Gerard Klauer Mattison & Co 4/12/00
GMST down almost 50% with the interactive TV stocks. The interactive TV
stocks are down on average 60% from their 52-week high with a range of 46%
for TV Guide, 48% for Gemstar and as much as 73% for Liberate. In our
opinion, Gemstar absolutely has the best business model of any of these
companies. While all of the stocks had a somewhat extraordinary run over the
last six months, we do not believe Gemstar should be coming down nearly as
much as the overall group. We reiterate our BUY rating and $110 price target.
Status of the merger. We still believe the merger will close in the
current quarter, but now are expecting late May rather than late April/early
May. Senators Dewine (R-Ohio) and Kohl (D-Wisc), leaders of the Senate
antitrust committee, have sent letters to Joel Klein of the Justice
Department and William Kennard, Chairman of the FCC, asking them to carefully
scrutinize the deal due to concerns that the combined company will monopolize
the EPG business. We note that Time Warner is the largest cable operator in
Ohio. We continue to believe the deal will go through, and given only a 3%
arbitrage spread, it appears the Street also has that belief. Furthermore, we
believe the downside risk of the deal not going through is already built into
Gemstar and TV Guide given the recent slide the two stocks have taken.
Lastly, if the deal did not go through, Gemstar would have roughly half the
number of shares outstanding and still have an estimated 50% share of TV
Guide's US cable TV EPG advertising business due to the cross licensing
agreement detailed on page 79 of the merger proxy.
Investor concerns about the March quarter. Given the trends in the
overall market, investors are starting to again focus on short-term
expectations. We have not received guidance on the quarter, but anticipate it
will be similar to the December quarter in that most of the growth will
probably come from recognizing more of the arbitration victory that Gemstar's
StarSight division had with General Instruments (now Motorola). We are
projecting EPS of $0.16 vs. $0.12.
INVESTMENT CONCLUSION
We have consistently stated that Gemstar, due to its EPG business, has the
most explosive growth potential of any media company we know. Given the
combined market capitalization of $26 billion, and an investor base that
includes Liberty Media and News Corp., we feel more media analysts and
investors will have to pay more attention to this company. We reiterate our
BUY rating. The expanded Thomson deal enhances our confidence that Gemstar
will create a successful worldwide advertising/e-commerce business. We
believe entering the e-book business is an intelligent move that could
provide a third high-growth component to Gemstar.
Additional Information:
o $110 price target. We believe Gemstar's worldwide advertising/e-commerce
business can be generating over $4 billion of advertising operating income in
5 years. We conservatively assume zero value for the e-book business, TV
Games network, VCR+ (currently an estimated $70 million of EBITDA) and TV
Guide's Entertainment Group and United Video group (estimated $335 million
2000E EBITDA excluding the EPG) and no interest income. The company is
projected to generate after tax EPS (before goodwill amortization) of over $6
per share in 2005 growing at 100% per year. Assuming a 50 multiple and a 20-
25% discount rate leads to a $100-123 price target. Taking the mid-point, our
price target is $110.
o Time Warner has been stripping the guide and VCR+ data in the VBI in
some markets. Cable operators are supposed to pass on all program-related
information with the television signal. Time Warner has stripped the Gemstar
data in some markets which we view as simply a negotiating technique and
Gemstar has sent a letter protesting to the FCC. While not elegant, this can
be rectified with a simple rabbit ear antenna attached to the TV or by using
Gemstar's 2-way paging frequency. We note that Gemstar has historically had a
very strong relationship with AOL, including a license agreement with AOL,
and assume the Time Warner/Gemstar issues will be resolved at the latest
after AOL completes its TWX acquisition.
o New advertisers on the guide. In addition to one new programmer, ESPN,
the following non-programmers have been advertising on the guide: Domino's
Pizza, Ford, AOL, Blockbuster, RCA, 1-800 Flowers and Flooz.com.
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