Digimarc Corporation (DMRC)

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Digimarc: The Revenue Begins
Jul. 6, 2017

Watermarked products are on shelves at Wal-Mart.

Virtually all major retailers have expressed interest.

Amazon's Whole Foods acquisition will speed adoption.

About two years ago, with Digimarc (DMRC) trading around $40 per share and Wal-Mart (NYSE:WMT) dropping hints about collaborating with the company, I concluded an article by writing, "a move from $40 to $200 is still good whether it happens in a matter of months or after several years."

Today, shares are trading around $40 per share again, but Wal-Mart is no longer being so coy. You can go to a store right now and scan some of their Great Value brand items using the Digimarc Discover app to observe Digimarc technology at work.



For people new to this story, what you see in the above video is the most salient application for Digimarc's patented watermarking technology. Those packages, while still carrying a traditional barcode, have been imperceptibly modified so that they are scannable in their entirety. This saves time at checkout, creates efficiencies throughout the supply chain, and creates an opportunity for effortless consumer engagement.



These time savings represent billions to retailers, and to answer a common question: No, the benefits don't accrue only after a critical mass of watermarking is achieved. Even if a cashier or warehouse worker is oblivious to the technology they are working with, the items will still scan faster as workers reorient them in search of the visible bar code.

The benefit to brands is harder to quantify, but Digimarc management has expressed surprise at the rate at which they've been approached by consumer packaged good (CPG) companies who are not waiting to feel pressured by retailers to make their move.

Solidifying the appeal of the solution is the pricing. Digimarc will be charging all but the largest companies a recurring $50 per shop keeping unit (SKU), which for the benefits gained, should create a great return on investment.

In fact, Digimarc has something of a Goldilocks solution. RFID can do something similar, but companies incur a higher cost to implement that solution since each item produced comes with an incremental expense. Wrapping a product in visible barcodes can get around the cost issue, but companies are not keen on having their brand crisscrossed with long black stripes.



Evidence for industry interest in Digimarc's technology comes directly from management who mentioned during their Q4 conference call, "We have some level of engagement with all of the top 10 retailers in the world and six of the top 10 CPGs. These relationships range from discussion of pilots to contract small volume production." These are in addition to ongoing fully operational roll outs with smaller grocers Wegman's and New Seasons.

When exactly Digimarc will begin converting talks and pilots into dollars is not totally clear, but the most recent call provided some encouraging color. Management disclosed, "This is the second master services agreement we have entered into with a top 10 retailer. The other relationship is further along and involves lots of moving parts and is taking some time to mature." In other words, talks haven't stalled with the big retailers. Signatures have been placed on the dotted line and now Digimarc just has to hit certain milestones.

Independent of this information, Digimarc has been disclosing bookings for a few quarters and finished 2016 with $1.8 million-a number that is symbolically, if not statistically significant.

If there was any doubt as to whether Wal-Mart was one of the two initial signers of the master services agreements, one need to look no further than Digimarc's jobs page:



So what are these master services agreements worth? From a few hundred thousand per year up to maybe a million? It's hard to say, but it's also not terribly important. Digimarc is not poised to succeed on have a couple of monstrous contracts but rather a bounty of small and medium sized ones. The list of supermarket chains alone, many of which have their own store brand, is enormous. This is to say nothing of CPG companies which could have one or tens of thousands of SKUs. Having the biggest names in the business on board is important mostly in terms of putting the smaller players in the industry on notice and creating a fast followers effect.

Once the reactive players begin to adopt, there is the potential for rapid acceleration. Management is fond of pointing out that the total addressable market in terms of SKUs is in the hundreds of millions. Obviously, Digimarc will never capture 100% of that, and capturing the first few percentage points will take time, but even so.... the opportunity relative to the company's current market cap of around $400 million is significant. Two million SKUs at $50 per year is $100 million of high margin and recurring revenue, and from there the potential begins to get downright preposterous.

Most recently, management estimated that the number of partners they have who have begun some sort of production using their technology to be, "probably 30 to 50." Significantly, there appear to be several heavy hitters in the bunch besides Wal-Mart with people scanning activated brand labels on grocery store shelves for Dr. Pepper, Smuckers, and Procter & Gamble. In fact, a secondary benefit to owning shares of DMRC may be that trips to the grocery store become Easter egg hunts for watermarked items.

Looping back to my quote from two years prior, things have taken awhile and they will most likely continue to creep rather than sprint (whether share price will do the same is another issue.) That being said, management has been learning as things have moved forward and are applying their new knowledge to help speed up the process.

Most dramatically, Digimarc has pushed against the idea that companies all need to run their own studies. This has led to national commissions in Germany and Japan where businesses can coordinate their testing and cut down on time to market. Signs point to things going well in these regions, as if one refers back to the job postings earlier in the article, they will see that local sales staff is about to be put in place.

Additionally, during the passage of those two years, stores of all sorts have continued to upgrade their scanning technology from laser based to image based, enabling the recognition of invisible watermarking. This is in accordance with the recommendation of GS1 the independent organization that manages barcoding systems. The shift is not happening because of Digimarc specifically, but the company is a happy beneficiary.

A final catalyst that should shorten the timeline of widespread adoption of digital watermarking is Amazon (NASDAQ:AMZN) acquisition of Whole Foods (NASDAQ:WFM). The conventional wisdom is that retailers who may have been tentative about taking the plunge suddenly see themselves in a more 'adapt or die' type situation as the online retailer brings its ruthless efficiency to their doorstep. Needless to say, there should be some interesting insights regarding sentiment during the Q2 call.

Consumer packaged goods companies may not feel the pressure of Amazon, but they have their own incentive to cross over approaching as new nutritional labeling requirements eventually go into effect. If a company must update their packaging anyway, the logic goes, that's the opportune time to embrace the invisible barcode.

There are other things to like about Digimarc that extend beyond this application or even this technology. They watermark audio, prevent eBook piracy, have a legacy business that protects US currency, and own a host of patents that in the past they have licensed as a means of generating revenue. Close partnerships with HP and Shazam, among a host of others, add major names and demonstrate the breadth of their ecosystem. Finally, an examination of their balance sheet will show they carry no debt, and have a multi year runway of cash on hand.



But the invisible barcode dwarfs these in terms of opportunity and so has been the focus here.

Two years ago Digimarc was a 'not if but when' type play. Now, there are a known two million in bookings that will be hitting the top line soon, and from there the initial master services agreements along with drips and drabs from other retailers and CPGs should begin to snowball. It's no longer about the when, it's about how much. And signals from management and store shelves are indicating that the answer will be a very large number.

Disclosure: I am/we are long DMRC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

https://seekingalpha.com/article/4086011-digimarc-wait?app=1&auth_param=f4h1u:1clsa5i:fa9480d69204518c655fa9e7cc7a24fd&uprof=54#alt2