Shares of Dolby Laboratories, Inc. (NYSE:DLB) have been trading largely flattish as the business frankly posts rather flattish results. The innovative licensing business looks appealing on paper, but actual growth has been underwhelming for a while, although the business recently announced an interesting bolt-on deal.
Given this situation, I am somewhat surprised to see shares command a premium valuation, one which I cannot rhyme with the actual performance, so subsequently I failed to see appeal here. All that being said, few immediate changes are expected as a premium valuation has been applied to Dolby for a longer period of time now.
About Dolby
Dolby Laboratories transforms the science of sight into spectacular experiences for audiences, which measure billions across the globe. Partnering with creatives, developers and businesses, the company aims to revolutionize the entertainment market with Dolby Atmos, Dolby Vision and Dolby Cinema. By focusing heavily on innovation, Dolby aims to elevate your entertainment, as this applies to music, movies, TV, and gaming.
Despite this interesting market segment and the well-regarded position of Dolby, the firm has seen relatively modest growth. Over the past decade, the company has grown sales from $1.0 billion to $1.3 billion, a solid growth trajectory, but nothing spectacular. The company furthermore saw very modest margin pressure over this time, although it managed to buy back about 5% of its shares over the last decade as well.
Forwarding to more recent times, Dolby reported a near 4% increase in its fiscal 2023 sales to $1.30 billion, that is for the year ending in September of last year. Over 90% of sales were generated from licensing sales, as the product sales element is relatively limited in the case of Dolby.
The company is quite R&D heavy, having spent over a quarter of a billion to these ends, with the company posting operating earnings of $215 million, as operating margins equal to 16% of sales were down quite a bit, after these margins came in comfortably in the twenties recently. Aided by net interest income received on net cash balances, the company posted net earnings of $200 million, equal to $2.05 per share as buybacks reduced the share count to nearly 98 million shares.
While GAAP earnings rose by twenty-four cents to $2.05 per share, Dolby posted adjusted earnings of $3.56 per share for the year as well. The huge gap is largely driven by a pre-tax stock-based compensation expenses of around $1.21 per share, making that a realistic earnings number comes in around $2.50 per share. That is, if we accept the adjustments relating to amortization charges and restructuring charges.
For the fiscal year 2024, the company did guide for flattish full-year sales around $1.30 billion, with adjusted earnings seen up modestly to $3.60-$3.75 per share, largely on the back of a reduction in the share count.
Troubling Valuations
In the post-pandemic world, shares of Dolby peaked around the $100 mark in 2021. Ever since, shares have largely traded in a $65-$90 range, as the stock commanded a premium valuation. After all, a $2.50 per share realistic earnings number translates into premium valuations, although that Dolby operates with a substantial net cash position.
In May, Dolby posted second quarter results, down modestly from the same period last year, undoubtedly the results of softer conditions in the automotive OEM sector, a key clientele for Dolby, after the first quarter was quite soft as well. Nonetheless, the company reiterated the full-year guidance, both in terms of sales and earnings.
The company ended the second quarter with $1.07 billion in net cash, restricted cash, short and long-term investments. Based on a share count of 97 million shares, that amounts to about $11 per share.
Trading at $79, that implies that operating assets are valued at $68 per share and with realistic earnings seen around $2.50 per share, the resulting 27 times earnings multiple was by no means cheap amidst flattish sales at best.
Commanding a $6.6 billion enterprise valuation, the company is valued at around 5 times sales of $1.3 billion, with the company trading at high earnings multiples, as some of these earnings were driven by net interest income.
An Interesting Deal
Early in June, Dolby put some of this substantial net cash position to work as it reached a deal to acquire GE Licensing, the owner, maintainer and licensor of a large IP portfolio which focuses on consumer digital media and electronics sectors.
The activities include a portfolio of more than 5,000 patents, mostly relating to pioneering video codec technology. The deal is valued at $429 million in cash, with the transaction set to be completed later in the year.
The company claims that the deal adds durable and high-margin revenues, while being accretive to 2025 earnings per share (on a non-GAAP basis) with none of these statements being quantified. Valued at an equivalent of nearly $5 per share in terms of Dolby’s stock, the impact on the valuation is not that meaningful, as shares have not seen a reaction in response to the transaction announcement.
This deal looks interesting, but unfortunately no further (financial) details were announced.
And Now?
Recognizing that Dolby Laboratories, Inc. stock has long traded at premium valuations, aided by predictable cash flows and strong net cash balances, I cannot escape the feeling that shares still command too premium of a valuation, at least too high for me to say any reasonable appeal.
Given all this, I am cautious to get involved, although I am keen to learn more about the deal with GE in the coming quarters.
