I was recently in a discussion with a colleague about the spate of consolidation underway in the IPTV and online video sector. There are a number of factors driving the M&A activity:

•   There is an increasing emphasis on place-shifting video in addition to the ability to time-shift content. As a result technology providers need to consolidate horizontally and enable solutions across the multiple markets and modes of content delivery i.e. terrestrial, cable, satellite, broadband, over-the-top and increasingly mobile.

•   There is a focus on vertical expansion as players move into new technologies along the value chain to address pricing and margin pressures. The trend is towards increasing percentage ownership of the complete solution. Hence the movement of encoding technology providers into ingest, DRM, CAS, billing and other delivery solutions or the movement of equipment vendors into middleware and customer premise equipment.

I think the diagram below illustrates this ‘movement’.

•   Third, a huge chunk of the transactions are also distressed deals. As the larger players consolidate and acquire adjacent technologies, smaller vendors with niche technologies find themselves increasingly isolated and struggling to address telco requirements. Raising funds to continue operations has also been increasingly difficult in the current economic environment making them easy bolt-on technology acquisitions.

Here are a few examples of the deals we have seen over the last 12-18 months.

HORIZONTAL EXPANSION ACROSS MULTIPLE MODES OF DELIVERY

June 2010 saw the acquisition of the real-time video transcoding firm Ripcode by RGB Networks in an all-stock deal. RPG Networks provides a video processing gateway which enables the delivery of a single video feed to multiple devices. Ripcode with its focus on on-demand and streaming video for mobile devices enabled their entry into the cellular frontier. The newly combined company has a valuation today of over $220 million.

At the same time we saw the acquisition of ExtendMedia by Cisco in September 2010. The acquisition reinforced Cisco’s focus on video by extending their coverage across multiples screens (IPTV, web and mobile) and across the lifecycle from ingest to monetization middleware. ExtendMedia provides content management across ingestion, DRM, billing, ad insertion and campaign management with their solutions implemented at the operator end. At $80 million, internet reports claimed the transaction was a 4-5x multiple on revenues.

We may still see some horizontal developments in the CPE market space. Currently CPE providers have been focused on the traditional – terrestrial, cable, satellite - markets or else gateways like Boxee, Hulu have laid claim to the over-the-top video market. Integration across these markets is rare as is integration with mobile services.

VERTICAL EXPANSION INTO NEW MARKETS AND TECHNOLOGIES

One of the most acquisitive players in recent times has been Google. In our market segmentation, the company would be positioned both as an internet platform provider (Youtube) as well as a CPE middleware vendor (Android/ GoogleTV).

August 2009 Google announced they were acquiring video compression technology provider On2 Technologies for $133 million. On2’s compression and encoding technologies enable video delivery on desktops and mobiles and claim better quality than the industry standard H264.

December 2010 Google acquired Widevine Technologies, a digital right management and video optimization firm. For the lay person, DRM services range from encryption to watermarking – encryption of content and insertion of watermark.

A digression - with growth in over-the-top video delivery services and the focus on multiple screens, DRM and watermarking services are gaining in importance. This will increase further with the provisioning of premium content online and on-demand by studios. One of the positive regulatory initiatives for the DRM and watermarking industry was the decision by the FCC in May 2010 permitting ‘unprotected outputs on set-top-boxes (STBs) to be disabled for video on demand (VoD)’.

Another positive development is the technological innovation in watermarking. Previously, watermarks were inserted in the baseband video after the content was decoded at the STB for display. Therefore, the technology needed integration with STB chipsets and was limited in scale and scope. Now an encrypted watermark can also be inserted at the head-end. At the CPE end, a software program or assembly extracts the digital watermark which in turn provides the key that is able to decode and play the media file. In addition if the output from the STB is being distributed illegally, the watermark will be inserted into the video stream thus identifying the source.

We should be seeing more activity in this space.

Anyway, coming back to consolidation in the head-end middleware arena, Feb 2010 saw the acquisition of Bitband by Motorola for $10 million. Bitband focuses on the on-demand IPTV market with streaming servers for content delivery and other over-the-top video services for IPTV QoE. The middleware business will integrate with Motorola’s home and networks mobility business unit. In Jan 2010, Motorola acquired SecureMedia, a security and DRM provider for IP video distribution and management.

May 2010 saw Harmonic’s acquisition of Omneon for an enterprise value of approximately US$273m in a cash and stock deal. The acquisition extends Harmonic focus from video distribution to video optimised storage, production and media management systems. For the year end 2009, Omneon’s 2009 revenues were $105 million – a 2.6x revenue multiple.

At the CPE end, November 2010 saw the acquisition of Latens Plc by Pace for £28 million. Latens’ software based CAS is deployed across OTT, cable, IPTV markets and further strengthens Pace in middleware solutions.

Pace has actually been in a very acquisitive mode for their middleware expansion. It started last year with the acquisition of Philip’s STB assets followed by the French Bewan and their gateway solutions and finally US based 2Wire for $475 million in July this year. At 2009 revenues of $667 million, the 2Wire transaction is a 0.7x multiple on revenues pretty much in line with our analysis of the sector a while back. (http://www.seedcatalyst.com/joomla/market-trends/motorola-integrates-cpe-and-mobile-divisions). However, Latens is the first acquisition initiating Pace’s entry into IPTV head-end middleware.

TECHNOLOGICAL  BOLT-ON ACQUISITIONS

There has also consolidation at the video encoding end of the chain. Optibase, a provider of video encoding solutions for IPTV networks was acquired by Vitec Multimedia, a provider of video acquisition and management products for the IPTV market for $8 million in March 2010.

The watermarking sector also saw some consolidation in July 2009 with the acquisition by Civolution of the Software & Technology Solutions (STS) watermarking business from Thomson. The aim was to bring under one roof a broader portfolio of content identification and tracking technologies.

Further in December 2009, another market leader in content protection solutions, Irdeto, also strengthened their offering with the acquisition of Philips Electronics white-box cryptography patents and applications. Like Civolution, this was product enhancement rather than market expansion.

Another interesting transaction was the acquisition of Anystream by Telestream in September 2010. The acquisition enables Telestream to provide video ingest and encoding facilities across content providers, operators and now even the enterprise sector.  Terms not disclosed.

A mention is also needed here of the sale of the content distribution business of Ascent Media Group to Encompass Digital Media in December 2010 for $113 million. While Ascent’s focus is more on cable and satellite services, this is a reversal of the general trend. Ascent seems to have decided to focus more on the ingest end of the chain and is gradually moving away from distribution. We should be seeing some accretive acquisitions from them in this space thanks to their current cash rich position.

There are still several independent names – Anevia, Ateme, Conax, Dreampark, Edgeware, Verimatrix – and this continues to be a sector worth watching.

So which are the areas where I think there is scope for further consolidation and expansion:

 - CPE equipment as we see the consolidation across delivery modes and further integration with femtocells and other mobile technologies. At the chip level there has been significant activity from Broadcom over the last few months. It now needs to play out across the customer premise equipment providers like Motorola, Pace and DLink

- DRM and CAS solutions will be more and more in demand with the increasing provisioning of premium content on demand and online. Instead of partnerships we should be seeing expansion  into these technologies by both the head-end middleware and equipment vendors and platform providers

- VOD servers, real time encoders and other associated technologies being integrated with head-end equipment vendors as the industry moves from a pure sale and deployment model towards provisioning solutions in a managed services model. Rather than pay a recurring fee to external vendors it would make sense to acquire and bring them in-house.