Redherring.com, January 29, 2001
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This article is from the January 30, 2001, issue of Red Herring Magazine.
Try to keep an open mind. It's true that interactive TV could easily vie for the title of most-hyped-yet-disappointing technology, but the economics are really starting to make sense. Yesterday's exorbitant hardware and infrastructure costs have come down dramatically -- adding interactivity through a set-top box costs only 10 percent of what it did just six years ago. That, combined with the powerful group of advocates having a vested interest in its success, makes sales of set-top boxes (and the stocks of the companies that make them) ready to take off.
For telecommunications companies and cable and satellite providers, ITV is the "killer app" -- providing big commerce and advertising revenue at next to no cost. How big? By 2004, 252 million homes worldwide will have digital set-top boxes, and in the United States alone $7 billion's worth of commerce will move through those set-tops, according to research firms Allied Business Intelligence and Forrester Research.
Results from the United Kingdom, where set-top boxes are already in one out of every six households, are promising. For instance, six months after first offering pizza purchases through the set-top box, ITV accounted for 2.5 percent of sales for Domino's Pizza. If companies can replicate this penetration stateside, the profit potential is huge.
OPEN & LIBERATED
Among the pure play set-top makers are two primary investment opportunities. The first, OpenTV (Nasdaq: OPTV), is the leader on the European front. With 4 million subscribers, the company generated $49 million in revenue during the past 12 months, more than all its competitors combined. OpenTV's middleware allows retrofitting of an existing base of 10 million cable boxes -- giving it an edge with current cable subscribers over competitors with middleware that doesn't allow such retrofitting. On the downside, the Mountain View, California, company doesn't connect users to the Internet. While its product beams interactive Web-style content to the TV, it does not offer the Web itself. To its credit, OpenTV has addressed that weakness somewhat with its recent acquisition of Spyglass, an HTML browser. But Spyglass needs to be converted from its Web roots in order to function effectively on OpenTV's ITV platform.
Despite its leadership position in Europe, OpenTV's stock has been pummeled. On January 29, it was trading at $19.38, down from a 52-week high of $245.75. While it still enjoys a price-to-sales ratio of 7.2 based on estimated 2001 sales of $117 million, sales should double in 2001. Combine that with potential net profit margins of 15 to 20 percent and an enormous market yet to be conquered, and there's no reason this stock couldn't hit $40 within a year.
The second interesting opportunity for investors is Liberate Technologies (Nasdaq: LBRT). The company, based in San Carlos, California, has momentum on its side, recently signing elite partners like America Online (NYSE: AOL), Cable & Wireless (NYSE: CWP), and Comcast (Nasdaq: CMCSK) onto its platform. It's also got more sophisticated technology and more substantial third-party software support than OpenTV. While Liberate had only 300,000 subscribers worldwide as of September 30, that number should grow to at least 3 million by the end of 2001.
About a year ago Liberate was the toast of the town, peaking at a market capitalization of more than $10 billion. As of January 29, however, it was trading at $16.88, giving it a capitalization of $1.8 billion. Even so, the company still has a very optimistic 31.8 price-to-sales ratio based on estimated calendar 2001 sales of $55 million. While the valuation is rich, Liberate is worth the premium, given its head start in signing deals with telecommunications companies and cable and satellite providers, as well as its relationships with third-party software developers. Not to mention the fact that Liberate appears ready to reach a 35 to 40 percent share in a worldwide market that's predicted to be $7 billion to $10 billion by 2004.
Michael Kwatinetz is a founding partner of Azure Capital Partners and was global technology head at CS First Boston. His book, The Big Tech Score: A Top Wall Street Analyst Reveals Ten Secrets to Investing Success (John Wiley & Sons, 2000), was cowritten by Danielle Kwatinetz Wood. Write to letters@redherring.com.
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