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[Note/update 3/9/06 – For whatever reason, the Company says it “disavows any statements made by its former CEO Douglas A. McIntyre (DAM) in any non-public forums and disavows any information posted on any web-based financial message board.”]
[Update 3/13/06 – The pricing information given below for the Flix Engine SDK came from these sources. On2 today issued a press release that indicated the price for the new version of Flix Engine SDK for Linux is $2,500/server.]
"If a picture is
worth a thousand words, then a video is worth a million..." -- Adobe Flash Platform Overview
On2 Technologies (Amex: ONT) is a small company that produces some of the best video compression technology in the world. The important goal of a video "codec" (coder-decoder) is to squeeze the original (large) raw video content into as small a package as possible, while maintaining as much of the original quality as possible. This allows faster, easier, and cheaper delivery of the video over its transport medium.
On2's flagship codec lines are VP6 and VP7. Many years in development, they are objectively measured to be better than their competition using the PSNR (peak signal-to-noise ratio) metric. It is also visibly obvious to the eye - and most readily apparent by a simple example: http://www.bigad.com.au (from partner Vividas). On2's staff is mostly engineers and mathematicians, and the company has authored over a dozen patents.
On2 has an uneven operating history, and as of Q3'05 had not yet achieved sustained profitability. In past years they had sold their technology to some large-name companies, but the products On2 was in generally had not achieved widespread success in usage or deployment. The company through 2004 had a relatively flat revenues year-to-year, until they made a strategic decision to change from an "up-front" payment model to a royalty-driven "back-end" model. With the changeover, immediate revenues dropped and bottomed out, and have since been in a gradual sequential recovery as the new model takes hold. Meanwhile, expenses have stayed relatively low and flat at approximately $1.5 million per quarter, providing good opportunities for operating leverage going forward.
One of On2's frequent competitors, the H.264 patent pool, can receive upwards of $3M-$5M per year from a single deployment (http://www.on2.com/technology/on2-vs-h264), with both per-unit fees as well as content fees. These are the types of royalty rates that exist in On2's marketplace - the potential demonstrated value when a world-class video codec takes a major product win.
Whereas in the past the company's codecs had not achieved widespread adoption despite their superiority, this is now changing. On September 13, 2005, Macromedia launched version 8 of its widely-acclaimed Flash platform, incorporating On2's VP6 video codec. The Flash platform has a base of 600 million users worldwide, and Flash 8 has since been enjoying extremely rapid uptake, with somewhere near two-thirds of those users already upgraded to Flash 8 in little more than four months of release, twice as fast as previous versions. Major websites like MySpace.com (the world’s seventh most popular) are starting to upgrade to Flash 8.
"Online video sites powered by Flash 8 and video codecs from On2 Technologies," was recently picked as a Top 10 Emerging Video Trend by Om Malik and Niall Kennedy. And another industry pundit predicted that in 2006, “Flash could overtake QuickTime and Windows Media player as the premier video format for Web, desktop application, and device delivery. Given that Flash video can include a level of robust interactivity that QuickTime and Windows media cannot support, along with its unique runtime alpha compositing features, it is natural that many video publishers will adopt Flash over other choices.”
Macromedia is On2's largest deal to date. Flash video is experiencing tremendous growth on the Internet, due largely to its cross-platform ubiquity (98% penetration) and ease-of-use. On2 is now beginning to leverage this position, just as Sorenson did before it. Through its Flix line of products (http://flix.on2.com $149-$379), On2 now directly sells encoders to produce Flash 8 video. The Flix line is both (1) the lowest-cost option available of producing Flash 8 video (see Attachment below), as well as (2) the highest quality possible ("two-pass" encoding).
On2 also has partnerships with other companies - Sorenson, Autodesk - and gets revenue for every Flash 8 video encoding package they now sell. Further, On2 also has begun selling SDKs (Software Development Kits) directly to companies and websites who want to automate/integrate/repackage Flash 8 video encoding capabilities into their own systems, software, sites, and products. These SDKs run on a variety of platforms and sell for tens of thousands of dollars, and typically include an ongoing revenue stream back to On2 for paid usage. These capabilities cannot be purchased anywhere else. Anystream, IFILM, VideoEgg, Saver Corp, Streamcraft, MNCast.com, muvee, Camtasia, Whirrl, and Vidiac are all recent SDK sales wins - and there should be many more to come as Flash 8 continues its mercurial spread.
On the other end of the scale from the corporate SDKs, the company recently announced plans to introduce a web browser-based Flash 8 video encoding product geared towards the masses, the On2 Video Publisher for Adobe Flash 8. This simple, small downloadable plug-in would allow almost anybody to quickly produce encoded video right within their own browser, nothing else needed. Applications for such a consumer-level "point, click, and publish" ability for the broadest video platform in existence are numerous: video news sites, auction listings, video dating, job postings, video blogging, etc. The cost to use the service has not yet been announced, but general availability is expected by the end of January.
Lastly, On2 has ways to participate in future revenue with Macromedia, but they have not been disclosed due to NDA (post #149979). Note however that even Macromedia's best (and costly) Flash Pro product offers only one-pass compression, and thus does not produce the same high quality of video as the Flix, Autodesk, and Sorenson packages do. Here is a gorgeous example of two-pass Flash 8 video encoded with Flix Pro: http://www.onlinelib.de/Vp6DemoLink1.swf
Or, if you’re looking for something in Flash 8 that’s a bit more animated, try Bugs Bunny, Ice Age 2, or Gopher Broke.
One additional note on Macromedia/Adobe - according to Businessweek, the CEO's aim is to outfit every cellphone and consumer device possible with the company's popular Flash software. Margins in the mobile business are compelling: Macromedia takes up $1 royalty per phone shipped. In 2006 some 700 million Flash-capable phones will ship, and that number is growing at 25% a year. Going forward, Adobe has said they will advance a powerful engagement platform with PDF and Flash at its core, which scales from mobile devices to high-end server-based solutions. This immersive platform promises to redefine the way people and businesses engage with information across a variety of operating systems, devices and communication channels.
Other major new deployments for On2 are powering the live two-way video in eBay's much-anticipated Skype version 2.0 (launched December 1, 2005), as well as the video in AOL's new version of AIM (launched October 4, 2005). The CEO has confirmed both of these are back-end revenue deals for On2, signifying royalities (as Global IP Sound gets for their audio codecs) and/or revenue sharing (see post #148004). The Skype 2.0 product went into official release on January 5, with Skype video-enabled hardware devices (cell phones and desk phones) expected to follow later in 2006, per On2's CEO. In a full product review, Skype News wrote, “Skype video is easy to use and fail-safe. The quality of the video is excellent... The size and usability of the video windows as well as the picture quality are outstanding.” eBay expects Skype to produce $200 million in sales in 2006.
The third major messaging service that VP7 has won is
Tencent, the largest IM provider in
In a recent interview with WallSt.NET (http://www.wallst.net/popup.asp?id=1589 with transcript at post #149513), the CEO hinted that more messaging providers were due to add next-generation video. Speculation is that Google Talk is one of them, and could be another customer for On2's VP7. This prospect is heightened by the recent alliance and equity stake by Google in On2's partner America Online. Part of that agreement was to provide interoperability between the two firms' messaging clients. AIM already employs On2 VP7 video, and Google Talk does not yet offer video, so draw your own conclusions.
Further (unrelated) analysis on the ONT message board has concluded that if/when Google also upgrades their (Beta) Google Video service from Flash 7 (at present) to Flash 8, they will almost certainly have to license SDK encoding technology from On2, presumably again with royalties. As outlined above, the ability to integrate turnkey Flash 8 encoding into any company's websites, systems or databases can only be purchased from On2. Currently, Google Video streams all their free and unprotected content in Flash as well as the 30-second previews for all their other videos. On2 affirmed recently that “Flash is the backbone of Google Video” and “I think it’ll look much better with Flash 8” (post #159016), and that On2 has a “long-term working relationship with Google Video going forward” (post #160649). Google, for its part, has written, “At this time we are working to make Google Video available to everyone. We will continue to enhance our services to be compatible with newer versions of Flash... We hope you'll visit Google Video beta in the coming months to see our additions and improvements" (post #163051). Like some other large sites, Google may be waiting for Flash 8 to achieve 80% penetration to make a move.
Some sites, however, aren’t waiting. New SDK customer
MNCast.com (Movie Network Cast) logged over 1,500,000 visitors in the first two
weeks following its late-December debut, and is positioning itself to become
the premiere online community for consumers throughout
At the Consumer Electronics Show in January, a number of announcements were made by On2, the most important of which was to provide the technology for the upcoming video service/systems from XM Satellite. This is again a royalty-driven deal where On2 would earn a "toll" per XM video device sold. At the show, XM unveiled a major product demonstration "showcasing in-car video with XM's partner On2 Technologies." The On2 blog touted the portable version as well: “One of the most impressive gadgets at CES is the new XM portable video device. I think the thing is killer, and not just because is uses On2 VP7 video. The device is an untethered iPod. Instead of having to go to your PC to download audio and video content, it is downloaded directly to the device from the XM satellite and repeater distribution system. Why go back to your PC when you can get the content on the fly? What if you don’t even have access to your PC?” The launch of these systems/services is expected in 2006.
Following the same business model as XM, there is also a similar "per-device" royalty arrangement in place with LeapFrog, who now uses On2 in their Leapster product which was reported to have been popular for the holidays.
On2 also has initiatives underway to deploy their latest
codecs onto cell phones for mobile streaming video. They recently signed deals
in
A possibly large new contract announced at this year’s CES is muvee Technologies, a pioneer and leader in instant personal video, partnering with On2 to enhance muvee autoProducer with Flash 8 video encoding capability. Under the terms of the agreement, muvee has licensed On2 Flash 8 Video SDK and will pay a per-unit royalty fee for each copy of muvee autoProducer sold. muvee's autoProducer software is bundled with many industry-popular personal computers, with over 30 million units shipped to consumers per year. The autoProducer product sells for $99.95. Hewlett-Packard is muvee's largest customer, and the software ships on all HP consumer desktops and notebooks (Pavilions and Presarios). Importantly, the versions that are bundled are fully-functioning, not trial or time-limited editions. Nikon and Sony are two other large muvee customers that bundle the software similarly with their cameras. Muvee management confirms these copies are paid for by OEMs, meaning then with Flash 8 video output added, On2 should also begin getting paid.
One further key recent deal in the Flash area is with Brightcove, a highly-regarded new company in the Internet TV arena with major funding from AOL and IAC. Brightcove also has a distribution pact for its content with/on AOL. Importantly, Brightcove has selected Flash 8 together with Flix as its IPTV video encoding product of choice - purchasing from On2 and providing free of charge to all of its hundreds of commercial preview customers. "The quality and flexibility of Flash 8 video make it the standard for delivering Internet TV content to the browser," says Jeremy Allaire, Brightcove CEO. "By offering On2 Flix Pro, we can give the first video publishers easy access to state-of-the-art encoding tools they need to prepare their content for delivery in broadband channels distributed with our service." Brightcove could be really big, and a full launch is expected in 2006. Two early examples of the potential of Brightcove are their initiative with Reuters to create scores of cookie-cutter affiliates for an instant worldwide video news network, as well as stunning video destinations like MediaStorm.
Other significant On2 partnerships are with the aforementioned Global IP Sound (GIPS), the leading provider of audio codecs (also in Skype, and earning royalties therefrom), and VitalStream, an up-and-coming Content Delivery Network that focuses on Flash streaming. Presumably, other CDNs such as Akamai and Limelight will soon have to move up to Flash 8 - and perhaps also contract with On2. The same goes for IBM with their DB2 VideoCharger product, which “uses the latest standard formats” but has yet to upgrade to support Flash 8.
Last but not least is the aforementioned Vividas, a
U.K.-based company that has really been gaining visibility in recent months for
both itself as well as On2’s codecs.
Vividas produces online full-screen, full-motion, playerless videos to
promote their clients products. They do a lot of work (primarily web-based
commercial spots) for car companies, travel firms, beer producers, and most
recently, television networks and film studios. Their video is powered by VP6
and VP7, again with good royalty potential for On2. Movie trailers and promos
look impressive with their presentation; here is one recent example: Pirates
of the Caribbean II (select from the FULLSCREEN
box in the upper right, then compare to the other formats available). Some
studios have even started streaming the first ~10 minutes of their releases
over the net with Vividas/On2, to get viewers hooked: Madagascar,
FLIGHTPLAN,
National
Treasure, Serenity.
Of course, movie trailers don’t look too bad in Flash 8 either: First Descent, Underworld Evolution. And one of the more interesting recent developments for online cinema is the selection of On2 and VitalStream for the presentation of 2006 Sundance Film Festival online to a global audience in high-quality, Flash 8 video. Last year, Sundance dabbled with online film presentation in the WMP and Real formats, naturally with extensive support and troubleshooting sections for those media players. This year, it’s all in Flash 8 video, and Sundance is the first major film festival to premiere films on the Internet simultaneous to their live premieres. 45 short films are now available for viewing here: http://festival.sundance.org/2006/watch
So, with the penetration of the Flash 8 Player estimated to cross 80% worldwide (500,000,000) by February or March, can online full-length, full-screen movies be far behind?
In sum, whereas in the past On2 struggled to achieve any sort of widespread adoption and success, at this juncture the company's products are arguably poised to become the most widely deployed video codecs in the world.
This write-up has intended to provide a brief overview of On2, its technology and its products, but there is much more to learn and see. There is a large amount of investor information on the www.on2.com website, including more video samples and performance comparisons, all the announcements, many press articles, "what's hot," a technical library, an investor presentation PDF, the last conference call, and an ongoing blog written by DAM, the CEO... He has said the single most important benchmark that investors should now watch for is growth in revenue.
g
This analysis is based
on months of intensive digging and research on the company, data picked up on
the net and through exchanges with the managements of On2 and its partners, and
the experience of my own decades in the software industry. It represents my
best assessment of the company, but it is my own assessment. It is believed to
be accurate, but accuracy cannot be 100% guaranteed. It should not be
considered investment advice nor a recommendation to
buy or sell any security – please do your own due diligence.
Attachment
: Post on Available Flash 8
Video Encoding Products
Subject: Flash 8 Video
Encoding - the line-up
by:
linux_reigns2
12/30/05
10:13 am
Msg:
155186
For
anyone who wants to create/put Flash 8 video on the web, which is increasingly
going to be a very popular thing to do - here are the options... There are no
others:
Product Ease of Use Highest Quality Video?* Cost $$$ to On2
Macromedia
Flash 8
Professional Low No $699 Maybe
Autodesk
Cleaner
XL/6.5 Medium Yes $599 Yes
Sorenson
Squeeze
with On2 VP6 Plug-In Medium Yes $318+ Yes
On2
Flix Pro
(screenshot) High Yes $249 Yes
On2
Flix Exporter
(newly out for Mac) High Yes $149 Yes
On2
Flix Studio
(new bundled package) High Yes $379 Yes
(* NOTE: “Highest Quality
Video” means two-pass encoding, which Macromedia tools do not do.)
Now
if you wanted to put the best and easiest video on your site, which would you choose? Perhaps the one with
both the lowest cost and the highest quality?
Two
others, Software Development Kits:
On2
Flix Engine SDK - for websites & databases that want to integrate Flash 8
encoding: ~$20,000 + royalties
On2
DirectShow Flash 8 Video SDK - for all Windows applications that want to do
same: ~$50,000 + royalties
