Financial analysis isn’t something I’m prepared to tackle publicly, so I’ve brought in some muscle for a multi-part series on TiVo’s numbers. Obviously this is speculative in nature and just one stockholder’s interpretation of the limited information TiVo chooses to disclose. Your mileage may vary. -DZ
In Part 1, we gave a value of TiVo’s existing subscriber base. But things are changing at TiVo: lifetime subscriptions are no longer available, and new subscribers can get free hardware, though they pay more in service fees. We need to know how this affects the value of new subscribers and how much TiVo should spend to acquire them.
To examine these issues, we will look at the Net Present Value (NPV) of subscribers, and the Return On Investment (ROI) in acquiring them (actually, instead of ROI, we’ll use MIRR, the Modified Internal Rate of Return). For the purposes of these calculations, we will use a 12% annual (1% per month) cash discount rate, as we did in Part 1. We will also use 12% as the finance rate for MIRR and 6% (0.5% per month) as the reinvestment rate (i.e., the return TiVo can obtain on short-term investments). As in Part 1, we will use 1% per month for subscriber churn, yielding an average sub life of 69 months. In this analysis, however, increasing the predicted churn rate will tend to reinforce our conclusions. Again, keep in mind that in this analysis, we are looking at value of bringing new subscribers on board, whereas in Part 1, we looked at the current value of existing subscribers.
To get a baseline for comparison, let’s consider the acquisition of subscribers under the old pricing scheme. We found last time that existing non-lifetime subscribers generate $8.39 per month in cash flow, and have an NPV of $416. To find the NPV of acquiring a new subscriber with under these conditions, we simply need to subtract the subscriber acquisition cost (SAC) from the NPV of his cash flow. In FY06, SAC was around $191, giving an NPV of $226, and an MIRR of 22.5% for these sub additions.
- NPVOLD,MONTHLY = $226
- MIRR = 22.5%
The value for acquiring new lifetime subscribers, back when that option was still available, is found in a similar manner. As we found in Part 1, existing lifetime subscribers provide an NPV of negative $55. But when they are acquired, they produce $299 in cash. Subtracting the FY06 SAC of $191, the lifetime subscriber produced $108 net cash up front. This gives:
- NPVOLD,LIFETIME = $53
- MIRR = 17.7%
That return indicates that the opportunity cost of lifetime subs versus recurring subs was only about 5% in rate of return, and since lifetimes are immediately cash-positive, low maintenance, and (likely) lower churn, it seems, on the surface, like a reasonable alternative to offer. But that is the wrong conclusion to reach, and a good example as to why rate of return is inferior to NPV when considering investment opportunities.
The fact is that there is not an unlimited demand for TiVo’s products. A lifetime subscriber at NPV $53 took away some opportunity to acquire a monthly subscriber at an NPV of $226. In other words, it took more than four times as many lifetime subs to produce the same value as a single recurring sub, but surely some of the subscribers who elected lifetime subscriptions would have signed on for monthly payments had the lifetime subscription not been available. And if only one in four did, TiVo would have come out ahead.
The NPV for an average subscriber under the old program was a weighted average of the monthly and lifetime subscribers, with the weights being their relative proportion of subscriber additions. When the lifetime program was eliminated, that mix was about 70% monthly and 30% lifetime.
- NPVOLD,AVERAGE = $226 * 0.7 + $53 * 0.3 = $174
So while Tom Rogers and Steve Sordello complained during the 3Q conference call about the lifetime subscribers’ drag on ARPU, the real reason for eliminating the option was its huge opportunity cost to TiVo in terms of not getting a higher-value subscriber. One of the most important things Tom Rogers has done for TiVo is correcting this huge mistake in the company’s product offerings.
Back To The Present
We now find ourselves examining the most important number that was mentioned during the 3Q conference call. It was a number the significance of which was completely missed by Wall Street. That number was 13.
During the 3Q call, management told us that the average monthly subscription price under the new pricing program was about $13. If we use this value, instead of the $9.50 we used for subscribers under earlier programs, we find that these new subscribers produce $11.88 in monthly cash flow (after adding advertising revenue, and subtracting service costs). This year’s SAC looks like it will average somewhere around $260, giving us:
- NPVNEW = $330
- MIRR = 23.2%
That means the new subscribers are nearly twice as valuable as the average subscriber obtained under the old pricing program, and 50% greater than even the monthly subs under that program.
This finding helps explain something that many people found troubling about management’s statements during the 3Q conference call. Rogers and Sordello indicated that, after a year of trumpeting the virtues of the zero- or low-upfront pricing, they were going to reconsider it, and likely move to a marketing plan that involved a lower hardware subsidy and a higher advertising spend. This seemed like another flip-flop from a company that cannot seem to stick with a plan. Less emotionally, it raises the question of whether any marketing plan can significantly improve TiVo’s subscription growth.
Looking at the options (hardware subsidy vs. advertising), we find that the subsidy is low risk – each dollar spent produces results – but costs go up linearly with results, and the approach does little to improve brand or product awareness. Advertising, on the other hand, is higher risk, since it can produce no results whatsoever. But its costs do not scale with results – costs are, in fact, essentially independent of results – and advertising improves brand and product awareness even if it does not lead to increased sales immediately. As Rogers pointed out during the call, TiVo has invested heavily in product differentiation. But in a competitive environment, that differentiation does them no good if consumers are not aware of it.
If we consider the NPV numbers we just came up with for subscribers under the new and old pricing plans, we find that under the new plan, TiVo could increase SAC to $416 and have the same NPV as subscribers under the old pricing plan. Put another way, TiVo’s price increases have allowed the company to spend $156 more to acquire a subscriber. (This is on top of the $69 increase we have already seen this year.) Given annual gross subscriber additions of about 500K, that $156 per sub amounts to a $78 million advertising/marketing campaign — about twice TiVo’s entire sales and marketing budget for the past twelve months (which includes fixed costs, overhead, etc.).
A $78 million ad campaign would at least quadruple or quintuple TiVo’s advertising spend. If this program produced any increase in sales, the costs would be spread over a larger number of acquisitions, decreasing the SAC and increasing the NPV of each. Were increased advertising successful, TiVo could cut the hardware subsidy, and increase advertising further. TiVo will, of course, not spend this much (at least not immediately). But the changes the company has implemented have given management the flexibility to implement some more significant programs in pursuit of growth. Whether or not those programs will be successful remains to be seen.
- If we have overestimated advertising revenue, the differences seen in the pricing programs’ NPV and MIRR will be exaggerated. Similarly, if we have underestimated ad revenue, or it grows, the differences will be reduced.
- While churn is an entirely negative factor, the higher NPV of new subs tends to cause us to somewhat overestimate its impact. As older, lower-value subs are replaced with newer, higher-value subs, the entire subscriber base improves in value. Thus, even if TiVo were at zero growth, with new sub additions only sufficient to cover losses from churn, the value of the business would still be growing for some time.
- Obviously, throwing advertising money into a black hole of no results is a bad thing. While the analysis above indicates that TiVo could do it from a value point of view and not lose ground to last year’s model, the results on cash flow would be extreme and painful. The truth is that increased advertising spend needs to result in higher growth to be justifiable.
- Our old vs. new analysis here is fairly conservative. Even if the old pricing program were still in place, SAC would likely be higher this year than last. Increasing competition from “free” cable and satellite DVRs, and the introduction of higher-priced hardware (the S2 DT) in order to remain competitive, would likely have driven SAC higher. The introduction of service commitments (to reduce churn) has also probably increased SAC. A higher SAC applied to the NPV of the old offerings would make them even less favorable when compared to the new offerings (which have the current SAC assigned by default.)
In Parts 1 and 2, we have looked at the value of old subscribers and new subscribers. In Part 3 we will try to put some of our findings together, look at the other aspects of the business, and see if we can come up with a value for the company.