors.