Dolby Laboratories: The Sound Standard - [Business Breakdowns, EP. 107]

26:43There's over a billion smartphones, and these are very rough numbers, but over a billion smartphones are sold each year, more than 300 million PCs and laptops, over 200 million televisions, over 250 million setup boxes and things like Firesticks and Rokus, over 100 million smart speakers. The list goes on and on. And all of these product categories could theoretically generate Dolby some royalties. So their TAM, if you like, their revenue opportunity is really a function of their value add that they can bring to that broader consumer electronics market. So hard to put an exact number on it, but the market from which they get a toll, consumer electronic volumes more broadly, is clearly vast.

27:23So there's plenty of runway for the business. Vast, and it seems to be growing. If we dive into Dolby specifically, how do you think about their own size and scale in the market, revenue, EBITDA, any KPIs or metrics which you find particularly useful for measuring the size and relevance of the business. So today, Dolby generates total revenues of approximately $1 .3 billion. For context, this compares to around $400 million back in 2006 following the IPO. And while growth has not been linear, this translates into a long -term compound annual growth rate of approximately 7 % to 8 % per annum. Now, this is also a very profitable business, not really a surprise given the royalty nature of the business model, EBIT in absolute terms is approximately $250 million on a gap basis.

28:13Now, Dolby is fairly opaque in terms of tracking specific KPIs. Something that we view as important is obviously R &D. Dolby spends around about a quarter of a billion dollars annually on R &D. And I think there's a few things we can note here. Given the royalty -based business model, ensuring technological leadership is an imperative. Dolby's investments in R &D have been persistent regardless of the year -to -year change in revenues. So for example, there was no pullback in R &D spending during the difficult years in the early 2010s when certain consumer electronic licensed revenues were weak.

28:47In fact, R &D's importance in the P &L has grown. R &D to sales has increased from 8 % in 2006 to 21 % today in the process. Absolute R &D expense has grown 14 % per annum in absolute terms. And while a quarter of a billion dollars is clearly not a small number in any case, the fact that Dolby is focused exclusively on audiovisual codecs means this is actually an even larger barrier to entry compared to a more diversified company. One metric we can track from an R &D perspective is the patent portfolio. Currently, it sits around 17 ,000 patents. And this is a portfolio that has grown at a CAGR of almost 20 % over time.

29:31And importantly, based on our analysis, it looks like the average duration of the patent portfolio has also been increasing over time. So in practical terms, Dolby's patents stretch out to around 2046. The final point I'll make with regards to R &D is you could almost characterize Dolby as a centralized R &D function for the audiovisual industry. it makes much more sense to have a single business working towards the continued evolution and improvement of codec technologies. And homogeny of standards is a huge benefit for everyone inside the industry. And just to clarify that one point on the R &D budget, that comes after EBIT, is that correct?

30:12The EBIT of 250 is inclusive of that R &D spend, absolutely. Oh, it is inclusive of the R &D spend. Okay. Yeah, I wasn't sure if it was a capitalized number. Okay. So completely changes the dynamics if not all of the EBIT is flowing back into R &D expense. And that explains a lot of the additional expenses that go into the model. That's why those are the interesting questions to ask. You've tapped into the royalty pricing model a few times, and we've beaten around the bush a little bit. Can you outline what that looks like, how that's changed over time, and the important dynamics that make up the royalty pricing model?

30:48So a recurring theme with Dolby is that disclosure isn't great. There's always a little bit of guesswork going on. And unfortunately, I'm going to give you another slightly vague answer, Matt. So as we know, Dolby's core revenue model is licensing its technology to third parties. They go incorporate that into products like smartphones, TVs, game consoles, sound systems, whatever. And in return, those manufacturers need to pay a royalty every time they sell a device. How is that royalty decided? What's the royalty pricing mechanism? It's commercially sensitive. So Dolby doesn't give us much help here.

31:22They don't give us straightforward answers. What they will say is that it ranges from cents to dollars. And if you were to really force me and say, okay, well, what's the rough rule of thumb? I'd say probably something like a dollar per device is the average royalty blended across all the different product categories. And importantly, that differs depending on the nature of the implementation, the mix of technologies that are being used, and then also volumes because they're very heavy volume discounts as well. So Atmos and Vision in particular are very important growth drivers because they will be materially accretive.

31:55We don't know the exact number, but materially accretive to that average royalty rate. So a high volume, highly concentrated product category that is using relatively basic, there'll be technologies, will on average have a lower royalty. And this is why we think, for example, the smartphone category, high volume and concentrate in the hands of just a handful of OEMs, Apple being the 500 -pound gorilla, that's why we think royalties on smartphones are probably the lowest across the different product categories. And on the other side of the ledger, a lower volume, less concentrated product category that uses richer technologies, so uses vision, uses Atmos, will have much higher average royalties.

32:33And that's why we think the TV market, for example, will be at the top end of that range, more than a few dollars compared to smartphones in the kind of sense range. That $1, if I just step back and think about pretty much all of the devices or products that we've referenced, none of those are really sold for under $100. Many of those are multiples of that. So Dolby as a percentage of the overall sale is sub 1 % of the sale of any product. Is that a reasonable rule of thumb to think about? It's difficult because obviously ASPs vary a lot, but I agree completely with the thrust of your question.

33:08If you're buying a $500, $1 ,000 TV and Dolby's maybe getting one to maybe $3 for every TV sold, this really isn't a material impact for the OEM. And something Paul said earlier, I think is important to remember. The OEM is getting benefit from incorporating Dolby technologies. Yes, they're the ones having to pay the royalties, but the consumer recognizes the Dolby logo, recognizes its relevance to high quality audio. And so they're actually able to usually price up. So what we typically see when Dolby introduces new technologies or tries to attack new product verticals is there's a bit of a kind of S -curve for adoption.

33:42So they start in the very high -end models. And if you wind the clock back five or six years ago, Atmos and Vision were mainly on the $2 ,000 TV sets. And then over time, they kind of percolate down. So that's usually their go -to -market. And we'll come to it later, but automotive is an interesting example of a much higher ASP category that they're looking to attack. We'll save that for later because I think that's an interesting bull case for the stock. Yeah, I have Dolby logo slapped into my car. They get really excellent real estate. You mentioned it before across various products. It's impressive that that's a piece of the sales process as well, making sure that they're featured.

34:19I wanted to tap into one of the markets we've referenced a little bit, but has certainly undergone some issues. It's one that I think about Dolby originally being associated with, which is movie theaters. Is the structural uncertainty, potential terminal decline of that industry a serious threat to this business? So you're right that the movie industry and cinemas broadly used to be a very important part of the Dolby business model. So in the 1990s and the 1980s, selling equipment to those cinemas was a big part of the business. Today, it's not. So licensing accounts for 93 % of revenues and substantially all of gross profit.

35:01It's about 99 % of gross profit. Now that remaining 7 % is product sales and services. And most of that is selling equipment to cinemas. In addition, there's some other bits and bobs in there, mastering services for Hollywood studios. There's other forms of support and consultation for content creators. But most of that product sales and services is the sale of equipment to cinemas. If we were undergoing a structural decline in the cinema market, that 7 % of revenues is under threat, but the profit contribution from it is essentially zero. So we're not particularly worried if that part of the business is in terminal decline.

35:34Now, there's one other part of the business where cinema exposure does pop up, and that's within the licensing side. So within the 93 % of sales that come from licensing, Dolby does earn royalties from its branded cinema experience, which is called Dolby Cinema. And if you haven't come across it, it's a lot like IMAX in many ways. So to be very clear, Dolby is not a cinema operator. But what they do is they sell specialized Atmos and Vision playback equipment. They set the specifications in terms of seating and screen. They leverage their brand. And then they operate those screens in partnership with the actual operators.

36:11So AMC, for example, is one of their big partners. And in return, Dolby earns a percent of all the box office receipts that are generated from that screen. And there's something like 260, 270 Dolby screens globally now. The majority of them are in the US. And as I say, AMC, for example, are a big partner of them. We think Dolby Cinema accounts for probably low single digits percent of licensing revenue. So it's not a material headwind if that is also part of the business that we think is structurally challenged. What I would say, and this is particularly true post -COVID, is that actually the cinema market is probably bifurcating.

36:45Legacy kind of mainstream offerings with those dated seats and small screens and tinny sound that haven't been updated since the 1990s, that's probably not an experience that the consumer is super pumped to pay for, particularly post -COVID. But actually, premium cinema offerings, and Dolby Cinema is arguably the most premium of all, have actually seen a really strong rebound post -COVID. And the growth rates pre -COVID were also strong. So we actually think there's quite an attractive outlook for that part of the licensing business anyway. How do you think about the cyclicality of this business more broadly?

37:16It sounds like there's certainly a large component which is tied to consumer devices. There's some GDP or GDP plus element to it. There's other end markets which have their own dynamics. How do you think about what this business looks like from a cyclical perspective and how that's really trended over time as well? So we need to make the distinction between cyclicality and product cycles in the end markets, the consumer electronic markets that Dolby supplies its technology to, and then also the product cycles within the Dolby portfolio of codex itself. We start with the end markets. The consumer electronics through which Dolby monetises IP are inherently cyclical.

37:55These are discretionary purchases in terms of their nature and therefore will ebb and flow with the economic cycle. That said, there are a number of considerations we need to overlay here. Firstly, there is considerable diversity in the range of devices that Dolby monetizes its license revenue through. While that doesn't necessarily reduce cyclicality per se, it reduces the risk of being overexposed to the economic impacts on a single category of devices. Within this, we also need to think about the impact of different product cycles. So if we wind the clock back to the mid -2000s, Dolby was growing revenues over 20 % per annum for a number of years from kind of 2005 onwards.

38:36This growth was being driven by the adoption of optical disk drives by primarily those included in DVD players and PCs. Notably, this growth was despite the negative impact on consumer electronics from the financial crisis. So I think this speaks to the point that product cycles can overwhelm broad economic weakness. I guess the flip side of that is by the early 2010s, the market for optical drives was becoming saturated, meaning Dolby was entering a period of digestion. The positive here is that while royalties associated with DVD drives were in decline, Dolby was seeing accelerating adoption of its IP in new use cases.

39:15So these included those embedded within TVs, which were increasingly becoming smart for streaming services, as well as those royalties that were growing from the mobile phone market. So these were two offsetting forces, which was something of a wash from a revenue standpoint. Now, Dolby didn't ultimately return to a level of consistent mid -single -digit revenue growth until around 2016 throughout this entire process. The situation we find ourselves in today isn't completely dissimilar, although somewhat nuanced. So consumer electronic sales are coming off a relatively strong period of demand following the pandemic, particularly the broadcast segment which captures royalties associated with TV sales.

39:57It's probably no surprise a portion of excess consumer saving during the pandemic coupled with stimulus checks found its ways into consumers upgrading their TV sets. Now the air pocket in growth that this has created has also been exacerbated by general economic weakness in recent periods. So this has been a sizable headwind to Dolby's core foundational license revenues for codecs such as Dolby Digital Plus and AC4. The positive here is that Dolby is benefiting from another type of product cycle. While during the 2010 to 2016 period, it was a few broad -based categories of consumer devices picking up the slack when optical drives began to rebase, the forces today are much more specific to Dolby, primarily in the form of Atmos and vision adoption.

40:45So growth in these next -generation codecs has been plugging the gaps over the past 18 months, leaving revenues kind of flat to slightly down at a total company level. However, it kind of seems only a matter of time before base foundational stabilizes as electronic device sales normalize, at which point Dolby will benefit from the full effect of Atmos and Vision adoption from a total revenue standpoint. So that's a very meandering path I've taken on there, Matt. But maybe to circle back to your original question, how cyclical is Dolby? But I think this depends on the level of maturity of the business vis -a -vis the level of ongoing innovation.

41:22An entirely mature Dolby ultimately offers you a royalty on consumer electronics volumes, which would be undeniably a cyclical income stream. However, this is not the Dolby of today, as the business continues to invest in moving the industry to the next generation of codecs, which both expand use cases and increase royalty rates. So we'd expect this factor to significantly dampen cyclicality in Dolby's revenues over time. That makes a lot of sense. You mentioned the general EBIT margin profile around 20 % before. How capital intensive is this business? Obviously, a lot of that is including an R &D budget in it, which we clarified.

42:03But in terms of CapEx or any type of free cashflow dynamics, what does this look like for the business? So maybe starting off with a bit more detail on the margin profile of the business, and then we'll tackle capital intensity. but Dolby's licensing business model makes it attractive from a margin and a cash flow perspective. So at a gross margin, Dolby generates a 95 % margin on its licensed sales, although at a group level, the gross margin has pulled down a bit to around 88 % due to the lower margin products, primarily those relating to equipment for Dolby Cinema. And now this naturally provides ample opportunity for reinvestment further down the P &L, and Dolby certainly does that.

42:40So we've already discussed the high levels of reinvestment into R &D, which is currently running about 20 % of sales. The other large cost buckets to think about is firstly sales and marketing. This is also sizable. So Dolby spends around 28 % to 30 % of sales here. And this investment is particularly relevant today, given we are still in the fairly early stages of mass adoption of the next generation codex we've talked about. And we're also seeing on top of that, expanding use cases. So this cost bucket primarily reflects Dolby's direct sales force, which both manages the relationship with device manufacturers, content creators, while also promoting the brand and technology at trade shows, conferences, and other industry events.

43:20The final bucket is G &A, which normalized is around 17 % of sales and primarily captures central costs. I think it's fair to say Dolby's more bloated cost structure is best reflected here, and we kind of struggle to see why that couldn't be a bit lower over time. But when you add all of that up, you get to this EBIT margin currently of around about 20%. And notably, this is the gap margin. So it fully accounts for stock -based compensation expense, which is there and is a real cost to us as shareholders. Thinking about where this margin could go on a prospective basis, we could argue that this is a trough point in profitability for Dolby, given we've got the combination of current market weakness in the core foundational business, while the company continues to spend aggressively on R &D and sales and marketing to progress the adoption of the next generation technologies.

44:11And if we look back at history, this is a company that has reported an equivalent margin in excess of 50 % at EBIT level. Now, this was, to be fair, in the early 2010s, around the time of peak sales of optical drives for DVDs. Now, at this point in time the business was growing 20 % and no surprises given the high gross margins Dolby has, it benefits from sizable operating leverage. So from our vantage point, when we think about the margins on a go forward basis, we kind of think they end up somewhere between where they are today and where they have been in terms of those peak margin levels. As it relates to capital intensity, look, this isn't a capital intensive business.

44:51Dolby is very cash generative. Cash conversion is typically around 100 % of earnings through time. CapEx to sales, which is very little of that is any capitalized R &D expense typically is in the 5 % to 6 % range. And actually, I think this overstates the capital intensity of Dolby at maturity because it includes some ongoing investments as they roll out the Dolby Cinema offering. Interesting point there in terms of potential operating leverage and when you have that type of gross margin opportunity to take on the overhead costs that exists. And I think you mentioned a little bit there with SG &A and where you might see that come into play.

45:28I want to talk a little bit about risks, threats to the business. I have some general questions or some particular subjects, but would be curious to hear your views first on what the major risks are here for Dolby. So maybe we'll start off with a more technical risk, which is line of sight on revenues. This isn't a business which gives you a best -in -class line of sight like you would with a best -in -class software company. And I guess this isn't a threat per se, but more a downside of the business model and something we've debated a lot amongst ourselves. So due to the license -based business model and diversity of devices that now incorporate Dolby's technologies, it's quite difficult for investors to have a clear view of that shorter term progression of revenues.

46:12This issue actually is magnified a little bit by accounting rules, which require that Dolby estimates device shipments, then uses true -ups quarter to quarter to adjust revenues based on shipments formerly reported by its customers. And while these adjustments are quite small, they create quite a lot of noise that amplifies that quarter to quarter volatility. And then on top of that, if you overlay the cyclical elements of device sales, it does create some challenges in predicting the shorter term. So potential investors in Dolby need to have their eyes open on this point. It's just the nature of the business model.

46:45I mean, that said, I think you need to consider that alongside Dolby's incredible market position, and of course, the continued rollout of new technologies. So this potentially means your conviction in the longer term prosperity of the business over the coming decade is maybe that bit higher, but we'll let others decide on that. So that's kind of risk one. The second one is probably more existential and it relates to the very nature of licensing business models. Licensing business models have a few notable benefits, not least the very high gross margins associated with a product with no direct marginal costs.

47:19This does increase the risk of your IP being abused. So to a large extent, Dolby is reliant on customers declaring and paying the right royalties when they use the company's IP. And as Dolby doesn't produce a physical product, they don't have anything they can withhold from customers in response to any such abuse. So when we think about obvious examples of problems occurring with licenses businesses, the immediate example that springs to mind is Qualcomm. They saw a few years ago, customer disputes with customers based in China, disputes with Apple, where customers were refusing to pay royalties relating to IP used in smartphones.

47:58And at the same time, Qualcomm was kind of fighting an investigation by the FTC into anti -competitive business practices. There are quite a few reasons why we think Qualcomm is an extreme example and why we feel relatively comfortable with Dolby despite a similar business model. Firstly, we think there's clear alignment of interests within Dolby stakeholders. This comfort primarily stems from the relatively nominal dollar royalty rate that customers pay to Dolby. So Matt, to your point earlier, less than 1 % of a product's ultimate sale price is going to Dolby in terms of royalties, and that feels very reasonable to us.

48:37You compare this to Qualcomm, which was charging a percentage royalty based on ASP of the device sold, and you can kind of see a stark difference in approach there. Another factor is there's a complete lack of conflict of interest in the way that Dolby manages its relationship with customers, operating almost exclusively as a provider of IP, which benefits the entire industry. Now, again, if we go back to the Qualcomm example, they were simultaneously licensing their IP whilst also selling semiconductor chips to the same industry and then using this as a tactic to negotiate more favorable terms, which was part of the FTC complaint.

49:16And then finally, when we look at Dolby's customer concentration, it's relatively low. So no one customer represents more than 10 % of sales. And we also have this diversity in terms of device types. All of that together means, yes, we acknowledge licensing business models carry some risks we need to be aware of, but we do feel they're relatively appropriately mitigated as much as possible within Dolby's overall business strategy. Historically, when there's been releases of something like Alexa, other smart speakers, what stops an Apple or an Amazon or Google from just producing this technology in -house?

49:54I suppose it goes back to two things. The first is the patent protection. And I suppose this is both a benefit and a risk. Dolby has 17 ,000 patents that protect them from direct competition with their technologies. We know that's a risk as well. And we've seen businesses that rely on IP, the pharma industry is probably the most notable, that when they do roll off, you're exposed to potential competition that can come in and compete on price. We think that element is actually fairly well contained for Dolby for three reasons. One, they've always done a really good job of extending protection windows.

50:27Their kind of cliff is always moving further out. Two, they always migrate customers fairly successfully to newer versions of technology. So WDigital is actually mostly off patent in the majority of markets. So they've rolled those customers to WDigital Plus or AC4 and Atmos. So they've done a good job at also migrating customers to newer technologies that again, extend the protection windows. And the final point is around branded technology. This isn't just that it delivers superior audio, it's that it has positive brand transference for the OEM. So that element above and beyond the technology is an important consideration for someone looking to cut Dolby out.

51:03But to go back to your question, though, remember the closed loop that, yes, someone else, Alexa, someone else, Apple could go out and say, hey, we've got a competitor to Atmos. It's as immersive as Atmos, but it's our own proprietary format and we don't have to pay those royalties to Dolby anymore. Well, Apple then needs to go and convince the content producers to actually encode their latest films, their latest television programs in those formats. And then they need to convince the distributors that those are the right formats to use. Now, the thing is, with someone like Apple deciding to try and introduce those formats into the ecosystem, is that no one trusts Apple.

51:40Everyone presumes Apple is looking after Apple, which they rightly are. The thing is, with Dolby being someone outside of the actual manufacturing process, their trust is an independent third party that yes, you have to pay royalties for them, but they then offer that to the entire industry and they're not trying to create an ecosystem that just benefits certain manufacturers. That's why we see someone like Apple who, it's fair to say, are known for being pretty aggressive with their supply chain and can be quite sharp elbowed with competitors. They are wholeheartedly supporting Dolby in everything they do.

52:12They were early adopters of both Atmos and Vision. What they're doing with Apple Music is really opening Atmos up to an entirely new market as well. So we think that is actually a very strong indicator of the value of Dolby's technologies, even to a company as sophisticated and commercially savvy as Apple is. And when it comes to visual, this feels like a pretty big step for a company that has historically been in audio, something that shouldn't be necessarily glossed over, that it's extending maybe beyond what they've historically had as a core competency. How much of the bull case or how much risk is there just in terms of investing into visual, pushing into visual?

52:55Is this a really important inflection for the company in terms of if visual does not catch on, does not work? Is that a major risk for this business? How do you frame that? It's now a very core part of the bull case. So I'll sketch that in a moment, but we think Vision is actually already quite far along in terms of becoming a new standard in the same way that Dolby's audio codecs and Atmos are becoming standards. So Vision competes against other HDR formats. There is a open source format called HDR10 and another one, a kind of successor technology called HDR10+. Although they don't attract royalties, have struggled to see the same kind of uptake that Dolby Vision has.

53:38And the reason for that, again is its place in the ecosystem. Dolby does a great job at helping content producers and distributors understand the value of the technology, make sure they're using it correctly, and make sure they're distributing it correctly. When you're open source, you don't have a kind of quarterback playing that role. The other thing is that HDR10 Plus is mainly sponsored by Samsung. And we have the same kind of problem that we described earlier with Apple, that Apple, for example, refuses to use HDR10 +, because they obviously compete with Samsung in the smartphone market and in other adjacencies.

54:12So because of that, any format that is introduced that has the backing of a major manufacturer, people presume there is a competitive edge there. And that's why Dolby is so uniquely placed to introduce new formats into the industry. Now, the bull case more broadly, I think, let's sketch it out. So in a nutshell, the bull case is that Atmos and Vision get to the same kind of penetration rates that the foundational audio technologies are at today. So Dolby Digital, Dolby Digital Plus, they are pretty much ubiquitous across product categories like TVs, PCs, smartphones. And today, those foundational audio technologies account for about 70 % of sales.

54:52We think that grows low single digits through cycle. And the reason for that is that penetration rates are pretty much capped. So they can go maybe a little bit higher, but they could slip in other categories. So we think it's a wash. They're pretty much where they will be. Royalty rates for those foundational technologies are also flat over time. So really, all you're getting is that index on volume growth. And through cycle, what we see is that consumer electronic device volume growth is kind of a low single digit range. So that's the growth rate in 70 % of the licensing business. Where things get exciting is the other 30%.

55:23And the other 30 % is a combination of Atmos and Vision. So these newer technologies. and they're growing much faster. And the reason for that is that penetration rates are much lower at the moment. Dolby being Dolby, we don't have great disclosure on this, but what we do know, for example, is at the end of fiscal 21, Dolby Vision was on something like 20 to 25 % of 4K televisions. So call it low to mid teens of the entire TV market. And again, we don't know the exact number, but we do know that Dolby Digital and Dolby Digital Plus are on north of 50 % of all TVs worldwide. That's something that Kevin, the CEO, has said.

55:56And actually, it's substantially higher in Europe and in the US. In Europe and in the US, close to every TV will have either Dolby Digital or Dolby Digital Plus. And so Dolby management have kind of pointed to this Atmos and Vision opportunity and said, well, actually, it's going to be at least as big as foundational audio in the fullness of time. And we think it can maybe grow 15 % to 25 % per year for the next three to five years. So if we take low single digit growth in 70 % of your licensing sales, and let's call it 20 % growth in the other 30%, you put those together and you actually have line of sight for Dolby accelerating to potentially low double digit top line growth.

56:32And that's something the business hasn't actually achieved in a very long time, not since those kind of heady days of the DVD cycle. Now with 95 % gross margins and what we think should be a fairly fixed kind of operating cost base, you can see that that significant latent operating margin potential should start to really kick into action if you're growing at that sort of clip. And as we discussed earlier, in that kind of 2005 to 2009 period, we saw 20 percentage points of EBIT margin improvement, 30 % to 50%. And look, we don't need to assume anything close to that this time around. And that's not what we necessarily think the business could get back to.

57:08But even if it's just somewhere along that curve, you can begin to see that there's quite exciting earnings potential in the business. So that's the bull case. Now, Now, where things get really interesting for us is the cherry on top, and that's the opportunity in automotive. Dolby technologies historically have been used in the car, but not as widely as they have in other product categories. So they're heavily used in the kind of back of the car. So if you have a kind of entertainment system in the back seats, you'll see usage of Dolby Digital, Dolby Digital Plus. But usage in the front of the car has been a lot lower than it is in other technologies.

57:41And the main reason for this is that Dolby Digital and Dolby Digital Plus aren't typically used for encoding music and radio. That is all changing with the adoption of Atmos in music. And now suddenly it makes a lot of sense for auto OEMs to really have the ability to play back Atmos in the car. And just in the last few years, we've had a number of announcements from Dolby in terms of OEMs that are introducing it across their models, Mercedes, Volvo, Polestar, Lucid, Lotus, just to name a few. Now, how big is this opportunity? Let's have some fun and let's paint what we think is a fairly blue sky scenario.

58:18But we have three variables we need to forecast. The first is the market size. So rough numbers, there's something like 70 to 80 million passenger cars are sold each year. That was a kind of pre -COVID number. It moves around a bit. Let's just call it 80 million for the purposes of this exercise. Second, we need to work out the penetration rate. Where does Dolby Atmos get to? Now, Kevin, the CEO, says he wants to see Dolby in every car in the world in the same where he wants to see Dolby in every TV, every smartphone, every soundbar. So let's just assume they can get to 50 % in the fullness of time.

58:49So they can get half of that market. The third variable, of course, is the royalty rate. We don't know it. Dolby's not going to hold our hand on this. We know it varies from cents to dollars. But what they have said is that the royalty rate will be materially higher for automotive than it is in other categories. As we were talking about earlier, a $50 ,000 car is not the same as a $500 TV. So let's just say for the purposes of this conversation, that they can get to $50 royalty. And actually, as a percent of ASP, that would actually be lower than it is on a kind of typical TV. So 50 % penetration of a 80 million unit market with $50 royalties, we're talking about a potential $2 billion licensing revenue opportunity.

59:31And that's on a business that today is doing $1 .3 billion in revenue. Potentially very, very exciting. Now, to be very clear, we're very early on in this journey. And this is really a source of optionality, but it's a pretty exciting form of optionality that we think sits on top of what is already a fairly attractive base case. It would certainly be a nice cherry on top, I think, when you outline those numbers. I've learned a ton here as a self -proclaimed audio man. There was way more to audio that I didn't understand and a lot of great takeaways, learnings. When you think about looking at this business, we always close with what lessons can be pulled out and applied for investors when looking at either this investment or other investments.

1:00:14What would you key in on here with Dolby for lessons? So for me, it's the merits of investing in family -controlled businesses. So Dolby is a controlled company. The Dolby family still have something like 35 % economic interest, but because of the split share class structure, it's something like 85 % of the combined voting power. Ray's son, David, is still on the board. And I think sometimes investors shy away from those types of businesses. Clearly, minority shareholders have very little ability to enact change. At Dolby, I think it's fair to say the company's disclosure and communication with the market is not where it would be if they didn't have a controlling shareholder.

1:00:55Maybe their cost structure wouldn't be, we'll use the word bloated, let's just say well -invested. Maybe it wouldn't be so well invested if they didn't have a controlling family at the helm. But we think, on balance, this type of ownership structure is a strong net positive for a business like Dolby. Dolby has survived waves of technological disruption over its long history. The digitalization of cinema in the 1990s, the shift towards streaming in the early 2010s, they really had an impact on Dolby's revenue model. And yet each time the companies come through that and come through it stronger.

1:01:32And if there was a management team at the helm with a shorter term horizon that was more interested perhaps in margin preservation during those periods, we think the business would be in a lot worse shape than it is today. And actually having that ownership structure with an intergenerational focus of compounding actually means that management can take those long -term views and make investments in technologies like Amos and Vision, which didn't pay off for the first few years, but we're now seeing some really nice incremental returns on invested capital. And maybe to add one, from my side, I think Dolby is a great case study for the benefits of strong stakeholder alignment.

1:02:08Stakeholder analysis is a big feature of our research process, and we believe good alignment can provide much higher confidence in the persistency of long -term cash flows. And as Will has explained, Dolby has been extremely careful and strategic about the way in which they monetize and price its IP. Now, this has created an industry dynamic whereby large consumer electronics companies have championed the company's technologies. So we shouldn't understate the point made earlier about Apple's willingness to actively promote Dolby as a brand. And that's a very, very, very unusual situation. And this dynamic has only come about because pricing relative to value delivered is so fair in Dolby's instance.

1:02:49Well, Paul, William, this has been an excellent conversation. Again, I have learned a ton about Dolby and the broader technology behind it. Thank you very much for joining us on Business Breakdowns. To find more episodes of Breakdowns ranging from Costco to Visa to Moderna, or to sign up for our weekly summary, check out JoinColossus .com. That's J -O -I -N -C -O -L -O -S -S -U -S .com.