RENT: Counting on Video On Demand

  ***RENT is an extremely speculative, micro-cap stock but if you want to speculate, this is probably as good a situation as you can find.  I don’t own any shares. ***

We were recently chosen as a Nielsen Family during Sweeps Week.  Nielsen periodically conducts these surveys which determine how much companies will be willing to pay for TV advertising over the next three months. 

Being a Nielsen Family was a completely ridiculous exercise.  During our week as a Family, we recorded our TV watching habits in a little blue book (which cruelly remind me of college exam week) in 15 minute increments.  This was in itself a very difficult task.  The little blue book got lost, drawn-on, spilt-on and finally, torn.  Finding a pencil to write with while you were watching TV was also extremely difficult.  Several of our entries were made in red crayon. 

The Nielsen survey also proves the Heisenberg Uncertainty Principle or what is known as the Observer’s Paradox – the mere fact of observation changes the observed.  I often switch from CNBC to Dr. Phil or Oprah in the afternoons, when I get tired of listening to the same "breaking market news" repeated for the tenth time.  But it’ll be a cold day in heck before I admit to that in writing.  So during sweeps week, I didn’t get my usual dose of Oprah’s "Anna Karenina" book club. 

After enduring this pain for a week (Friday and Saturday might have been more "guesstimates" on our TV watching habits because being a Nielsen Family was becoming a bit tedious), I had to send the little blue books back to Nielsen. I went around the house, under the piano, and behind the TV to find all the books to send back to the company.  For submitting ourselves to this scrutiny, we were paid $15 in cash (cash…how quaint) which was mailed to us (mail…how quaint).  Ironically, Nielsen paid us before I sent the books back.  Someone a bit less moral than me might have taken the $15, gone to Starbucks for a cup of Joe and never bothered to send the books back at all.

The whole experience was a time warp back to the 1980s.  Even though I have three boxes on top of the Papa Idiot box (two of which – TIVO and the cable box – are perfectly capable of figuring out exactly what I watch at any given second), advertisers still pay to know what I "watch" during one week out of the quarter and base their advertising spending on that slightly drawn-on, spilt-on and torn information.   

The other problem with the Nielsen survey is that what’s on TV has little bearing on what we actually watch.  The TV is hardly ever just on when someone is watching it.  In the morning, ESPN’s SportsCenter is often on but it’s background noise – if there’s an interesting play or game, I’ll turn around and watch it.  In the mid-morning, Nickelodeon is on but the kids are usually just running around having a pillow fight.  And CNBC is often on in my office but it’s usually on mute. 

The only time something is on TV – that we’re actually watching – is when we fire up the TIVO or watch an On-Demand video.  And that kind of TV watching should be much more valuable to an advertiser than the typicall background noise.  Of course that isn’t being counted…yet.

The whole process of monitoring what actually gets watched cries out for a technology upgrade. 

Rentrak (RENT) has such an upgrade. 

VALUATION MEASURES   
Enterprise Value (11-Jan-06)3: 80.01M
Trailing P/E (ttm): 29.37
Forward P/E (fye 31-Mar-07) 1: 22.78
PEG Ratio (5 yr expected): 0.68
Price/Sales (ttm): 1.25
Price/Book (mrq): 3.42
Enterprise Value/Revenue (ttm)3: 0.92
Enterprise Value/EBITDA (ttm)3: 11.439

Income Statement
Revenue (ttm): 87.25M
Revenue Per Share (ttm): 8.349
Qtrly Revenue Growth (yoy): -25.30%
Gross Profit (ttm): 28.48M
EBITDA (ttm): 6.99M
Net Income Avl to Common (ttm): 3.81M
Diluted EPS (ttm): 0.35
Qtrly Earnings Growth (yoy): -39.00%

Balance Sheet
Total Cash (mrq): 25.10M
Total Cash Per Share (mrq): 2.376
Total Debt (mrq): 0
Book Value Per Share (mrq): 3.011
 
Cash Flow Statement
Operating Cash Flow (ttm): 7.99M
Free Cash Flow (ttm): 4.51M

Rentrak is actually two businesses – an old one and a new one.   The old business is based on traditional video rentals.  The company acts as a middle-man between the major movie studios (Warner Home Video, Paramount, 20^th Century Fox) and small, independent video stores.  Rentrak allows small video rental stores to “borrow” large quantities of newly released movies on DVD or VHS tape.  This service allows small video rental stores to compete with Blockbuster and other large rental chains in “guaranteeing” their customers that a new, high-demand movies will be in stock of Friday and Saturday nights (such as the Star Wars Episode III DVD.)  For this service, Rentrak gets paid a percentage of the rental revenues from the video store.

This is a decent business but it is going to go away as fewer and fewer people rent movies and instead just download them from the Internet or view them on-demand.

This is where Rentrak’s new business comes in.  In 2000, Paul Rosenbaum became the company’s new CEO.  He realized that the existing rental business was going to go away so he set out to build a new business using Rentrak’s core competency – tracking and analyzing consumer movie watching behavior.   To make sure RENT gets paid on the videos it “lends” to the video stores, Rentrak built a technology database to instantly count which tapes were rented out to customers.   RENT is using this same technology to now count how many customer order “video on demand” movies and TV programs from their cable TV operators. 

The key to the company’s new strategy lies in Rentrak’s technology to process the data and provide instant reports. Rentrak’s system was successfully expanded to track box office transactions at the theater level. Rentrak captured 80% of the market, having signed most studios in 18 months away from competitor Nielsen.   So the technology works and the data is useful to Rentrak’s customers. 

The company has now expanded its technology to track “video on demand” (VOD) viewing. Rentrak has signed up six cable operators including Comcast, Insight, Cablevision, Charter, Bresnan and Mediacom to run trial tests and is currently capturing transactions at an estimated 53% of U.S. video on demand enabled homes.  Rentrak will start aggregating and syndicating collected data in 2007.  Rentrak will then package and sell this data to advertisers, who could more efficiently allocate advertising campaigns across different media.

The reason this opportunity exists is that it’s a leap forward to how competitors such as Nielsen currently track TV and Video on Demand viewing.  Nielsen and Arbitron rely upon a sampling methodology where data from an panel is statistically projected to a population. This model of sampling is completely antiquated in today’s world where consumers get information and entertainment from many sources.  By comparison, Rentrak counts every transaction from a participating media company’s systems, with the data processed and presented in reports instantaneously.  It’s a leap forward compared to the competition and will relegate Nielsen worthless if Rentrak is successful.

Despite the great technology, this is still a speculative stock.  There’s no way to know if the new business will succeed because it’s still in the trial stage.  However, RENT has a leg up on any competitors that might get into the market.  The company has the cash to invest in the new system and shouldn’t need outside funding.  Investment in the new businesses is being funded by the cash flow from its legacy, mature, pay-per-transaction business. In addition, the company has net cash on its balance sheet of over $2 per share. There are only 12.2 million fully diluted shares outstanding, so any success in the audience measurement business could be quite meaningful to the stock price.

It’s impossible to value this business because the old business is disappearing and the new business hasn’t ramped up yet.  The stock is currently trading around 1x revenues.  Based on the multiples where Arbitron (ARB) is currently trading (3.7x revenues), it looks to me like the market is valuing the new business at $0.00.   It’s probably worth more than that today and could be worth a lot more in the future if the business takes off.  My guess is that the stock will move in fits and starts until revenues from the new business start coming in.  But that won’t be until 2007 or 2008.  So I don’t think there’s a rush to own the stock right now but it’s probably worth keeping an eye on.  And if for some reason you own Netherlands-based VNU Corporation (which recently tried to buy IMS Healthcare) and which owns the Nielsen Rating Agency, you might consider "returning it to the video store," so to speak.