OFF SUBJECT, but does mention DVD at the end. And will this help CUBE?
osted 11/7/97
Archived 11/14/97
Snapshot
Price History
Overview
Earnings Estimates
Creative Cranks Up the
Volume
The maker of SoundBlaster PC sound cards
has finally filtered out its earnings static.
Look for another sonic boom in the stock.
By Michael J. Burry
Creative Technology Ltd . (CREAF), the
Singapore-based maker of the popular
SoundBlaster brand of computer sound
cards, has been on a tear recently, its
stock just about causing a sonic boom as
it has rocketed more than 300% over the
past year.
With that kind of gain, investors prescient
enough to have bought last November
might be tempted to cash out today. Yet
a close examination of the company's
market position and financial statements
suggests Creative is the rare stock that
combines powerful growth and significant
value with a substantial margin of safety
and a robust brand franchise.
First, let's consider the growth.
Creative Technology is really a turnaround
story. The SoundBlaster line of computer
sound cards became an industry
standard soon after its introduction in
1989, allowing Creative to ride the boom
in personal computers worldwide. Creative
introduced its popular multimedia kits to
retail customers in 1991 to complement
its original equipment-manufacturer
strategy, providing further fuel for profits.
In 1991, the company earned 11 cents
per share; by the end of fiscal 1994, that
figure had increased tenfold to $1.12.
But the music soon faded, and 1995 and
1996 were not good years for Creative.
Forays into CD-ROM software and the
video-game market, along with a
leveling-off of SoundBlaster sales,
contributed to a 1996 loss of 45 cents per
share. Moreover, Chay Kwong Soon and
Ng Kai Wa, two of the three original
founders, resigned from direct involvement
in operations. Both remain on the
company's board.
Founder Sim
Wong Hoo has led
a dramatic
resurgance over
the last year.
Founder Sim Wong Hoo, who personally
owns more than 28% of Creative, stayed
aboard and has led a dramatic
resurgence over the past year. The
company's 1997 earnings per share of
$1.76 is expected by securities analysts
to increase to $2.53 in fiscal 1998 --
demonstrating that the company is back
on track. And as a result of beating
estimates in each of the last five quarters
by an average of 78%, Creative
Technology is rapidly attracting Wall
Street's attention. According to Zacks
Investment Research, the number of
analysts covering the firm has expanded
to seven from five in the past three
months.
Said Sim to a group of analysts recently:
"Creative is in its best position ever. I
believe that fiscal year 1998 will be our
year of opportunity and growth."
How much does it cost to participate in
this growth today? At a 1998
price-to-earnings ratio of just over 10,
Creative Technology can be had for a
discount to its projected growth rate even
by the most conservative estimates.
While this may be enough for some
investors, the value investor would want to
know more. For instance: What has all
this growth done for the balance sheet?
And is there a margin of safety?
The balance sheet is reassuring. Over the
past four quarters, the company has
steadily doubled its cash hoard to $463
million. Subtracting the cash holdings
from the sum of the long-term liabilities
and the market capitalization will yield the
company's enterprise value, which can be
thought of as the true acquisition price.
So right off the bat you can subtract
about $5 from the stock price. Accounting
for this, the enterprise trades at a cheap
price-to-sales ratio of only 1.6, and the
1998 P/E falls to a mere 8.
The key is to look
at the stock from
the vantage point
of a long-term
investor, and to
recognize the
value within the
SoundBlaster
brand name.
Can we affix a
value to the brand
name, in terms of
share price
dollars?
Just as Intel and
Coke have done,
Creative
Technology is
using its powerful
brand name
franchise to
consolidate its
market
dominance and
grow profits.
Further, the increase in cash holdings
shows that the earnings are not just an
accounting phenomenon. In fact,
adjusting for current cash holdings,
Creative Labs is trading at a very
reasonable 8.6 times its trailing one-year
retained cash flow.
But the final test for all value investors is
the margin of safety. What about this
stock guarantees a minimal downside?
The key is to look at the stock from the
vantage point of a long-term investor, and
to recognize the value of the
SoundBlaster brand name.
When looking at the valuation of brand
names, look first at profit margins. The
higher the margins, the better the brand
name. The idea is that truly valuable
brand names translate into higher prices,
which will translate into higher profit
margins in the hands of capable
management.
Intel Corp. (INTC) is a classic case. Its
silicon-plated brand name allows Intel to
earn net profit margins nearly 300%
higher than the industry average. The
evidence is everywhere you buy personal
computers: You pay more for "Intel
Inside."
Thanks to its SoundBlaster line, Creative
Technology's profit-margin advantage
compares favorably with that of Intel. Its
net profit margin of 18.4% creams the
industry average of only 4%. Once again,
a simpler comparison is right on the store
shelf. Configure a computer at the web
site of Micron Electronics (MUEI), and
you pay a $99 premium for a
SoundBlaster over a comparable Yamaha
sound card. And Yamaha is no slouch.
Is such a price premium defensible?
Apparently so. Online retailer CDW
Computer Centers (CDWC) lists 20
manufacturers of sound cards. Yet the
SoundBlaster technology still finds its
way into seven out of every 10 PC sound
systems sold, according to recent market
research. In fact, Awe64, the latest
incarnation of the company's proprietary
multimedia technology, is gaining market
share despite the price premium -- adding
to an already massive SoundBlaster
installed base of 45 million.
Affixing a value to the brand name in
terms of share-price dollars is a difficult
exercise fraught with many variables and
potential errors. Several university finance
professors have put forth a variety of
formulas for the valuation of brand names,
but none are widely accepted.
Investors might instead be better off
looking to Philip Fisher, the man who
taught Warren Buffett the meaning of the
word "franchise" with seminal books in
the 1950s. His description of a valuable
brand name centered on such qualities as
the ability to maintain or increase margins
in the face of hostile competition, and the
ability to maintain the premier market
position. Fisher did not describe
quantitative valuation criteria. And it is
debatable whether such a tool is really
necessary for successful investment.
The darkest cloud on the horizon for
Creative is the trend toward embedding
PC technologies on a single central
processing unit, such as the next
generation of Intel Pentium II
semiconductors. This trend has already
put the hurt on makers of
graphics-accelerating chips, such as S3
(SIII) and Trident Microsystems (TRID).
Creative Technology
press releases from
Research Central
As ballast against such a paradigm shift,
Creative has a variety of products with
which to diversify and improve upon its
multimedia franchise. In addition to the
upcoming 64-bit upgrade cycle, Creative
now has DVD technology for the new
generation of video-disc sound and audio
systems, as well as graphics cards, new
Internet multimedia technology called
Creative Inspire, and the line of PC
speakers formerly owned by the highly
regarded Cambridge SoundWorks. The
company's solid finances and balance
sheet can help out the growth story here,
as the lack of debt offers the opportunity
to expand aggressively while maintaining
margins.
Further, brand names do not just happen.
Sim, the chief executive, has won high
marks from securities analysts for his
restructuring of operations, guiding the
company to its recent fifth straight quarter
of margin expansion. In late October, the
company announced earnings that were
up 252% from the prior year; the stock is
up 30% since then despite the market's
fretfulness over the fortunes of companies
based in Southeast Asia.
Indeed, margin expansion in a competitive
market is the hallmark of a strong brand
identity coupled to capable management.
Much like Intel and Coca - Cola (KO),
Creative Technology is using its powerful
brand-name franchise to consolidate its
market dominance and grow profits. And
despite the spectacular run in the stock,
the balance sheet and growth prospects
appear strong enough to support
substantial further gains, with little
downside for the patient investor. In other
words, this one sounds like a winner.
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