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Thursday, March 24, 2011

Sonic Foundry (SOFO): When Will the "Market" Notice the Mediasite Franchise?

We started this post Tuesday and didn't have a chance to finish before -- boom -- Polycom (PLCM) announced the acquisition of Accordent Technologies Wednesday morning for approximately $50 million in cash, or 5.55 times 2010A sales of $9 million (per press release).

We tweeted the news yesterday and were surprised to see shares of Sonic Foundry (SOFO) actually trade down yesterday. However, the "Market" did seem to take notice today -- from Google Finance:

Before we go any further, we should say this: we have a short reprieve on our ability to publish on the broader technology sector and Sonic Foundry. As readers may recall, beginning late last year, we were unable to share our commentary on the sector and company.

At that time, our post included links back to our prior commentary and research. Importantly, we believe our prior analysis and core thesis remains fully in-tact today:
  • The company remains a leader in a rapidly growing and large addressable market, with reasonable fair values potentially double or better from current trading levels. Valuation estimates are readily supported by comparable M&A transactions, reproduction cost, and hidden balance sheet assets such as significant net operating loss carry-forwards and growing unearned revenue. Moreover, valuations can now be supported by earnings power and excess cash generation.
NOW, we have a fresh M&A comparable transaction where a large, cash rich, growth seeking technology company is scooping up a smaller competitor to Sonic Foundry for nearly 5.6 times trailing sales. We note that Accordent's annual revenue is less than half that of Sonic Foundry, with correspondingly lower market share. Arguably, any potential take-out of a market leader -- in any sector, whether technology, consumer packaged goods, real estate, or garbage collection -- warrants a premium multiple.

Interestingly, in a January 2010 post, we mentioned that Polycom could use Mediasite:
  • We suspect Polycom management would not only agree but likely prefer to use Mediasite to deliver their quarterly message (and other corporate events). Thus, as discussed in our "Get the Memo" post on 1/03/09, Polycom provides us with yet another example of an organization that needs Mediasite, albeit one sitting squarely in the video arena.
Okay, well... Polycom now has Accordent, which serves similar markets and sometimes competes against Sonic Foundry. YET, from our perspective, comparing the two companies remains somewhat of an apples and oranges exercise. We recommend all readers visit Accordent's Web site to learn more about the company's solutions and visit the "Resources" section to view case studies/Webinars/etc. Then, visit Sonic Foundry's Web site and do the same. Although we understand that Accordent has certain strengths, we see Sonic Foundry's broad, high quality product and service portfolio as industry leading.

Moreover, taking into account the entire Webcasting landscape, our objective analysis continues to support our "Did Your Firm Get the Memo" view:
  • As Webcasting becomes evermore pervasive, we submit that everyone can benefit from Mediasite -- from schools to corporations to government organizations to hospitals and all of their respective end-users.
We've been talking about the Mediasite Franchise since 2009. Importantly, we see ample evidence all around us that the franchise is bigger, better, and stronger than two years ago. Just a few examples:

(1) Third patent awarded by the U.S. PTO:
  • Sonic Foundry, Inc., the recognized market leader for rich media webcasting, lecture capture and knowledge management, announced today the company has been granted its third patent by the U.S. Patent and Trademark Office for its flagship Mediasite product line.
  • The patent, U.S. No. 7,913,156, entitled "Rich Media Event Production System and Method Including the Capturing, Indexing and Synchronizing of RGB-Based Graphic Content," strengthens the company's intellectual property position as it relates to Mediasite, the award-winning webcasting platform. Specifically, the patent further protects Sonic Foundry's market leadership position by recognizing Mediasite's unique ability to digitally capture RGB images during presentations via a video capture device, and allowing the images to be marked, synchronized and viewed both live and on-demand.
(2) Students praising Mediasite, via Jake McClure's blog in The Hardest Question to Answer from Interviewees on Their Interview Day (see link for full text):
  • But now a year further into my medical education, there is one thing that I would like to address… and it revolves around the use/impact/advantages/etc. related to “Mediasite”. I put Mediasite in quotes because at Vanderbilt, it is its own little culture—its own frequent viewers who tune in just as regularly as those sitting in class. Also, it is a verb... both past, present and future tense (i.e. “Did you Mediasite Dr. ________’s lecture from this morning?”, or “Yeah, I’m planning on Mediasiting that lecture after my research meeting.”)
  • So, for the prospective students considering either interviewing or actually coming to Vanderbilt that may be reading this, you may wonder, “Well, how does Mediasite actually work?”.
(3) Satisfied customers recounting why they chose Mediasite and how they use the solution -- well worth a listen:

Lecture Capture Systems in the Cloud: Why New York Law School Outsourced Hosting for Campus-Wide Capture

Lecture Capture Systems in the Cloud: Why New York Law School Outsourced Hosting for Campus-Wide Capture [Classic Player]

  • Why did New York Law School decide to host all of their lecture capture content – now more than 5,700 class recordings – outside their network? Because after a thorough analysis, they determined placing the Mediasite server back end in the cloud would save them time and money, let them scale faster without losing any features and avoid burdening their own network infrastructure.
We could go on, but there's plenty of information on the Web for consumption and research. One additional item we will relay is that online education is here to stay and is arguably transformational -- please see: "A glimpse of Online Education and the Internet in infographic" via @mcleod's Mind Dump.

SO, the fickle "Market" seemed to notice Sonic Foundry on Thursday. But, by "noticing," we really mean shares should be trading in the $20s (or better) for all of the reasons we've previously discussed.

There were "unconfirmed rumors" regarding a takeout of Sonic Foundry at $30 last month. Who knows where these things come from and management put the kibosh on the rumor at Sonic's recent Annual Shareholder Meeting. Nonetheless, the facts are as follows:
  • The company is growing annual revenue at a 20% plus clip and the current quarter (end-March) could see revenue grow 30-40% on an easier Y/Y comparison (which might attract more "Market" attention). Notably, the company's near- and long-term growth prospects remain solid and are even improving as all lines of business expand.
  • Operating income and cash earnings are becoming meaningful as operating leverage arrives.
  • The company's balance sheet is improving -- please see uptick in shareholder equity and net tangible assets.
  • The company remains undervalued on an absolute and relative basis.
  • Applying the Polycom/Accordent 5.6 times sales multiple to Sonic Foundry's trailing twelve month revenue of $21.9 million implies a $123 million market value, or $27 per fully diluted share (including all options and warrants).
  • Applying a more aggressive, Market-is-in-love-type Salesforce.com (CRM)-like multiple of 10 times sales would imply an approximate $50 share price.
Let's revisit something we included in our initial May 2009 post from this section:
  • "Reproduction Value – Valuing a Technology Company with No History of Profitability" (toward bottom of post)
  • Conclusion: Sonic Foundry’s increasingly entrenched market position might suggest an additional purchase price premium, bringing an informed buyer to pay more than five times revenue. Informed buyers could include any number of large technology original equipment manufacturers (OEMs) including Cisco, IBM, HP, Dell, Tandberg, Polycom, and Blackboard. Nearly all of the large players face slowing growth in their core businesses and, with large net cash positions, are on the hunt for growth areas with sizable addressable markets. Specifically, Cisco is pursuing a “’build, buy, and partner’ innovation strategy to move quickly into new markets and capture key market transitions” and, in 2007, paid approximately seven times trailing revenue for WebEx.
AND, from an August 2009 post regarding Google's (GOOG) acquisition of On2 Technologies:
  • For all we know, Sonic Foundry may remain a stand-alone company indefinitely. However... An M&A team at fill-in-the-blank large tech company might consider paying such a multiple with the goal of using the company's clout, branding, and distribution to grow the Mediasite franchise into a $50 to $100 million revenue business with 20% operating margins. In this scenario [$120 million], the company would be paying 12 times operating income at the low-end.
We'll see what comes to pass, if anything, on the M&A front. But, we do know this: over the medium- to long-term, fundamentals always drive share prices and the "Market" eventually takes notice. Consider the equity performance of transformational companies such as Amazon.com (AMZN), Netflix (NFLX), and Priceline.com (PCLN) over the past decade. In some cases, it took years for for the Market to notice the companies, even while the companies were growing larger and more profitable year in and year out. While not perfect, we see a slight parallel to Sonic Foundry:
  • Fundamentals are sound and the company is the leader in markets expected to grow 20-30% over the next five years. We believe the ducks are in a row for continued favorable operating results and a revaluation by the Market.
Happy investing,

Jeffrey Walkenhorst

Disclosure: long SOFO.

© 2011 Jeffrey Walkenhorst
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1 comment:

  1. Jeff,

    Glad to see you posting on SOFO again.

    1. What was the expected growth rate of Accordent in 2011?

    2. With PLCM selling at EV/sales roughly of 2.6x, don't you think SOFO is fairly valued at 2.0x sales if you assume $26 million this year?

    3. Do you have an EBITDA estimate for the company in 2011?

    Thank you,



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