Avid Continues To Deliver Seat-Based Model Raises Concerns (NASDAQ:AVID)

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Published on the Value Lab 24/7/22

Avid Technology (NASDAQ:AVID) is one of the many companies that are now moving away from perpetual license models to subscription models delivered through the cloud. The advantages are clear. They mean more recurring revenue and the opportunity to rebill clients who’d since gone dead unless they’d been on maintenance contracts. Avid overall users continue to grow, and pricing and volume efforts are helping grow revenues, even though there’s some cannibalisation of other businesses and a bit of an issue on the semiconductor and hardware side. While the company is attractive, it is not cheap, and with tech being a difficult area, especially enterprise tech that charges on a per-seat basis, we think the macro-outlook is still going to be an issue for getting returns on the stock. Pass for now.

Q1 Update

Q1 is generally a pretty strong quarter, as noted by one of the analysts on the call. However, this time supply chain issues, specifically problems with semiconductor supply, have been hurting some of the elements of the business that are usually more stalwart, and slowed down turnover in some of the higher ticket businesses for the company. Revenue overall grew by 6%, which isn’t bad, and gross margins improved YoY as well.

Avid Q1 financial highlights

Financial Highlights (Q1 2022 Pres)

Subscription revenue continues to grow as well as the company converts customers who were previously on perpetual licenses that mean recognized revenue on a one-off basis into customers that will constitute a growing flow of revenue once they’re closed in for a full year of revenue recognition. The strategy has two prongs of rebilling customers once deemed dead as well as allowing for revenue uplift between 120%-140% thanks to continued maintenance arrangements but also the ability to re-tier and reprice customers to better discriminate the user-base. In particular, the release of Pro Tools Artist as a lower tier hobbyist offering opened the door for higher prices on enterprise clients.

AVID Revenue breakdowns

Breakdown by Type (Q1 2022 Pres)

Subscription revenue combined with maintenance revenue was a little more disappointing, and this was primarily because the company saw declines in maintenance revenue. Maintenance is sometimes offered together with subscription services especially to larger customers who have converted to perpetual licenses but not always, so in part these declines can be explained by an expected cannibalisation. But as for maintenance as part of integrated solutions for the larger clients, a segment that is still generally seeing growth, supply chain issues have meant delayed recognition of revenues associated with parts that cannot be delivered because they cannot be sourced from semiconductor suppliers. Likewise, tickets are rising in integrated solutions but delivery has slowed on account of these semiconductor issues. Nonetheless, the overall strategy continues to take for with an increase from 75% to 79% in recurring revenue as a proportion of total revenue.

Software revenue, even including perpetual licenses which declined from $7 to $5 million in revenue, grew overall driven by subscriptions by 19.5%, indicating that issues are primarily in the hardware related businesses slowing down demand.

Conclusions

The company guided for pretty limited sales growth this year, and certainly for the coming quarters. Indeed, this quarter did come in a bit soft and the broken expectations were not well-received. There have been some concerns. While entertainment has shown its mettle over the course of the pandemic, even some of the very exposed areas now that people are calming down about COVID-19, the economics of programming for companies that rely on appreciation of growth by markets like Netflix (NFLX) are worsening with the macro environment. Indeed, Netflix in its last quarterly call said it would cut back. While Avid says that slowdowns aren’t being seen on the software side yet, we need to be a bit concerned in general about headcounts in the entertainment industry as well. Contracts are on a per-seat basis and the number of those seats will have to fall to tackle inflation, and unemployment could start flywheeling. With multiples up in 15x EV/EBITDA, growth is baked in. We think the peculiarities of the rebilling economics and the unearned revenue balances should cushion growth and keep it going even if there is a slowdown in contract winnings for AVID, but the multiple doesn’t offer a great margin of safety to invite conviction to buy on the way down, for example. We think there are better exposures on the market right now that don’t trade with weak market areas like enterprise software. Indeed, we’ve been burned ourselves here. As such, we pass for now.

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