EarlyBirdCapital Research Reports
March 12, 2000
ACTV, Inc.
RATING: BUY
(iatv, $37 1/4)
Industry: Interactive TV/Internet
February 9, 2000 One State Street Plaza
New York, NY 10004
tel 212.792.8197 877.EarlyBird
Anthony Stoss
Overview
ACTV, Inc. (IATV) is a leader in digital cable "interactive TV" software solutions. The company also markets HyperTV-a software that offers media programming companies a convergence solution.
Investment Highlights
Patent Position Covers Individualized Television Programs and Simultaneous TV and Internet
Convergence Applications
HyperTV Technology Creates "Impulse" Buying Over the Internet
Shareholder/Partner Liberty Digital (LDIG) gives the Company a Strong Partner in the Cable Industry
Another Alliance, Fox Sports Net, Brings a Leading Brand Name in Sporting Events for IATV to Leverage
Distribution Agreement with TCI (now AT&T) Gives Potential Access to 20 Million Subscribers
Joint Venture for National Events with Liberty Media Offers Ability for "Interactive" Pay-Per-View (PPV)
National TV Events (e.g., Major Sporting Games, Concerts, etc.)
Recommendation
We are initiating coverage of ACTV, Inc. (IATV) with a BUY rating and a price target of $60 per share. We maintain our view that this stock should be purchased for long-term investors and also recommend purchase for investors with a shorter-term horizon. We believe the market is starting to understand, but has not yet recognized the ultimate value of the company's patent position, HyperTV product offering, or the emerging trend of digital applications for cable TV. Moreover, the industry in which IATV anticipates has seen valuations soar over the last few months, and we feel that IATV's current valuation, is not in-line with other current peer valuations. One peer comparison, Liberate, Inc. (LBRT), has seen its market capitalization rise 250% in just 3 months (Oct 1) from $1.8 billion to $6.3 billion. Other peer current valuations, Wink Communications, Inc. (WINK--$1.4 billion), TIVO, Inc (TIVO--$1.2 billion) and partner Liberty Digital, Inc. (LDIG--$10.0 billion). All of these companies are in their infancy and have relatively small revenue production. Over the last few months, the company has announced HyperTV contracts with TBS, ShowTime (unit of Viacom), The Box Music Network (also a unit of Viacom), New Line Cinema for the PPV showing of Austin Powers-The Spy who Shagged Me. The company also announced an interactive PPV event partnership with Liberty Digital and Viewer's Choice (which basically owns all of PPV). IATV has also recently raised approximately $120 million (4 m shares @ $30 in an underwriting led by CS First Boston) which should help increase exposure.
Company History/Description
IATV is a ten-year old software company focused on bringing "individualized TV" to the mass market on digital set-top boxes. The company should also enter the DBS satellite cable market as their technology works with DBS receivers. The move by U.S. cable operators from analog to digital TV that has long been building is now finally taking place. IATV's software enables interactive programming that allows viewers to select from different video feeds seamlessly.
IATV's individualized sports programming, for example, allows a digital cable subscriber to select from different camera angles, sports trivia, layer profiles, in-depth statistics, instant replay, scoring summaries and a "star cam" (e.g., follow around Shaquille O' Neal for the basketball game) all while staying on the same TV channel. This technology can also be applied to non-sports programming such as news or entertainment.
IATV also has an Internet division and a technology called HyperTV. The first application for HyperTV is focused on the educational and business raining industries over the Internet. The most recent application focuses on the entertainment market. HyperTV's technology, under the entertainment genre, has the ability to "push" e-commerce content creating impulse buying and other services over the Internet. We believe that HyperTV will drive IATV's valuation over this year.
We believe the revenue generation potential from "individualized or interactive" services is too large for cable operators to overlook. Moreover, we believe this software technology offers advertisers a new medium for target marketing and collection of marketing data by recording the viewing pattern of the subscriber including the topics viewed. Advertisers could place interactive advertisements on their systems and users could choose which advertisement they wish to view and interact with the advertisement. For example, during a Toyota commercial the user can decide to view a message about the Toyota Celica rather than the feed for the Toyota 4Runner truck.
This technology will also allow other cable television networks to differentiate their programming by offering their audience viewing choices they've never had before. Cable operators are looking for new ways to generate revenue and improve cash flow as new entrants compete for their customers. By going digital, cable operators not only boost the number of channels they offer but can provide other advanced services to attract more customers.
Industry Background
IATV's software is designed to run on digital set-top cable boxes currently being deployed by the cable industry. Cable operators are now transitioning from analog boxes to new digital boxes. In order to understand the timeliness of IATV's technology one must first understand the history of digital set-top box deployment. Members of the cable industry stated back in 1991 that they would be going "digital" in the fall. The fall just happened to be the fall of 1998. Due to recent digital set-top box deployments, and infrastructure build-out in the cable TV industry, IATV has had a wave being created behind them.
The move to digital is not intended to be a niche offering by the cable operators. They plan transition from analog to digital service in every cable home in time. By doing so, the operator frees up more valuable spectrum for itself (more channel offerings with less expense), not to mention interactive services.
Most importantly, the set-top box transition is now taking place far faster than earlier projections. On December 17, 1997, General Instrument (GIC) announced agreements with leading North American cable TV operators to supply 15 million digital set-top boxes over the next three to five years at an estimated value of $4.5 billion (GIC also an equity owner in IATV). Then, in February 1998, GIC announced that it had reached definitive agreement for the delivery of these boxes. As more of an incentive, GIC issued warrants to the cable operators, exercisable upon the delivery target levels of digital terminals, to purchase GIC stock. Scientific Atlanta (SFA), the other major manufacturer of digital set-tops, has also recently announced that a consortium of cable operators has collectively committed to purchase digital units from them. IATV has technology agreements with both of these set-top box manufacturers.
GIC has sold and placed over 1000 digital head-ends in cable operators' systems to date and has passed over 41 million TV households. GIC currently serves over 80 cable operators worldwide This upgrade to digital head-ends from analog head-ends is needed before the deployment of digital set-tops can take place. To date, we forecast that GIC alone has shipped 5 million digital terminals with most coming over the last two quarters. Moreover, we expect GIC and SFA to ship around 10 million additional digital boxes in year 2000. Now that digital set-top boxes are being deployed, cable operators are selecting the applications and other advanced services (such as IATV's) to run on those boxes.
Cable currently passes close to 97% of all TV households in the U.S., and has approximately 68 million current subscribers. While today's analog cable systems usually have the capacity to carry up to 80 channels, an upgrade to fiber and digital systems enables a leap in capacity (through compression technology) to over 500 channels.
IATV's Set-Top Box Agreements
IATV has already announced technology agreements with General Instrument and Scientific Atlanta to enable IATV's technology in their digital set-top boxes. IATV's integration with GIC's DCT1000, 1200 and 2000 boxes is already complete. The question that has lingered for some time in the industry is how quickly a digital deployment will occur. We believe that the cable operators are now in motion for volume deployment of digital set-top boxes.
Most cable operators (except for TCI/AT&T, Comcast and Cox) have sat on the sidelines over the last few quarters, not rolling out digital boxes. Over the last few months, however, those same operators have begun to announce aggressive deployment plans beginning immediately. Moreover, GIC and SFA are both announcing plans to add production lines to keep up with demand for the digital boxes. This is the key since once cable operators have an adequate number of digital boxes in their subscriber's homes, they will look to sign agreements for advanced services like IATV's.
IATV's Digital TV Service
Downloading a 17kb kernel of software (a very small amount) into a digital set-top box enables IATV's functionality. The software can be distributed to the cable operators via HITS (Head-end in the Sky) which is a mechanism for national distribution of programming and content to cable operators, or locally depending on the cable company's architecture. Once received, the IATV software is sent over the network system into their subscriber's digital cable boxes. HITS is a satellite distribution system run by TCI/AT&T and is located in Denver, Colorado. HITS is the main mechanism to distribute programming nationally and is generally not used for regional broadcasts. IATV will be able to utilize HITS to distribute its 17kb of software very quickly but the company will use traditional fiber based systems for the distribution of its regional sports programming. The individualized programming for national PPV events will also be distributed by HITS. There is no additional equipment needed at the cable operator's head-end to run this service. IATV's technology can be distributed via systems other than HITS, such as DBS.
IATV's Partners
Liberty Media & Liberty Digital- Liberty Media Group has invested roughly $9 million in IATV and will receive new options in IATV that may be exercised over a five year period. If these options are fully exercised, Liberty's investment in IATV will total more than $100 million, representing an estimated 25 percent interest in the company. In our opinion, this was the most significant event in the company's history. Liberty Media's Chairman is John Malone, the former Chairman of TCI. Inthe fine print of the equity agreement was one line announcing a joint venture between IATV and Liberty Media. This investment is now part of Liberty Media's Liberty Digital Company (LDIG).
We believe the joint venture covers national "individualized" events such as sporting events, concerts or other marquee programming that Liberty Digital is able to secure the rights to. We believe that Liberty Media could also prove to be a valuable partner to IATV not only for individualized events but also for HyperTV. HyperTV's concept of "pushed" e-commerce services (time-sequenced data to the PC coinciding with TV programming) is an ideal fit with Liberty Media's cable programming properties. Liberty Media owns all or a stake in dozens of cable networks. HyperTV is discussed in detail later in this report.
General Instrument---GIC and IATV announced the formation of a joint venture-Digital ADCO. This entity is 51% owned by IATV and 49% ownedby GIC. GIC invested $5 million to initially fund this entity that will focus on developing cable equipment that could selectively target commercials to consumers (ie., your neighbor sees a certain commercial and you may see a totally different one).
Fox Sports Net---Under an agreement with Fox Sports Net, which runs through 2003, IATV has the rights to license Fox Sports Net programming from each of Fox Sports Net's 22 regional affiliates, and offer individualized regional sports service to any distributor that carries the corresponding Fox Sports Net channel. IATV's current regional agreements cover Fox Sports Net Southwest, Fox Sports Net West, Fox Sports Net Bay Area, Fox Sports Net Rocky Mountain, Fox Sports Net Northwest and Sunshine Network. IATV's regional sports programming will use the Fox Sports brand, which is a major advantage for he company, as this brand recognition is unequaled in the marketplace.
We expect IATV to launch one market in the third quarter of 2000 (Southwest market), five markets in 2001 and eight new markets in 2002. The Southwest region was chosen for a number of reasons. First, TCI has a large established base of digital set-top boxes in that region as it was one of the first to have digital boxes deployed. Second, the Southwest region (Texas, Louisiana, Arkansas, Oklahoma and parts of New Mexico) is large, with over 5 million Fox Sports Net subscribers. IATV has already established a master control facility in Irving, Texas to service this large region. This facility controls production and distribution within the Southwest region but could also serve other regions. Last year, IATV had full scale live production of the individualized service for over 100 sporting events in the Southwest region. As a result, we expect the production room capabilities for commercial service to go off without a hitch.
Fox Sports Net's 22 regional affiliates reach 58 million out of the 65 million U.S. cable subscribers. TCI is the first cable operator (15 million subscribers) to offer IATV's regional sports service and we expect more agreements with new cable operators later this year. The first sports to be covered include professional basketball, baseball and hockey, as well as college football. We forecast that the service will cost the subscriber $9.95 per month. IATV's production techniques and close collaboration with Fox Sports Net contribute to its relatively low cost per event. The revenue splits are discussed later in this report.
AT&T/TCI---IATV has an agreement with AT&T/TCI to distribute the individualized programming to AT&T's cable subscribers as a premium service. IATV's initial markets are the Texas area and Los Angeles, which are both AT&T markets. We believe that soon after the concept has been proved with AT&T, other cable operators will open their markets to Fox Sports Net programming.
SkyConnect-IATV and SkyConnect, Inc have formed an agreement to integrate IATV's individualized television technology wit SkyConnect's digital advertising insertion technology. SkyConnect offers digital video ad insertion systems to the cable industry. Advertisers benefit from this agreement as the individualized commercials allow viewers to choose what commercial they want to see by pushing a button on their TV remote. On the marketing side, advertisers can record viewer's choices and send another commercial with additional information mail information tailored to fit the viewer profile.
National Events
We are excited about the pay-per-view (PPV) national events business for IATV. We believe that this and HyperTV hold the largest upside shareholders. The ability to offer individualized PPV events could be enormous. While neither company is commenting on specific events, we could foresee the technology being used someday to offer individualized PPV events like the Super Bowl, all-star games, Olympics, boxing, etc. We believe the joint venture covers other national individualized events such as concerts or other national programming for which Liberty Digital able to secure the rights. Liberty Digital is IATV's partner in the national events business while IATV retains ownership of regional events. Liberty Digital owns the majority of this national events entity and IATV owns the remainder.
Imagine inviting friends over for an interactive Super Bowl party, or having the ability to choose which sport you want to watch during the Olympics. Viewers, instead of watching cross-country skiing, could seamlessly transfer (staying on he same TV channel) over to the downhill skiing footage. For another example, a boxing sports fan could select to watch only the punches that Mike Tyson throws in a boxing match. IATV's system allows the viewer to select instant replay shots virtually at will (e.g., keep watching Mike Tyson knock his opponent out). We expect the cost to be between $9.95 to $49.95 depending on the event.
We believe that the initial launch for a national event will take place in the fourth quarter of 2000.
Moreover, we believe that this business could secure the rights to and distribute roughly four to eight national PPV events per year. It is important to point out that the production costs of a national event are closely inline with a single event produced for IATV's regional sport service. We expect that marketing expenses for the national events will be split between Liberty Digital and the cable operator. Up from $1.2 billion in 1997, the PPV business grew to $1.3 billion in 1998 (this period suffered due to the lack of marquee boxing events like Mike Tyson fights) and individualized national PPV events could propel the PPV market significantly higher in the years to come. The following table outlines our estimates for the size and scope of the "individualized" national PPV event business.
Helps Drive Digital Penetration
The company's patented software brings individualized TV to the cable operator at zero incremental equipment cost. In our opinion, the very fact that the individualized programming can be delivered over HITS, and without the need of additional equipment to the cable operator, makes for a quick distribution model. Part of the problem the cable industry has in rolling out digital boxes is the need to send a technician to install the new digital boxes. This process is the largest hurdle in quickly upgrading the cable industry to digital boxes and offering new services. IATV's technology and service could change the cable operator's ability to speed up the deployment of digital boxes.
The revenue generation potential by moving customers to digital and offering advanced services is far too large for cable operators to overlook. As a result, we believe the risk of IATV's not signing any additional agreements is low. The following table presents the ten largest cable operators in the United States and the number of subscribers to whom they provide service.
Revenue Sources
Both the Internet division and the company's cable TV division represent an attractive investment by themselves. The company derives revenues from three distinct areas; monthly subscriber fees, advertising dollars and national PPV events (covered earlier).
Monthly Subscriber Revenue-IATV receives a percentage of the monthly subscriber fee which is usually $9.95 which may vary on the region offering the Fox regional sports enhancement. The cable operator receives approximately one-half of the share and Fox Sports Net receives a yet smaller percentage than IATV. We expect that AT&T's Southwest market (Texas area) will be the first launch (3Q00) for the Fox Sports Net service followed by the Los Angeles market in the first quarter of 2001. In the Southwest market, for example, IATV will provide enhanced programming for Fox Sports Net's professional sports line-up including baseball, basketball and hockey, as well as college football. Since there are usually 30-40 sporting events occurring each month in a major region, the cost to the subscriber per sporting event is around $0.33 ($9.95/30 monthly events). As a result, the cost to the subscriber for the service is relatively low per sporting event and makes the event much more enjoyable.
Advertising Revenue--In addition to monthly subscriber revenue, IATV's technology would enable interactive advertising over digital cable networks. For example, advertisers could place interactive advertisements on their systems. This technology could be a boon for advertisers since with the press of the user's remote control, information could be collected on each subscriber's viewing patterns.
Patents
The company holds 19 U.S. patents, fifteen of which are geared toward the digital cable TV. The other four patents are aimed at the Internet. IATV has initially targeted the largest of TV transmission providers, cable line companies, since they represent about 90% of the total cable market. Due to its patents, however, IATV will eventually target companies like DirecTV and Echo Star to take advantage of this technology for satellite companies. We believe IATV may partner with one or more of these satellite providers in the near-term primarily for the "individualized" national events business. Direct TV, for example, already has over 4 million subscribers capable of receiving an "individualized" national event.
Internet Division-"HyperTV"
IATV's other division, which is focused on the Internet and commonly referred to as HyperTV, is set to capitalize on the convergence of video programming with Internet delivered content. The concept is to stream data to a PC that is synchronized to a TV program. HyperTV would receive revenue from a percentage of e-commerce transactions, advertising fees and portal registration opportunities.
The concept first appeared in January of 1999 offered in conjunction with the Fiesta Bowl. The Fiesta Bowl (coll g football game) offered a "push" content service with select information synchronized to the viewers' home PC from the ESPN web site while viewers watched the football game on TV. The content included game statistics, player profiles and other "pushed" data. The web site was jammed with such a rush of users that the server handling the traffic went down early into the game. ABC, which was broadcasting the game, had to announce on TV that the server went down and Internet users should not attempt to logon to the web site. Part of the appeal to marketers was the fact that every user wishing to use this service had to register at the go.com web site owned in part by Disney. This way a database of users could be recorded for future marketing purposes.
Current Deals for HyperTV
Over the last few months, the company has announced HyperTV contracts with TBS (James Bond Marathon), ShowTime (unit of Viacom), The Box Music Network (also a unit of Viacom), New Line Cinema for the upcoming PPV launch of Austin Powers-The Spy who Shagged Me. We expect the HyperTV division to experience tremendous growth and look for significant deal flow from this group.
E-commerce Applications--HyperTV's concept of "pushed" e-commerce services (time-sequenced data to the PC coinciding with T programming) is an ideal way to create impulse buying over the Internet. It is also a way for the cable TV networks to enhance their brands and generate incremental revenues. With this in mind, we believe that HyperTV is an ideal fit with Liberty Media's cable properties. Liberty Media, which owns all or a stake in dozens of cable networks (including IATV), could create HyperTV applications for its cable channels. Other cable networks could also benefit. For example, a music video oriented cable TV network (like MTV or the Box Music Network) running a Rolling Stones video on its cable channel could allow viewers to log onto its web site and have content pushed to them in time sequence corresponding to the music video on TV. Viewers could also have the ability to buy the Rolling Stones CD while they are watching it on the TV set simply by selecting purchase with their PC's mouse on the web site. When the next music video comes on the TV (e.g., Billy Joel), the next set of pushed content corresponding to the video content (Billy Joel information and purchase capability) is sent to the viewer's PC.
The Box Music Network. The Box Music Network has announced a collaboration between it and IATV for an individualized version of viewer controlled music programming. This collaboration will give more control over what the viewer wants to see like artist bios, focus on a single band member, song lyrics or data on a song or record. he Music Box Network is the only 24-hour all music network, and currently reaches more than 55 million household worldwide. The Box Music Network was the first to launch a variety of them music channels for next generation digital cable. The different music type choices are available over HITS and include the Box Edge, Box Pulse, Box Classic, ox Urban, Box Exitos and Box Tejano. The Box Music Network is also a prime candidate for HyperTV's "pushed" e-commerce service in our opinion. The service will be launched in January 2000.
In our opinion, the Box Music Network is a good example of the e-commerce potential IATV could derive from HyperTV. This HyperTV contract will be "on-air" 24 hours a day, seven days a week whereas some of the HyperTV contracts are for one-time single events or a series of TV programming (TBS' James Bond marathon).
The Box is a logical early user of HyperTV's technology due to the e-commerce applications and the prior agreement with IATV for individualized TV content. IATV and the Box have an agreement for pushing content via different video streams over the digital cable TV. The Box Music Network was the first to launch a variety of theme music channels for next generation digital cable.
IATV could also use HyperTV technology to synchronize Fox Sports games with Internet delivered content in the already agreed upon areas. This would serve two purposes. First, would allow users to get involved in the sporting event and give Fox Sports and IATV new avenues to exploit the Internet. Second, it would allow Fox Sports to advertise both companies individualized Fox Sports service offered at $9.95 per month.
Today there are really only three ways to accomplish convergence. First, video can be sent to the TV and data sent to the PC in a synchronized way allowing for the user to "interact" jointly with the data and video combined. Second, he user could install a TV tuner card inside the PC and combine the video with data side-by-side (limited penetration as users need to upgrade their computers). Third, the user may have to wait for the next generation digital set-top boxes (DCT 5000) that could combine video with data on TV while splitting the TV screen.
Part of the problem of trying to display Internet data on the TV is re-sizing the Internet data to fit properly on the TV screen. IATV can currently deliver converged programming over the Internet and will move to the TV set as soon as the appropriate set-top boxes are deployed. IATV believes that its patents may protect them under all three scenarios in this new market for synchronized web casting.
While the market for a one box HyperTV product on cable TV sets is on the horizon, IATV has already been utilizing this technology today in a two box format for entertainment genres.
Convergence Theory---Major companies are betting that cable TV viewers will eventually have a split screen, part running the normal video coverage, the other running synchronized Internet or data information.
Management Team William Samuels is IATV's Chairman and CEO. Mr. Samuels is credited with the company's vision and has been with the company for 10 years. Prior to IATV, Mr. Samuels built and sold a worldwide multimedia company. Another key employee is David Reese the company's President. Mr. Reese is the "relationship guy" of the company and was credited with completing the Fox, General Instrument and Liberty Media deals. Mr. Reese has also been with the company nearly 10 years. The other key players include; Bruce Crowley who heads the Internet division, Christopher Cline the company's CFO, and Dave Alworth who heads the sports business at IATV and was formerly an executive with Major League Baseball. Brent Imai runs the West Coast operation for IATV and was formerly the Executive Producer of Fox Sports West. IATV's Regional Sports General Manager, Dick Baron, founded five of Fox Sports Nets affiliates. Other key talent includes Craig Ullman who was the architect of HyperTV, Frank Deo the VP of Engineering and Kevin Liga, the Chief Technology Officer.
2000 Outlook and Beyond
Year 2000 should be a pivotal year for IATV. The backdrop for their technology (digital boxes) is being deployed in scale, which should allow the company to sign additional cable agreements through the remainder of the year. We expect the launch of one regional sports market in the third quarter and we also look for the first nationally televised "interactive" event to take place in the fourth quarter of this year. We think the idea of national "interactive" events will be well received by cable customers and the awareness of this service will grow.
Moreover, the national events business should propel the regional sports service being rolled out as consumer discover the value of individualized programming. The goals of launching the service and demonstrating its value should be accomplished in 2000, which should translate into a mass-market commercial product in 2001. We also have high expectations for the company and its national events business in 2001 when we look for the company and its partner Liberty Digital to air at least four nationally televised "interactive" events.
We would also look for strong contributions from the HyperTV Internet division and its new entry into entertainment applications for this patented technology. HyperTV should have a banner year in 2000 as the technology gets proliferated. We expect deal flow from the HyperTV division will drive IATV's valuation.
Risks
IATV has similar risks common to most technology companies. In the cable TV industry IATV's risks include a highly competitive market constantly changing technology, dependence on the cable TV industry and digital service/interactive acceptance, dependence on the cable networks for programming and advertising deals and the company's reliance on its proprietary technology. First, we are seeing signs regarding the acceptance of IATV's technology in the cable TV industry (AT&T will be the first deployment).
Second, the digital set-top box full-scale deployment is finally taking place allowing the operator to think of applications. The fact that IATV's technology allows the cable operator to offer individualized TV at zero cost to the operator over digital set-top boxes gives us a high level of comfort in respect to its potential acceptance. The company will need to secure future funding to continue to deploy its service to the other regional Fox Sports Net affiliates. We estimate he cost per region at around $10-$15 million to achieve break-even in a region.
Financial Projections
We expect the launch of the company's individualized TV service and HyperTV to rapidly increase the company's revenue going forward. To date, the company's revenue was a result of Internet educational contracts. We expect the entertainment side of the company's business to increase significantly in the mix. Our 1999 revenue estimate of $2.1 million does not take into consideration any individualized TV revenue. We forecast year 2000 revenues will grow by 333% to $9.0 million with net losses estimated at $33.2 million in 2000 compared with a projected loss of $23.7 million in 1999. Our 2000 revenue projections could be conservative given the tremendous growth beginning to occur in t is industry and the upside of the national events business. We forecast profitability on an annual basis in 2001 for IATV with the company potentially earning $0.08 per share on a projected $68 million in revenue.
Balance Sheet
IATV's balance sheet is strong and should further strengthen with the recently completed follow on offering that raised approximately $120 million.
Our cash balance projections call for the company to end the March quarter with $140 million on hand, the June 00 quarter with $130 million on hand and the Sept 00 quarter with $115 million. By the end of March, IATV should have an idea of how many regional sports markets they intend to enter in the following quarters. We forecast that the company will begin to enter at least one new regional sports market per quarter the |
