Avid Technology: Supply Chain Delays Continue

Avid Technology (NASDAQ:AVID) holds a set of great brands that makes it entrenched in the digital music production space. They are pulling an Adobe (ADBE) and getting past perpetual licenses and maintenance into a more recurring subscription revenue model. That's all well and good, since it allows repricing and re-tapping old leads. Their deltas lately are from the integrated systems side of things, where things have been slowed down and margin eroded due to supply chain issues. The benefits from that loosening are getting deferred, but that's fine. Things should look better in the coming quarters, also as they plan on doing some more cost cutting and their ARPUs are coming up. However, despite some positives, the stock appears expensive also because of potential sale possibilities.

Looking at Q1

The Q1 is a story where ARRs from the conversion of customers from perpetual license and software maintenance is going quite well. The big changes is that there is quite a lot of activity on the enterprise side and that's allowing for a 150% uplift and to reactivate old users and leads. Maintenance on the software side is coming down, and the weakness in delivering hardware as part of integrated solutions is an issue for the hardware maintenance revenues which are here to stay after the transition.

As the uplift kicks in and as ARR effects come to fruition in annualised revenues, the outlook is that revenues should come up almost 10% which is great net of the losses in perpetual license and maintenance revenue, as per the transition. The reason it's not higher in the outlook is primarily because of integrated solutions where the delays from a while ago continue.

Backlog is building in the integrated solutions business and activity is good in the end-markets. However, the supply chain issues are slowing down revenues as well as eroding gross margins due to inflated hardware prices. This is also capping performance in the hardware maintenance business, which is mainly for clients that have bought integrated solutions. The issue is that even the revenue that is coming through is hitting margins pretty meaningfully due to the loss in segment profitability. When more liquidates mix effects will be worse, even though the segment is still profitable. The hit overall from the underwhelming integrated solutions performance is around $3.5 million, which is a lot against the $12.7 million in adjusted EBITDA this quarter.

The company is also planning restructuring and early retirement initiatives which together should save $15 million annually, but these things rarely fully pan out.

Bottom Line

There have been discussions that Avid is considering selling itself with a push likely from activist investors Impact Capital. The question is whether someone will pick up AVID which currently trades at a ~$1.5 billion EV. The strengths are a powerful platform of brands that have important share in the music and content creation industry, as well as a business model being proven out that demonstrates recurring revenue and good retention throughout the transition. There will be a milestone coming up where we'll see how enterprise customer churn. This will be important to assess in the next two quarters, as performance in the enterprise segment would signal good retention.

A possible acquirer to speculate on might be something like Adobe. While Adobe Audition isn't bad, it's less of an industry standard and not a major element of the Adobe Suite, where After Effects and of course Photoshop are the go-to elements. Pro Tools is much more of an industry standard and a more capable programme, and much better positioned for integrated solutions since hardware can be dedicated to Pro Tools. Pro Tools is arguably more competent and versatile of a workstation as well. There are other things in Avid's portfolio that may be interesting enough like Sibelius to warrant a look from Adobe, and gives some integration across the chain of activities in music composition and creation.

At around a 15x EV/EBITDA it would be on the steeper side considering M&A markets. But if M&A markets were to inflect on the recent CPI news for example, it is a possibility if there is a strategic buyer out there like Adobe or others that may be able to afford the premium. On that basis, there is some speculative merit to Avid, but it is a little expensive for us considering the current rate of growth and the troubles in profitability that rest on cost cutting and restructuring measures.

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