On August 3, 2023, Reuters wrote that Symphony Technology Group and Francisco Partners are “among the private equity firms competing to acquire media editing software maker Avid Technology.” Citing an anonymous source, Reuters indicated a deal “could be signed as early as this month.”
This reporting follows-on from a May 2023 article, which asserted Avid had retained Goldman Sachs to conduct a sale process. The day this report appeared, Avid’s stock rose 22.9%.
After Reuters August 3rd article, Avid’s stock price gained 18%, to close at $27.32, equating to an enterprise valuation of $1.35 billion.
This post pulls the various figures together to contemplate the broader meaning of the valuation of a flagship company like Avid by a financial entity. It is an intriguing reference for all media technology industry professionals.
We are at a moment in time where the US film industry is shutdown because of existential business model conflicts. Yet, sophisticated institutional investors are (allegedly) considering a purchase of one of the largest, most recognized technology suppliers in that market.
Adding some weight to the discussion, we have often observed M&A is a subject like real-estate: All people have an opinion, and it is a window into their perspectives of the future of a community. In this analogy, your opinion on M&A is a proxy for your feelings on the future of the media technology sector. Extending the analogy, Avid is an ideal case study to not only muse about the impact of the Hollywood shutdown on the technology-side of the industry but also how technology trends are impacting the future of the industry. Here are a few: Does the transition to operating expense business models make the industry bigger (or smaller)? More (or less) lucrative?
I confess my initial reaction to the May reporting by Reuters was incredulity. Twitter, now X, records my initial reaction to the May Reuters report.
Expanding on the above point, the below chart shows the stock plot for Avid over the past 12 months, denoting the 52-week high (April 10th: $33.21) and 52-week low (May 16th: $20.06).
Pricing Considerations
For a moment set aside all academic arguments of valuation. As a practical matter, if you were a senior executive or board member of a NASDAQ-listed company could you reasonably accept an acquisition proposal valuing the company at or below the price quoted on the market four months earlier?
Have macroeconomic circumstances radically changed to reset valuation or has the company’s operating profile diminished such that the psychological reference point of April is no longer valid? Consider that during the same period, the broader NASDAQ-100 index gained 17%.
Proceeding from the above, what then is a practical price Avid could accept and – because symmetry is necessary – the price a private equity firm would pay – and much more interestingly, why they would pay it?
Prior to the most recent speculation, Avid’s stock closed at $23.08 per share. The then 30-day weighted average price (“WAP-30”) for Avid was $25.19. The below table puts these figures in perspective against acquisition prices at or above the recent April high.
We introduce the above to make vivid there is a floor on a price Avid can in practice accept. At the same time, keep in mind the buyers could conduct the reverse analysis (versus low) and make inverse arguments.
How a Financial Buyer Evaluates a Leveraged Buyout
The nature of the buyer matters. A private equity firm’s ROI (return on investment) is a function of the ‘I’ or investment as much as it is a function of the ‘R.’ Observe the buyer has much more control or the ‘I’ than the ‘R.’ Investment is different than the price the buyer pays; it is instead the amount of equity the buyer puts into the deal. The balance of the price could consist of existing investors rolling equity or – everybody’s favorite – raising debt from third-party lenders.
Debt levels are a function of the operating cash flow of a business and broader conditions in the debt markets. Here we re-introduce the reader to the exhausting measure of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). In rare instances where it is not misunderstood or misused, EBITDA approximates operating cash flow and by extension serves as a quick reference for determining the debt carrying capacity of a business.
To understand the ‘I’ of a potential acquisition, consider the below table of various valuation measures at different, imagined acquisition prices.
Should the valuation levels in the above seem high, it is because they are. As discussed more extensively in an earlier blog post, Avid’s valuations are at an all-time high owing in large measure to its successful business model transition.
Now if a deal is weeks away, as suggested by the Reuters reporting, then the valuation is in the table. We have trained our minds to look at revenue multiples – and you may have noticed ARR is all the rage with youngsters these days. However, revenue multiples are tools of strategic buyers, we are talking financial buyers. Apply a lesson learned from the schoolyard trick question ‘Which weighs more: a thousand pounds of feathers or a thousand pounds of steel?’ The lesson applies to how you service debt. While recurring revenue might allow you to borrow more (because of the visibility into future revenue), it doesn’t allow you to service more.
We answer the question of ‘I’ by directing our attention to the EBITDA multiple columns. This presents the ‘Adjusted EBITDA’ metric disclosed by Avid’s management team for the trailing twelve months of performance and a second column the mid-point of management’s guidance for ‘Adjusted EBITDA’ for 2023.
A good measure of the amount of debt (as a function of EBITDA) is available from a recent blog post by Adams Street Partners. The post discusses the challenges posed by recent interest rate increases on using debt in leveraged buyouts. You will note typical levels of debt are on the order of 5x – 6x EBITDA and the average pricing is around 12x – 13x EBITDA.
For those yearning for an interest rate anecdote specific to the media technology sector, Avid lends a relevant data point. In January 2021 Avid entered a new Term Loan (i.e. debt) in the amount of $180 million. The agreement was amended in February 2022 to set the interest rate to SOFR (Secured Overnight Financing Rate) plus 2.35%. At the time SOFR was 0.05%; it is now 5.3%. This is not an issue for Avid’s current balance sheet, but it is a matter of upmost importance to a post-transaction Avid balance sheet. (As an aside the interest rate rise is a really big deal for certain highly leveraged suppliers.)
Let’s presume lenders to a potential transaction accept 2023 Adjusted EBITDA as the funds available to pay interest on debt. This is generous to the seller. In your career, should you find a counterparty willing to value you off future ‘Adjusted EBITDA,’ sell them things.
Pricing Example, Investment Consequences
To reify the valuation discussion, let’s play out a scenario.
Private Equity Firm X and Avid agree a transaction price of $32.5, at a 40%+ premium to the August 2nd closing price, 29% premium to WAP–30 days, and a slight discount to the recent April high. Further, imagine some syndicate of lenders agree to lend 6x NTM EBITDA to finance the transaction. This leaves the Private Equity firm responsible for the remaining ~10x NTM EBITDA or approximately $1 billion. The buyer must then fund this amount using its own equity (this is the going-forward basis of ROI), have some existing Avid investors roll their equity into the new company, or a third option discussed below.
Rolling equity is complex for several reasons. This requires convincing investors to move from a public entity to a private entity (often this is not a possibility), finding a few large ownership blocks of investors to convince, and offering a compelling reason. At the thought experiment price of $32.5 price – again a price exceeded four months earlier – why would a large institutional owner transition to private circumstances? The compelling reason must be something Avid can’t do as a public company but can do as a private company.
One such idea is almost as old as Avid itself. That is to consider breaking up Avid into pieces because the sum-of-the-parts of Avid may very well be worth more than the whole. The most familiar version of the story is to sell Avid’s audio business, and more specifically the crown jewel of Pro Tools.
Avid ceased breaking out its Audio business in its financial reporting in the 2021 financial year. During the 2020 financial year, Audio products were 45% of product revenue (no disclosure on services). The subscription picture highlights the size of the user base.
The chart is excerpted from Avid’s first quarter 2023 earnings presentation. It illustrates the breakdown of paid software subscriptions. Note the purple (Pro Tools) and green (Sibelius) layers are audio product lines.
Any reader with even a passing familiarity of audio production will appreciate the market strength of Pro Tools. The user base is fanatical. There is good analytical support as well. Below is an excerpt from our annual survey (2021 edition) of buyers and users of media technology products. From left-to-right it shows the net promoter score (“NPS”) recorded for Pro Tools (as a product), Avid (overall company), Median supplier profiled (100+ suppliers), and lastly Avid when removing Pro Tools users. We are condensing a longer discussion of customer loyalty in the chart. The takeaway is the exceptional customer loyalty of Pro Tools users.
While many industry professionals intuitively believe there the sum-of-the-parts are larger than the whole of Avid, it may not survive a detailed analysis, and even if an analysis is persuasive, then there still is the matter of successful business execution.
Assuming Avid’s Audio business could be sold at a valuation level meaningfully more than the blended average paid for Avid, then such a divestiture would return all excess valuation to the owner. While we will refrain from guessing the specifics of the Audio business, let’s continue the above example. Assuming you bought Avid for 16x NTM EBITDA and sold the Audio business for above 16x, then as long as the valuation of the remaining Video business hasn’t declined by an equal and opposite amount, you have found extra money. One could even argue this scenario would leave the new owner of the remaining Video business with more lucrative options for its eventual exit.
You could understand wanting to consummate such a series of transactions outside of the public markets as they have been combined businesses for almost 30 years (Digidesign was acquired in 1994). Separating the business is a process, and once separated, the stand-alone Video business may no longer fit public market investor appetites (smaller, lower valuation, greater volatility to financial profile, …).
Alas, the entire paragraph above is baseless speculation with lots of moving parts.
Framing Investment Return Possibilities
Having covered the ‘I’ or investment, let us interrogate the ‘R’ or return portion of the calculation. The fun part.
Absent a meaningful rolling of existing equity owners or a sum-of-parts approach, at our assumed price of $32.5, Private Equity Firm X is the new proud owners of the shiny technology company Avid. Starting the 5ish year investment odyssey with $600 million of debt and an equity basis of $1 billion.
To proceed on this basis is to believe exceedingly happy thoughts about the future of the media technology sector. This conclusion follows from the limited opportunities remaining for cutting costs from Avid.
We are dismissive of the opportunities to enact meaningful cost savings because of the scope of the financial gains sought and the specifics of Avid’s existing cost basis, which the management team has been optimizing for the better part of two decades. It is not obvious how much more efficiency remains in the operating profile.
During the first quarter of 2023 earnings call, CFO Ken Gayron outlined the latest cost savings enacted by management. A early retirement program (voluntarily) was initiated in the first quarter, which is expected to reduce costs by $2m in 2023. Adding to this Avid has implemented a restructuring expected to reduce costs by an additional $13 million in 2023. These initiatives will bring the 2023 expected operating expenses to $215 million.
How much could a new owner reasonably expect to cut without impacting revenue? Remember, Avid is a technology company. They must spend on research and development (~$70 million of that figure). Currently levels of sales and marketing spending are not outrageous at around ~22-24% of revenue. Employee counts are in-line with levels a decade ago and, more acutely, operating expenses per employee have improved considerably over the past 10 years.
This leaves two avenues for generating a return: grow the valuation or grow the business.
Banking on increased valuation levels is dubious, absent some foundational transition to more lucrative business models with higher levels of recurring revenue, increased ability to scale (profitably), and at expanded margin levels.
Specific to Avid’s valuation, 85% of Avid’s revenue is recurring today – not much room left. The next owner needs to grow the business to justify the contemplated pricing levels. Any alternative strategy has a main ingredient of hope.
What is then a reasonable organic growth measure to expect? Depends on your views of the future.
The Growth Story of New Business Models
It took a few pages, but the reader’s patience is finally rewarded by addressing the fundamental question of this post, and the author would argue the primary question senior executives at media technology suppliers need to have a good answer.
While 85% of Avid’s revenue is recurring today, it takes didn’t forms. Below is a breakdown of the percentages from subscription, traditional maintenance agreements, and other long-term agreements.
Avid has been guiding investors, and executing with clients, a transition of maintenance agreements to subscription relationships. Management has communicated (for several years) this transition comes at an uplift to revenue. During the first quarter of 2022, CEO Jeff Rosica indicated the uplift ranged from 120% to 140%. By the fourth quarter of 2022, CFO Ken Gayron stated uplifts were “in excess” of 140%, and on the most recent earnings call, management provided uplift guidance of 150%. Meaning, every $1 of annual maintenance is – over time – transitioning into $1.5 of subscription revenue.
Before you get the impression Avid is mischievously boiling its customers in their own budgets, management makes statements about uplift in the same breath as discussions the compelling reasons for customers to transition to subscription. Our interest remains with the economics of the subject.
Rosica stated during the Q4 2022 earnings call Avid had transitioned about 30% of these maintenance customers to subscription. Greater levels of detail were provided by management on the recent Q1 2023 call. Gayron said the team believes about 40% of MediaCentral maintenance customers have transitioned to subscription and over $40 million of maintenance remained in the storage, video server, and graphics product lines.
In terms of customer numbers, during the subsequent Q&A with analysts Rosica talked about the dynamics of the customer transition. “From a number of customers, it’s a smaller number of customers that have converted because it’s…the more sophisticated larger customers have gone first in many cases. We’re now working…down through more what I’ll call the small and medium-sized businesses and that is a heavier channel play that we do in that space and we’re working hard to really enable and get our channel really capable at subscription.”
These are some of the most intriguing data points about how the economics of the media technology sector transition to new business models and technology paradigms. We choose to build the picture by starting with a reminder of the recent history of operating expenditure business models.
We have tracked how customers and suppliers are transitioning their respective business models in our annual survey efforts. If you search your own memories, even five or six years ago, industry buyers not only preferred capital expenditures, but they also took great efforts to minimize all post installation payments. The story is best told through the eyes of IT suppliers into the media technology sector, who were bemused at the tragically low levels of maintenance paid for media technology products.
Here is a chart shown during last year’s Devoncroft Executive Summit | Amsterdam illustrating the average levels of annual support pricing (as a percentage of product pricing). Contrast an 8.5% average against more typical IT rates of 20 – 25%+. There was a deficient.
Blindingly obvious to all MBA and non-MBA wielding executives was the opportunity for media technology suppliers to reprice maintenance agreements in-line with typical IT support pricing. In practice though it is never easy to reset buyer expectations after they’ve been set for a generation. Success has been mixed.
The next (or concurrent) step was to begin the transition of users to subscription models. A progression measured in inches, not miles. For example, consider the progression of Pro Tools. Here is a chart from our annual survey highlighting the slow, though steady progress towards subscription during the 2018 – 2020 period.
We referenced the below slide in our ‘State of the Industry’ presentation in Amsterdam last year to bring together these economic concepts of business model transition. There are multiple dimensions to consider, both revenue impact and supplier valuation impact.
Beginning with the bar chart, we normalized operating expense payments on the IT model (20 – 25% of initial purchase price). To the left is the historical industry model at a 70% deficient, to the right is the anticipated uplift to subscription models, and the envisioned (dreamed?) further uplift to cloud business models.
The source of the 1.2x expectation for subscription and 2.0x for cloud is a series of interviews we conducted with industry executives and investors. For those seeking more compelling persuasion or perhaps empirical evidence, we can offer Avid’s experiences in transitioning at an uplift of 1.5 to subscription (more than the expectation last year). What is the support for the claim of further uplift to cloud or even an outline of those business models? We have nothing but the expectation of those interviewed, which seems to have a construction built only from an expectation – so don’t go believing it just yet.
Even if you are unpersuaded there is a further uplift to the cloud, the progression still narrates a part of the media technology market GROWING with the transition to new business models and next-generation technologies.
There are, of course, still limits to growth. Successful investors doggedly interrogate forecasts.
At Avid’s 2021 Investor Day management introduced a series of 2025 key long-term financial targets. This was updated at the 2022 Avid Investor Day. We will mention the fine print at the bottom of the slide, before mentioning the targets. It reads: “We do not consider our four-year operating model for 2022F through 2025F to be financial guidance, and we do not intend to provide any updates with respect to such outlook.”
Working from the most recent 12-month performance of Avid, the mid-point targets represent a more than 40% growth in revenue and doubling of EBITDA, in a little over 2.5 years. Holding to the deal structure outlined above and assuming you sell at the same valuation you buy, then such financial performance would double your equity investment. Of course, if you can achieve the 2025 target financial figures in the time frame described, you deserve nothing less than such a return.
The reader may view the 2025 targets as awfully optimistic, especially when tracking against the revenue year-over-year growth recorded in the past four quarters of (beginning with most recent) of -2.8%, -2.4%, 1.3%, 2.9%. Lower levels of optimism (than the 2025 targets) in the buyer’s mind could still work out to justify the prices contemplated for Avid. But you aren’t paying the prices contemplated if you are ambivalent about Avid or by extension the industry’s future. So, if sophisticated, informed investor’s view Avid’s price as a bargain, it is a billion dollar plus bet on something special in the industry over the next few years…or there is some other entirely different explanation afoot.
The Motivation of New Business Models
We conclude by addressing the remaining dimension of valuation described in the economic transition slide above. Based on observation (public and M&A comparable) and aligning with intuition the revenue multiples escalate in attractiveness as you move from the historical (a) sell and fix when broken model, to (b) a typical IT deployment model, to (c) a subscription model, to (d) an imagined cloud future.
You might expect most suppliers to justify the choice of transitioning business models based on the well-founded belief it grows shareholder value. We had a similar pre-conceived notion when we added the question to the survey script to last year’s survey. The surprising results are below.
Maybe there is something to all this business model transition after all.
Hope to see and discuss the above with you in Amsterdam at the annual Devoncroft Executive Summit.
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