Why Adobe Should Buy On2 Technologies

For Adobe, it may now be time to take On2 Technologies out of the market. With today's announcement that Bill Joll has resigned as President and CEO of On2 and as a member of their Board of Directors, and the recent problems surrounding falsified revenue at On2, Adobe could swoop in and acquire On2 for a very reasonable price. On2's stock price is nearing the lowest it's ever been in almost 5 years and sales for Q1 were only $4.5 million on a loss of almost $5 million for the quarter.

While there is much debate in the industry over On2's VP7 codec being replaced by H.264, the fact remains that there is no one single codec that will rule the world. VP7 and H.264 both have strengths and weaknesses and both are needed in today's market. While I have never seen numbers published on how much money Adobe pays On2 to license the VP6 codec, clearly it's not a lot of money with On2 still having single digit revenue each quarter.

If Adobe could acquire On2 for a reasonable price, it could take On2's the line of Flix products and offer them to the market for free, or at a much cheaper cost than On2 charges today. Doing this would help accelerate Flash based video adoption and enable Adobe to offer a better live Flash encoder. It's a safe bet to think that some of the technical resources and development skills at On2, especially in the Hantro division could also be useful to Adobe with regards to their mobile video strategy. And while Adobe is not paying On2 a lot of money for licensing the VP6 codec, acquiring On2 means they would never have to deal with another licensing contract, if Adobe wanted to renew it when it expired. I know many will ask and the answer is, no, I don't know when it expires.

On2 has some smart technology folks at the company, but their revenue should be more than it is today. They have seen very little revenue growth over the past 12-18 months, all the while the market for online video continues to grow. On2 can't stay this small forever and like many companies in today's market, needs to be part of a larger organization to truly grow to the next level. On paper, this is one of those acquisition ideas where it seems to make a lot of sense from both a financial perspective and a product and technology one.

Comments

[John Veserat]

What do you mean by "having single digit revenue each quarter"?

[Dan Rayburn]

Single millions. As in not doing $10 million a quarter.

[Roger]

It's not a new topic, but as ever for Adobe you'd have to wonder, why buy the cow when you get the milk pretty much for free? Also Adobe definitely seems to be putting less emphasis on VP6 these days with heavy promotion of H.264. So I'm not sure it makes sense for Adobe from any perspective - especially financial, since as you point out On2 had losses larger then sales last quarter.

For On2 I'm not so sure it would make sense either as they would probably rather be an independent provider for their other customers. In other words I'm not sure that Adobe all of the sudden becoming a provider of codecs like VC-1 would go over so well around the community. Adobe would also then be getting into the business of trying to sell products to competitors of theirs.

So overall such a speculation sounds both messy and unlikely to me.

[Dominic Crotty]

As a long time suffering shareholder of On2 all I can say is please, please, please, please someone buy us and put us out of our misery.

[vidiva]

What makes you think the contract will expire? The full details were never revealed, but I believe the 2004 deal was a one-time $1.4 million for "in perpetuity"...

[Pez Dispenser]

Along with the above comments, Adobe would also get their hands on On2's unreleased VP8 codec at the same time they might be able to either put the screws to Sun Microsystems who was planning on using On2's codecs for JavaFX or profit from Sun.

[Pez Dispenser]

Then again maybe Sun Microsystems should look into buying On2.

[Dave Burstein]

Dan

An interesting related speculation is what the value of ON2 says about the "reasonableness" of the MPEG LA royalties. Your article is yet one more piece of evidence that the ON2 codec is comparable in quality to MPEG 4. Since that's the primary asset of ON2, we have a rare, fairly clean valuation of intellectual property.

ON2's market cap plus debt is less than $125M, and includes business relationships etc. Their annual R&D has been about $1M, and some sales and administrative costs need to be figured in. The price of the stock is consistent with annual royalties of $12-25M, including a factor for expenses and ongoing research.

I never got around to writing this before, so thanks for reminding me. Now I have to consider how to get a good number for the MPEG 4 total.

db

[Dress Arts]

Perhaps Adobe should take a look at Divx. Divx owns Mainconcept the video codec software provider that Adobe uses. http://www.mainconcept.com/

[Pez Dispenser]

"Perhaps Adobe should take a look at Divx."

The difference there is that Divx doesn't own their technology. On2 does.

[dan]

Any guesses on a buyout figure?.

[tom]

ON2 has an excellent engineering team but though slow at the moment, the revenue model will eventually gather speed and the codec will be a major player. Buyout will be in the $6.5 to $7.5 range.