Sonic Bets on High-Quality Video on the Net with DivX Acquisition

Consider the myriad of electronic devices in the home: Connected TVs, DVRs, game consoles, smartphones and so on. Ultimately, consumers will want to get high-quality Hollywood entertainment on these devices, right?

This is the vision of Sonic (SNIC), developer of digital media software (its flagship brand is Roxio). To this end, the company has agreed to shell out $323 million for DivX (DIVX), which develops technologies that allow the delivery of high-quality video across any device.

In the deal, DivX shareholders will get a combination of cash and stock that will come to roughly $3.75 per share. The deal is expected to close in September this year.

DivX's Powerful Brand

Founded in 2000, DivX first created video compression-decompression software (known as a codec), allowing for video distribution across the Internet and on consumer hardware devices. Since then, there have been hundreds of millions of video downloads.

This wide-scale adoption has made DivX a powerful brand, which has led to a strong ecosystem of users, partners and developers. For example, the company has solid relationships with major Hollywood studios, and its technology is on over 300 million devices across digital TVs, DVD/Blu-ray players and more than 80 mobile handsets. There's also a thriving website, which gets 12 million unique visitors per month.

While DivX generates revenue from a variety of sources, such as advertising and content distribution, the main focus is on royalties and licenses. In the latest quarter, revenues came to $23.3 million, up from $18.7 million in the same period a year ago. Roughly $21 million came from licensing.

Challenging End-to-End Vision

For two decades, Sonic has been an innovator in building next-generation entertainment technologies. The company realizes that it needs to take some major steps to leverage the Internet, mobile platforms and online video. And the deal for DivX will be key to Sonic's ambitions. By fiscal 2012, the estimate is for a doubling of earnings per share (on a non-GAAP basis).

However, creating an end-to-end solution will be tough to pull off. True, Sonic and DivX claim that they have similar cultures. But that's often the claim.

So, besides dealing with major competitors, Sonic will now have to undergo a complex integration of technologies and partnerships. It's a big risk, and investors are definitely concerned and skeptical -- at midday today, Sonic shares were off almost 11%, at $10.53.