Chaos doesn’t stop, folks. Not even at weekends!
As you know by now, I’m always on the hunt for chaos.
But not your everyday kind of “bad” chaos.
I’m talking about tech sector chaos. The kind of disruption that rocks life as we know it.
Technologies and companies so influential, they reshape entire markets – and make investors a fortune.
To find these companies, I put them through C.H.A.O.S. – my rigorous, five-step system, where each letter represents a metric that’s critical to a company’s prospects and investment potential.
(Seems fitting, right?)
They’re the same metrics that every high-powered venture capital firm uses. I know this because I pinched my methodology directly from Silicon Valley!
C.H.A.O.S. is a notoriously tough system to crack.
A company needs to score a lofty 85/100 to win my official, “stop-what-you’re-doing-and-buy-this-sucker-right-now” recommendation.
Suffice it to say, hitting that magical 85-point level isn’t easy.
And throughout history, only seven companies have scored a perfect 100.
Go here to find out who they are – and get full details on how C.H.A.O.S. works.
Let’s get to today’s next company…
Brightcove… But Bright Prospects?
Headquartered in Boston, Brightcove Inc. (BCOV) is a global provider of online video services. The company’s flagship product, Video Cloud, is a cloud-based platform that allows customers to publish and distribute their videos – be it web content or online marketing – to PCs, smartphones, tablets, and smart TVs.
It’s a relative newbie on Wall Street, having hit the market in February 2012 at $14.50 per share. Within six weeks, shares had run to $25.50.
Alas, that level remains the stock’s all-time high, as the price has tumbled to $7.95.
However, a few days ago, the trading volume on Brightcove shares surged above its three-month average. Which got me wondering… is chaos brewing?
Let’s find out…
On Wednesday, Brightcove delivered strong earnings results, exceeding both sales and profit expectations.
It continued a trend that’s seen Brightcove beat estimates in eight of its last nine earnings reports.
First-quarter revenue jumped to $31.1 million – up 26% from Q1 2013, and above the $29-million consensus estimate.
After factoring in operating costs, Brightcove’s revenue yielded a net loss of $0.02 per share. Analysts had projected a loss of $0.10.
Looking forward, the company slightly lowered its guidance for Q2 2014. But it reaffirmed the full-year revenue outlook, and said it expects better earnings than it forecast in January.
But that’s where the good news ends.
This quarter’s earnings beat was hardly a victory when you consider Brightcove’s overall financials.
First, Brightcove has extremely large operating expenses, evidenced in the company’s profit margins.
While its 66% gross profit margin indicates that Brightcove keeps $0.66 for every $1 in sales, the minus 9.3% net profit margin shows that it soon evaporates. That’s significantly worse than its industry peers.
As I’ve said before, though, it’s important to remember that young, microcap firms like Brightcove often have some ugly numbers. That’s why C.H.A.O.S. considers the total picture before we make a judgment.
C.H.A.O.S. Meter: 11/20
As the name suggests, a high-impact technology either needs to completely obliterate an existing industry, or create an entirely new market, with technology or products that nobody has seen before.
Since it was founded in 2004, Brightcove has done the latter.
The company laid the groundwork for the commercialization of online video platforms and was named one of the top-two U.S. video platform vendors.
Its cloud-platform technology is segmented into three main areas:
1. Video Cloud
This service enables customers to quickly and cost-effectively publish high-quality videos to connected devices. It can be used for a number of reasons…
Content Management: Whether short clips or full-length episodes, Video Cloud organizes content and offers unique control. For example, a user can set geographic and scheduling rules to define where and when their videos are viewed.
Distribution and Syndication: This distribution strategy spans customers’ own websites, partner websites and sites like YouTube. These tools help drive web traffic, which increases brand awareness.
Uploading and Encoding: When videos are uploaded, they’re encoded to maximize quality while minimizing the file size. Video Cloud then automatically enables distribution to users via third-party networks like Akamai or Limelight.
Zencoder is a global media distribution service that includes more advanced security features for outlets like broadcasters and professional content providers. Its streamlined integration supports most major transfer protocols and accelerated file transfers.
Once is a new addition to Brightcove’s offerings, stemming from the company’s recent acquisition of Unicorn Media.
It’s a cloud-based ad and video service that eliminates platform-specific ad technology. That makes it possible for customers to deliver live or on-demand videos with customized programming and targeted advertising.
Brightcove’s innovation led Frost & Sullivan to award the company its Global Market Share Leadership Award for Online Video Platforms for 2011 and 2012. And in 2013, Forrester Research recognized Brightcove as having the best enterprise-wide track record and ecosystem.
To maintain its high innovation standards, Brightcove has steadily increased its R&D spending. That’s a positive growth move, but the company’s lack of profitability underlines how expensive it is to stay competitive.
C.H.A.O.S. Meter: 15/20
To keep up in a rapidly changing industry, Brightcove has to constantly upgrade its technology.
How does it do that? Well, it’s a consolidator within its industry, not a takeover target. So while it often releases new products and upgrades existing offerings, it tends to acquire new businesses to do so.
Now, while this could drive the company’s long-term growth, taking on more debt and expenses serves as an anchor on Brightcove’s near-term acceleration.
Especially since the company also likes to offer shares as a form of payment.
The final offer to Unicorn Media included 2,850,547 shares of Brightcove’s common stock. This is partly why the shares are becoming increasingly diluted – which hampers price acceleration.
Speaking of the shares, here’s another red flag. Take a look at the company’s top-10 shareholders…
There’s only one company insider with a top-10 stake – former CEO and current board member, Jeremy Allaire. The rest are institutional investors, like investment banks and hedge funds.
All told, there are 121 institutional investors in Brightcove, making up 65% of the ownership. Not only does this convey a lack of confidence on management’s part, it also means that there’s potential for share price manipulation in favor of institutional investors… at the expense of retail investors.
Also, no insiders have bought shares since May 2013. Instead, we’ve seen a string of sales.
But my major concern here is that despite Brightcove’s great technology and services, its patent protection is weak. For example, it only has one issued patent and four patent applications pending.
It’s a perilous position, underlined by the fact that Brightcove currently faces two patent infringement claims.
While a favorable verdict in both suits would be a positive catalyst, a negative verdict would hammer the stock. So Brightcove bombs the “Acceleration” metric.
C.H.A.O.S. Meter: 6/20
As digital data continues to soar, Brightcove stands to benefit, since its technology focuses on helping customers monetize their distribution channels with targeted video content and marketing.
The company offers its products on a subscription-based model. And at the end of fiscal 2013, Brightcove had 6,318 customers in over 70 countries. Many are household names, spanning areas like media, retail, financial services, governments and non-profit organizations.
In 2012, Brightcove grew its customer base by an exceptional 64%. But growth was relatively flat in 2013. Still, retention is high, with the company able to retain 94% of its revenue since 2012.
In the last quarter, however, Brightcove’s customers slipped to 6,100. Yet revenue increased markedly.
This is a potentially ominous discrepancy.
Some companies can massage their figures by “borrowing” from end-of-quarter credits that haven’t yet hit the books. But if those customers end up cancelling or refunding, the numbers look false.
Plus, Brightcove’s entire business is heavily reliant on the sales from its Video Cloud services. So if business slips, Brightcove’s other revenue streams can’t compensate for the loss.
C.H.A.O.S. Meter: 11/20
Suffice it to say, it’s massive and highly competitive. And the technology is changing rapidly.
So in order to scale up and compete, small fries like Brightcove need to spend, spend, spend. And unlike an industry behemoth, that can be a painful transition.
But Brightcove does have competitive advantages…
- It offers a high-impact, unique technology that stands out in a saturated market.
- It offers high-quality services at less expensive prices.
That may change, however. And soon…
Entry barriers are low, so rivals can sprout up quickly. As a result, the competition is intensifying, and prices are becoming cheaper industry-wide.
C.H.A.O.S. Meter: 12/20
Final Verdict: Brightcove is a young company operating in an industry that it helped to shape with its high-impact technology.
Unfortunately, the landscape has grown much faster than Brightcove. And while the company has very good technology, sales and blue-chip customers, its margins, growth strategy and patent situation make this a risky bet. Moreover, the price tag for staying competitive is far too high to justify investing in it, based on my C.H.A.O.S. standards.
But I don’t want to leave you with nothing.
One outfit that does invest in Brightcove is the First Trust ISE Cloud Computing Index (SKYY). The ETF holds 684,931 shares of the company, which is 2.1% of its portfolio.
More than that, though, it allocates roughly 96% of its investments to the tech sector, including several of Brightcove’s peers. So it’s a more diversified play that gives you more exposure to the $30-billion internet software and services industry as a whole.
Your eyes in the Pipeline,