A Tiny Company That's Beating Verizon And AT&T Could Gain 50%

Tivo has not only prevailed in court -- time and again -- but its core business is getting strong as well, giving the company's cynics another reason to upgrade their view.

Verizon blinks
On Monday, Sept. 24, Tivo announced that Verizon (NYSE: VZ) has decided to stop a court fight and pay Tivo at least $250 million during the next six years (Verizon will pay $100 million now and the rest in installments.) This continues a string of legal wins for Tivo, which I discussed a few weeks ago when I added this stock to my portfolio.

If you keep winning legal settlements that bring upfront cash now and annual payments later, then you're bound to develop a bullet-proof balance sheet. Tivo's cash rose from $209 million at the end of 2010 to $619 million at the end of 2011, and with the Verizon settlement, that figure is bound to keep rising. 

Roughly speaking, Tivo's cash pile will likely be worth around $5 a share by the end of this year, and perhaps $6 or even $7 by a share by the end of 2013. That depends on how still-pending lawsuits with Cisco Systems (Nasdaq: CSCO) and Motorola (Nasdaq: MSI) play out. The fact that Verizon and AT&T  (NYSE: T) have chose to settle with Tivo increases the likelihood that Cisco and Motorola will acquiesce and take the same path.

Here's what some investors may be overlooking from this week's legal settlement: Not only did Verizon agree that it infringed on Tivo's patents, but it's also looking at ways to use Tivo's technology in its businesses. For example, Verizon's joint venture with Coinstar (Nasdaq: CSTR) to launch a video-streaming service under the RedBox brand may use a Tivo interface. This means the $250 million headline figure could actually be much higher.

For Tivo, these victories put cash on the balance sheet and help lower the company's legal bills, which have been stubbornly high the past few years. And falling legal expenses are likely to come at a time of rising sales for the company, helping Tivo generate rising free cash flow.  As I noted a few weeks ago, a number of cable operators are giving Tivo's software a fresh look as the company continues to develop its technology platform. Simply put, Tivo's heavy research and development (R&D) spending has led to a rising degree of functionality that other solutions can't hope to match. That's a conclusion Verizon has just drawn by agreeing to use Tivo's technology -- and one that other industry players are beginning to realize as well.

Risks to Consider: As long as Cisco and Motorola seek to drag out their legal proceedings with Tivo, shares may still be dogged by too-high legal expenses.

Action to Take -->  Tivo's agreement with Verizon came on a day in which stocks are moving lower. So an initial 15% premarket pop is now just a 5% gain as trading is underway. Yet it's likely only a matter of time before analysts revise their balance sheet and income statements assumptions for Tivo, along with their price targets. So the muted share price reaction in Monday trading provides an entry point for those that failed to get into this stock ahead of the Verizon verdict. On a sum-of-the-parts basis, I still see this stock moving into the mid-teens, or roughly 50% above current levels.

-- David Sterman