Remember the legend 'In Technicolor' displayed prominently on movie screens before shows begun? That was about a decade ago. Technicolor is a France-headquartered company that introduced colour to movies.
It makes most of its profit by licensing its rich portfolio of 40,000-plus patents in mostly audio and video technologies. The company is known for its animation and special effects prowess seen in movies as wide ranging as the James Bond flick Skyfall to Shrek and the Madagascar series.
A lot of those are done out of Technicolor's Bengaluru offices where it employs 2,000 'artists' (as it calls its employees) out of its global headcount of 14,000.
Apart from the intellectual property licensing, Technicolor also sells set-top boxes - Tata Sky and Bharti Airtel are prominent customers - DVDs and Blu-Ray discs. Technicolor also had a role in developing MP3 technology.
Frederic Rose, the CEO of the company, helped Technicolor turn around from a loss-making entity to a profitable one.
In the latest half-yearly numbers publicly available, Technicolor had revenues of $1.75 billion and an operating income of $137.5 million. He was in India recently and spoke to BT's Venkatesha Babu. Edited excerpts:
Q- From a near-death experience, Technicolor not only survived but is also thriving. How has this been possible?
A- Since 2011, we have been generating free cash flow and every year we have been doing better. The guidance we have given for 2014 is again to improve over the prior years. In 2012, we were in the middle of the transformation and the end of our film chemical business (was) transitioning to a new era. We are very proud of the fact that we have been able to navigate through fundamental technological shifts without resorting to acquisitions because it would not have been possible for us at that time. We have made some good bets particularly around two domains - the visual effects business and also in terms of our licensing business - being able to develop our smartphone licensing programme. A lot of analysts were telling me I should sell my set-top box and gateway business because it was losing money; we would never do anything…
Q- That was because it is seen as a commodity business...
A- Yes, but interestingly enough people seemed to have changed their mind a little bit because for whatever reason people don't believe that you can turn around a business operationally, which we did. We have turned around our set-top box business to a major cash flow contributor to the company but more importantly it is also becoming a technology leader again. For example, the 4k set-top boxes launched through TATA Sky. We aim to have a 100 per cent market share in India in the 4k set-top boxes. Why India? Because India is the first country in the world that is deploying 4k technology in set-top boxes. This obviously is due to the cricket World Cup. So, what has changed in the last few years is no strategic change but the financial results are better. That puts us in a very interesting position where suddenly we are now transitioning to looking at non-organic moves. We are starting to look at saying - our balance sheet is repaired, our leverage ratios are now in the right place, we feel good about our cash flow generation, so now we should look at non-organic opportunities.
Q- Have all the three divisions - entertainment services, digital and the IP licensing - turned around? IP Licensing used to bring 70 per cent plus of your EBIDTA. Have you been able to change the numbers because the accusation is that you live off the past…
A- So many people will tell you that anybody who has a licensing business will live off the past. The question is: are you making enough money today? What has changed in the last three years is our licensing business remains as profitable but the other two businesses have increased their profitability tremendously and will continue to increase their profitability. Why? Because you cannot just depend on your licensing business. You may have a good streak and you may have a poor streak. Therefore, your operating businesses are quite important. The good news with the licensing business is that it helped us navigate through the restructuring of the company. But now we are at a point where our other businesses are again contributing very materially to the bottom line. You will see in the next two-three years that the part that they contribute to will keep on increasing.
Q- This 40,000+ patent portfolio which you have, roughly around 4-5 per cent becomes redundant every year. Have you been able to replenish that and keep that at the same level because that is one indication of constant innovation happening within the company?
A- One of the biggest problems we have is that we are trying to limit the size of our portfolio to 40,000 because anything bigger than that becomes almost unimaginable. We are again over 40,000. Why? We have never been more productive in terms of new disclosures than we have in the last two years. The last two years have more productive disclosures than in the last fifteen years. Why is this? Because some new technologies that are being developed right now stand out right from the beginning. I am very happy to work around these, for example, take the HEVC* compression standard. Three years ago people said, "compression, you did this 20 years ago… It's over; you are living off the past". But when you look at our position in the new HEVC standard, we are one of the leaders in that standard, showing our relevance in this again. If you look at what's happening around sound… audio people said "MP3… that was 20 years ago… you're dead". Look at everything we are doing around 'MPEG - H' - the new audio standard. Look at when you talk about the new video display technologies - when people talk about the UHD, talk about High Dynamic Range - who created it? We announced last month the creation of a consortium - Technicolor with six other leaders that are now creating one unified standard for UHD and tomorrow you will see what we are doing in High Dynamic Range. I feel very, very good about the quality of what we are doing. ATSC - the US North American Television Standard, very strong active position. I feel very good about what's happening, and the quality of our portfolio if anything is improving rather than reducing.
Q- In terms of contribution to the bottom line, does it continue to have the same effect as it had a few years ago?
A- Basically, the numbers are pretty constant and have been constant over the last few years. So, I expect 2014 to be quite consistent with prior years. And you know the reality in the business is you could move up or down Euro 50 million, it doesn't take much because it's just one or two deals. But you know I think we are where we expect to be, where the market expects us to be and we have laid down a good groundwork for 2016-17, which is really what matters. It is the next programme - the signing of our first mobile contracts that was really important for the second half of the decade, you will see the birth of new standards which will be very important for our licensing organisation. So we are doing a few things that will become very clear as this year evolves that will give a lot of comfort to our stakeholders.
Q- Don't you already have an understanding with Samsung with regard to mobile standards?
A- When you say that signing up in the latter half of 2015/16, what are these new sign-ups that you are speaking about? With Samsung we have lots of different licensing agreements except in mobile phones. We don't have one for mobile phones. So obviously, everyone was waiting for when we are going to sign two big players and I am not giving any dates but I can assure you that you will see progress this year and we will be making announcements as the year goes on. I feel quite good about the work we are doing. We have a long way to go but I think the deals we did with Sony and LG clearly set us up in the right place - to demonstrate the value and validity and strength of our portfolio.
Q- Are 4k set-top boxes even relevant?
A- Because the television sets aren't there yet or they are too expensive and there isn't mass acceptance… It is not 3D, let me tell you that. I'll tell you why a 4K television set is not 3D.
If you have the content, it doesn't matter. But there are some simple technological solutions. Let's talk about the price points. Today in China, the average price of a 4K television is below $1,000. That's mass market. And what you will see in North America at the beginning of this year, but certainly next year, is that every TV over 55 inches will become a 4k TV. 4k is replacing HD. So it is a substitution.
The reality is similar to when we had HD ready TVs. So that's where we are at. And it's there. It's going to happen. But what is really interesting is the next revolution after 4k. 4k is interesting but that's just pixellization. The next big revolution that is going to change the viewing experience is called HDR- High Dynamic Range - it's the luminosity of the experience. That is a big deal.
That you will see starting 2017/18, it will create a completely different viewing experience in the quality image and picture. So we are working on a lot of exciting things but 4k is not a gimmick.
When people like NetFlix and Amazon are starting to record and film everything in 4k, when cricket world cup is to be broadcast in 4k and also the football world cup will be next, you know it's there.
The reason that it took a long time, the reason people talked about it three years ago and said it was dead is because like everything the buzz goes ahead of the market. But we are already at the price points… we are no longer at $10,000 a piece - even in the United States you can buy a beautiful 55 inch TV; on Black Friday, they were selling it for less than a thousand dollars. So when you see the numbers reported for Q4 2014 you will be blown away.
Q- Do you expect HDR to mainstream in the next three years?
A- HDR will be next generation. What happens after 4k? It will be HDR and that will be the second half of the decade. May be 2017 or 2018, who knows… It doesn't really matter, it is the next generation.
Q- How is your partnership with DreamWorks Animation* in launching Video on Demand going?
A- That is a joint venture called 'M-Go'. I am happy to report that we have millions of customers. India is a huge country I know, but going from zero to millions is not bad. We are very happy with our partnerships especially with Roku and Samsung who are two of our key partners in addition to DreamWorks Animation. Today, every 4k TV sold in North America by Samsung embeds our technology for 4k. If you look at Roku, which is bigger than Apple TV in North America, we are their default 'over-the-top' service. So I am very happy - the technology works, the platform works. International expansion - I was optimistic to think we could do this, but it is not a technology issue, it is a content issue. You need to renegotiate content rights territory by territory, country by country. And I have not put the priority on that, I have put more priority on making the platform technologically the best there is because we are, in the end, interested in technology. But I think you should expect one or two announcements this year in this area. I won't say more…
Q- Do you still produce those old world DVDs? Every analyst actually says that this is a dead business. Isn't it great that all analysts agree on something…?
A- So let me tell you about DVDs. Our best year ever was 2011. Our second best year ever was 2013. The best selling title we ever made was in 2014.
Q- Which was this?
A- Frozen. So 2014 was not a record year… But why? Because it is the box office. For my customers, in the first half of the year their sales were down 29 per cent year-on-year. So of course if my customers are down, I am down. But the fundamentals are it's still a business of billions of units of shipments. Of course, it is an 'end of life' technology and an 'end of life' business but strange how an 'end of life' business can go on for a long time. How many of your readers realize that music CDs is still a big market? It's not what it was 20 years ago but still hundreds of millions of units of music CDs are being bought every year. So it is a business we operationally execute very well, we are the largest player. It contributes to the cash flow to the company and I don't pretend it to be a growth business but the reality is even if analysts say you should sell the business but who would buy the business? The only reason someone would buy the business is either I sell it at a big discount or they are dreaming of buying my business and combining it with somebody else. Problem is they cannot do this, with the anti-trust law it doesn't work. So at the end of the day, I keep on with the business and it keeps on generating cash.
Q- One of your largest shareholders wants to split the company. Has the insistence on keeping things like the DVD business actually created dissonance between the management of the company and one of the largest investors in the company?
A- No, it's not that issue. The issue is fundamentally…
Q- Because they want to sell off parts of the business completely…
A- Basically, we have one of our shareholders who signed a shareholders' agreement with the company and one of the undertakings was that it would agree with the company's strategy. And what the board discovered, and that's not been made public, is that actually that they were misleading.
That they came in with a purposeful view to break up the company and keep only the patents and basically create a 'patent troll' which means not to keep the research, not to keep the operating business - just to sell everything off… This is a very excel spreadsheet myopic view and one that is driven by mistaken understanding of how licensing works, how patent licensing works. The great thing about these funds is they just look up at what worked yesterday and they are driven by very short term returns and not in terms of growing and creating businesses.
So in this case, their view is that the company will be worth more selling everything and just keeping patents. But the problem today is interesting - if you look at these 'patent trolls' they are not doing so well. Companies like us and other players are no longer putting up with patent trolls. If you don't contribute research, if you don't contribute to standards, we'll see you in court and some of these companies are having a lot of problems.
So fighting yesterday's war. The board also feels that it can create a lot more of shareholder value by having an integrated business different from the way Erickson does it or Qualcomm or Nokia. Our business like Dolby - is a business model that seems to drive more integration.
And if you look at our share price evolution over the last three years and our operating performance, it seems to validate the fact that this business model is one that makes sense. It's one that positions us right in the ecosystem and one that actually generates financial benefits to the customers.
Q- So there is no question of the company being broken up and the parts being sold out, at least under the current management irrespective of what …
A- A shareholder has a right to express their views. Since it's their right, they can do it. They are free to do it. I wish they would not do it in newspapers but if they do it that's their privilege. But yes, free to express it, it is a free world. But you know if you want to change and if you want to fundamentally make a change in the company against what the board wants, what the management of the company wants, there is only one way to do it and it's not to talk. The expression is 'Talk is cheap'…
Q- Does Asia continue to be your growth engine? What percentage of revenues comes from Asia?
A- Yes, we have done very well in South East Asia down to Australia and New Zealand. We have seen very significant growth. We don't break out the numbers but if you see just in India, the growth we've had in market share in terms of our set top box business and also if you see the growth in our headcount in Bangalore - where we now have almost 2,000 people…
Q- From 1,200 to 2,000 in two years is a pretty big jump. So actually, in terms of the heft that India has in Technicolor global has increased…
A- Globally, we have about 14,000 people. Close to 20 per cent are based out of here. Animation is based out of here. Our gaming business is based out of India and we are looking at other things. So I feel very good about that. There are other things that are more frustrating… Our success in China - very painful, very difficult for a non-Chinese company to compete in China. It is very easy to fight Chinese companies outside of China, very difficult to compete in China. And then of course, you know the dream is to penetrate Japan and Korea but that's a dream… So, much progress in the last two years but still a huge opportunity even just in India. So very proud of our achievements, we could not have done much more than that so fast, economically, there is a limit. All organically… But we are quite excited about the next few years - we'll probably do a few non-organic moves in this region.
Q- Any particular area that you are looking at?
A- We are looking at technology start-ups in India. Companies in video technologies, companies that are investing in video technologies. We are also looking at companies that do what we do in terms of skill sets. You know the market in visual effects, animation -- so those are two examples.
Q- Are you focused on creating content for Microsoft Halo or an Oculus Rift kind of device?
A- That's right. We are not focusing on the object itself but we are focusing on the content. How do you create immersive content? The problem is immersive content is 360 degrees, that's the problem. And today, we have done some demonstrations working with Samsung for example on their version of it but there is a long way to go. And maybe gaming seems to be going somewhere but the rest of the industry is not there yet. We don't know how to make a movie from that perspective. We know theoretically but we don't know actually how to do it…
It is a story telling challenge. A film maker makes a movie and he tells you where one should go (with his story). When you're immersive, you actually get to choose (where to go) but that changes the story. Do I want you to choose? When you walk into the house, the camera forces you to look at the left of the door. But when you are with that thing in your head, you could decide to look to the right or look behind you or look above. That's not what the creative experience allows. So, how do you storytell? In Gaming it is ok doing it that way because it's all about options. But storytelling immersively is first of all an artistic challenge and then we have the technological challenge. But you first have to figure out how you tell your story that way. It's a completely different medium…
Q- What has the India ops has been focusing on?
A- In animation, India is the centre of excellence; this is where majority of the work is being done because it started that way. It started with a major customer - we started with DreamWorks Animation and Nickelodeon. Today, it is not one studio with one creative head. It is several bespoke studios that are built around our clients' businesses. So Rockstar Games, for example, is a huge presence within our studio as is DreamWorks Animation…
We also have our own group company, MPC, which is almost like a Dedicated Unit within our studio cluster. Now each of these have very different technology pipelines, so if you look at the studio overall, it has completely independent workflows all in the CGI space. We actually get to straddle many technologies.
We are beginning to work with our own Research and Innovation for what the next generation of tools and technologies can be out of this activity while we are remain a substantially services business. Our success has been to become the 'room next door'. We are the 'room next door' to two of Rockstar studios.
We are 'room next door' to EA sports. We are the 'room next door' to MPC's three other film locations and the 'room next door' to six other locations in MPC Advertising. And all this actually is a recipe comprising of talent, technology and infrastructure and the blend it creates. And I think that's created a kind of leadership. Hence even the policymakers in Karnataka who view this sector positively just met me and are inviting us to create a Centre of Excellence for the industry. I think the artists and technicians come to Technicolor India for the best projects and they come in to work on the best technologies.
Q- When will we see a Bollywood movie actually being worked on by Technicolor?
A- Have its budgets scaled up to attract you? We have scanned the market place but basically the economic model of Bollywood is very different from the rest of the industry. I don't know what the ratio is but 75- 80 per cent of the Bollywood budget is spent on talent, which is a completely reverse ratio of what's being spent outside of India. So until that is rebalanced I do not expect us to do a lot with Bollywood.
*The story has been updated to reflect correct information at mutiple places. The error is regretted.