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DMRC Digimarc Corporation - Initiation Note

Digimarc Corporation

BUY (DMRC, $28.35)

Retail Revolution Driven By The Barcode – Initiating With A BUY Rating & $36 PT

August 28, 2017

Ilya Grozovsky

212.417.8219

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INVESTMENT CONCLUSION
We are initiating coverage of Digimarc Corporation with a BUY rating based on our belief that the company’s Barcode and Discovery technologies will bring about a revolution in the retail space. Digimarc’s ability to fund these new products with profits from long term government contracts for its legacy products, gives us comfort and a baseline for future growth and mitigates some business risk. We believe that the retail and CPG landscape is ready for this innovative approach to barcoding the visual and audio universe, and is supported by recent major market trends such as the Amazon (NASD: AMZN-NR- $945.26)-Whole Foods acquisition. We are establishing a 12 month price target of $36 per share based on our belief that as Digimarc progresses and begins to bring its Barcode technology to the broader market, the discount to fair value that is being applied will narrow.

DMRC

COMPANY PROFILE
Based in Beaverton, Oregon, Digimarc provides businesses and governments worldwide with the means to identify all forms of content, including audio, video, packaging, and imagery. Digimarc develops solutions, licenses intellectual property, and provides development services to global business partners across a wide range of industries including banking, retail and consumer packaged goods (CPG), media, entertainment, publishing and several others. Digimarc holds a large and growing intellectual property portfolio that spans the breadth and depth of innovation in digital watermarking and content identification, with over 1,100 issued US and foreign patents, and even an Emmy Award for technology & engineering (won in 2015). Digimarc’s solutions enable the reliable, efficient and automatic recognition of objects and many media formats, a technology category known as automatic identification and data capture (AIDC) or “discovery.”

Digimarc Corporation participates in the watermarking space, providing protective technologies primarily to central banks. However, Digimarc is investing in barcode and discovery technologies as it plans a significant push into the retail and space and into consumer packaged goods (CPG), which comprise short lifespan products that are typically purchased multiple times, as opposed to durable goods which last.

Implications of Amazon Whole Foods Acquisition. We believe that the June 16, 2017 announcement that Amazon is buying Whole Foods has created an expectation that Digimarc’s Barcode and SDK technologies will be the new “norm” of grocery shopping, expediting check out and enhancing the shopping experience.

Hot deal pipeline. Digimarc has made clear during previous earnings calls that it is in the process of negotiating several deals with CPG providers that management was not able to disclose at the time. It is expected that some of these will be completed and publicized leading to a further expansion of market share for Digimarc’s product. Along with the announcement of a growing partnership with WalMart, Digimarc is engaged in conversations with the top 10/10 major retailers.

International expansion has potential for driving increased revenue growth. Digimarc has announced in 2016 its partnership with GS1 in Germany, which will provide for greater global adoption of Digimarc’s barcode and SDK technologies in Europe. Digimarc has also partnered with Dai Nippon Printing Co., Ltd. (DNP), SATO Corporation (SATO) and Monic Corporation (Monic) to form a Study Group, "Shopping for the Future," aimed at creating a market in Japan, in order to address the dramatic change in demographics there and how this will affect the retail industry.

Dependence on small group of customers for majority of revenue stream. A small number of customers account for a substantial portion of Digimarc’s revenue. Therefore, we believe that the loss of any large contract could significantly disrupt the business. We believe that as Digimarc will continue to depend on this small number of customers, it will act on this pressure to expand to different sectors over the coming years.

Potential for augmented/virtual reality applications for marketing. Digimarc’s barcoding and scanning technologies can provide visual identities that may be accessed through augmented/virtual reality platforms, such as Oculus goggles, Google Glass, Snapchat Spectacles, and others. We believe Digimarc can play a key role in this augmented reality by providing unique visual access to products and advertisements.

We are initiating coverage of Digimarc with a BUY rating. We are initiating coverage of Digimarc Corporation with a BUY rating based on our belief that the company’s Barcode and Discovery technologies will bring about a revolution in the retail space. This, coupled with the unique financing structure of the company that allows it to rely on long term government contracts to fund its development of these new products over the next several years, make this a strong stock from our perspective.

We are establishing a 12 month price target of $36 based on our DCF analysis. We are establishing a 12 month price target of $36 per share based on our belief that as Digimarc progresses and begins to bring its Barcode technology to the broader market, the discount to fair value that is being applied will narrow.


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