Here is what Briefing.com had to say about C CUBE on feb 24, 1997:
C-Cube: Stay the Course
Daily commentary updated February 21, 1996
Company Brief
C-Cube Microsystems (CUBE 26 3/8) is a leading developer of integrated circuits and software that implement international standards for digital images and video. The company's compression
technology allows for full-motion video and true-color images to be incorporated into such
fast-growing applications as multimedia computing, cable/broadcast television programming and CD-based consumer electronics. The company recently acquired DiviCom, a leading provider of
systems hardware and software for Digital Video Networks (DVN), such as Direct Broadcast
Satellite, digital wireless, etc. The acquisition puts C-Cube in the position to provide the most
complete system solution for the deployment of DVNs.
In Retreat
Since our original bullish report on 12/24/96, CUBE has staged a full retreat - dropping by as many
as 12 points (33%). Much of the selling has occurred over the past few days in response to a
negative article in the March 3, issue of Fortune, entitled "The Little Chipmaker That (Probably)
Won't." In the article the columnist states that C-Cube's "hold on the VCD chip business is slipping -
ESS Technology is selling a cheaper chip and gaining market share." The article also raises questions
about C-Cube's ability to succeed in the impending Digital Video Disk (DVD) marketplace,
suggesting that competition there will be even more intense. Finally, the article points out that it could
be a "long" time before C-Cube benefits from the DVD market due to the delayed rollout of DVD
players in the U.S. As if the above wasn't bad enough, the enlightened author notes that C-Cube is
o ne of the most heavily shorted stocks on the Nasdaq.
These concerns are both old and exaggerated. Nevertheless, the article ignited panic selling that has
left the stock damaged from a psychological and technical perspective. But in our opinion this sell-off
creates an exceptionally good long-term buying opportunity for aggressive growth investors, seeking
above average capital appreciation. Of course, the stock's volatility makes it a candidate for only the
most risk tolerant investors.
Through the Fog
In order to get a clearer view of C-Cube's future, we will attempt to lift the fog of uncertainty
created by the Fortune article. First of all, it should be noted that while ESS is gaining market share,
C-Cube remains the dominate player in the industry - serving over 75% of the VideoCD market
worldwide. Though CUBE is likely to continue slowly losing market share, as is natural of an
industry leader in such a fast growing market, the explosive growth of the company's market should
enable the company to continue growing profits and revenues at a strong double-digit pace over the
next several years. In addition, C-Cube's wider range of chips, variety of price points and strong and
expanding list of strategic partnerships will make it difficult for the competition to keep pace. These
factors, in conjunction with tight cost controls and impressive volume gains, have enabled C-Cube to
grow margins even while losing market share.
Second, the company's history as a leader/innovator in the industry and its breadth of product
offerings suggest to us that it will more than hold its own in the Digital Video Network (DVN) and
the upcoming DVD competition. In fact, C-Cube is expected to unveil a new DVN product later this year which should again put it at the head of the field. It should again be noted that the potential
growth in these markets is great and that C-Cube doesn't need an overwhelming share to achieve
average annual revenue/earnings growth of 35% over the next few years.
As for DVD being delayed - big deal. The street didn't anticipate material revenues from this market
until FY98 - at the earliest. But at some point the emerging Digital Video Disk (DVD) business
should prove to be another growth opportunity for C-Cube. DVD incorporates MPEG2 video
technology in order to deliver studio-quality video, theater-quality sound, 135 minutes of play time
on a single side and support for multiple camera angles, multiple versions of a movie on a single disc
and multiple language versions of a movie. In addition to its applications for the movie business, look
for PC makers to incorporate DVDs into their systems to capitalize on DVD's superior data
capacity and its enhanced audio/video capabilities. Digital video also materially increases transmission efficiencies which will enhance video conferencing and enable cable TV systems to
carry 6-10x more channels of video programming.
Finally, being one of the more heavily shorted stocks on the Nasdaq could prove to be just the fuel
needed for a strong recovery. If we are right and the market begins to reward C-Cube with more
industry-typical multiples (23x-25x future earnings), then short traders will be forced to cover their
positions, thereby adding further support to the stock.
Valuations
C-Cube's wide-range of leading edge products combined with dynamic growth in the Video CD
market, the growing digital satellite business and the emergence of DVD should enable the company
to continue delivering superior revenue/earnings growth. Based on an average annual growth rate of
35% over the next three years, it is Briefing's opinion that C-Cube is attractively valued for
long-term capital appreciation, as the stock trades at a remarkably low 12.7x estimated FY97
earnings of $2.08. Though price instability partially explains why the stock trades at such a discount
to its growth rate, we believe that the market will assign the stock a higher multiple once the earnings
momentum is realized. We look for the stock to trade at 65% to 70% of its long-term growth rate,
or 23x to 25x estimated earnings. Using these parameters, our upside target is 48 to 52. However,
given the technical damage done by the recent setback we are pushing out our time horizon to 18 to
24 months.
Risks
Increased competition
Margin erosion due to pricing pressures
Continued strength in the dollar
Rapidly changing technology
Potential for cannibalization of the VideoCD business by DVD.
Market risk
Conclusion
The recent Fortune article has cast a cloud over the company's earnings prospects. Though we
don't agree with the article's conclusions, we recognize that the stock has suffered a serious setback
and will need time to consolidate before launching an advance on our upside targets. However, we
remain convinced that C-Cube's status as a technological leader in a number of fast-growing
markets positions the company to continue delivering high double digit growth over the next few
years. At present, the company trades at a sharp discount to the market, its l/t growth rate and to its
industry group. Meanwhile, projected earnings growth over the next 5 years exceeds the industry
and market growth estimates by 12% and 29%, respectively. As the company delivers on its
earnings promise, look for significant multiple expansion to propel the stock sharply higher. Our
18-24 month target range is 48-52. However, the stock's price volatility makes it a candidate for
only the most aggressive growth, risk-tolerant investors. Supports are at 24 and 21 1/2. |
