part 2 ...IATV: A Good Story Getting Better; Livewire Deal Analysis
--OPINION-------------------------------------------------------------------
2001 estimates for ACTV. We are increasing our 2001 EBITDA estimate to
about $(15) million from about $(20) million and our EPS estimate from
$(0.32) to $(0.22). Given that the completion of the AT&T/Liberty
Livewire hosting services will not be completed until 4Q00 and the need
to train Livewire's creative staff in HyperTV authoring, our full year
2000 estimates are unchanged for the time being, although upside is still
achievable based on the potential for an accelerated rollout of HyperTV.
For modeling purposes, we have assumed that the Livewire deal will allow
HyperTV to sign up an incremental one new TV network partner beginning in
2001, while increasing the number of half-hour shows per network by one,
as well. We have also ratcheted up our audience assumptions. Beginning
in 2001, we have boosted our penetration rate assumption to by 5
percentage points a year, which implies 22.5% penetration beginning in
2001, growing to 42.5% in 2005. However, this revenue boost will be
offset by the outsourcing of hosting services to Liberty Livewire. As a
result, beginning in 2001, we have eliminated hosting revenues from our
HyperTV model. Similarly, we have accelerated the reduction of ACTV's
content creation revenues in order to factor in Liberty Livewire's role
in developing HyperTV content. We had previously assumed that ACTV would
develop HyperTV content for 30% of its TV programmers in 2001 and holding
steady at 20% every year thereafter. Our revised estimates now assume
that ACTV will provide content creation services only to 15% of its TV
programming partners in 2001, 10% in 2002, and 5% per year beyond 2002.
Consequently, our revenue estimates for HyperTV are essentially unchanged
through the duration of our model.
However, as we mentioned earlier, the removal of lower margin hosting
services and content creation and the greater emphasis on higher margin
online advertising, e-commerce, software licensing, and data management
should boost EBITDA margins for HyperTV. For the year 2001, we have
raised our HyperTV EBITDA estimate to about $7 million from $2 million.
Longer term, we estimate that HyperTV steady state margins should improve
about 500 basis points to approximately 55% from 50%, while also
improving the return on capital profile.
HOW IS OUR DCF MODEL AFFECTED?
Our revised estimates translate into a modestly higher valuation for
ACTV. Factoring in our new forecasts, our five year DCF model implies
about $2 upside to our $50 price target for ACTV. The underpinnings of
our DCF valuation remain unchanged; we utilize a 15% discount rate, which
approximates ACTV's weighted average cost of capital, assuming a 6.5%
risk free rate, a 5.5% risk premium, and Barra's predicted beta of 1.548
for ACTV. Our DCF incorporates a 35x terminal multiple. Although this
terminal multiple may appear aggressive, our assumption implies a 12%
perpetual growth rate which we believe is justifiable for a company still
in the early phases of growth with returns on invested capital in excess
of 35%, excess returns in the neighborhood of 20%, and significant free
cash flow generation abilities. In addition, we believe that our
terminal multiple compensates for our conservative operating model which
assumes contributions from only two Fox regional sports networks for
ACTV's Individualized Television service (despite ACTV having struck
deals with 5 Fox regional sports networks) and excludes potentially
lucrative data mining revenues for ACTV's interactive advertising
application.
INVESTMENT CONCLUSION--A GOOD STORY GETTING BETTER
Net-net, we view the joint marketing pact with Liberty Livewire as a
major strategic positive for ACTV. ACTV's stock has been under
significant pressure recently (down about 23% over the past week),
declining in tandem with the overall Nasdaq Composite and the pullback in
its interactive television brethren. Nonetheless, we maintain our
positive stance on ACTV, which we believe will emerge as a key
beneficiary of the explosive growth of digital/interactive TV and the
convergence of the PC and the TV. Based on our current operating
projections, ACTV's closing stock price of $20.69 implies a hefty 35%
discount rate, more than double ACTV's 15% estimated cost of capital.
While current market conditions may suggest a higher risk premium is
warranted, we consider the market-implied hurdle rate as too high,
particularly in light of the Livewire deal, which we believe lowers the
risks associated with HyperTV execution and scalability. With the
company making significant strides in deploying both HyperTV and In
dividualized Television, no external capital requirements required over
the time horizon of our model, and firming relationships with key players
such as Liberty Media, we believe that ACTV is a good story getting
better. We maintain our 1S (Buy, Speculative) rating.
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