The short case.
For purpose of disclosure, I am short SRCM at around these price levels. Not a lot, but enough to matter. I don't think posting here will affect the stock price, but it can sometimes generate additional information, both in favor and opposed to my opinions. I welcome both.
I have followed Source for over a year. As their stock price has climbed recently, I have begun an intensive due diligence. I think Source's stock price is going up due to the ongoing hype about the cable buildout (I am long HLIT, and they tend to move together).
Reasons to not own this stock:
1) Company continually misrepresents their prospects
2) Their virtual modem product has limited market potential
3) Their Interactive Channel has been a failure
4) They are over leveraged
5) Their telephone business is actually declining
1: Source has a long history of misrepresenting their prospects. As I have seen no significant insider selling, I don't think it is to defraud investors, but instead is the only way they know to run a business. As they have never made a profit, they must continually access the market for cash.
As far as compatibility with GI(Nextlevel) set-top boxes, read RJC's post above. I also checked with GI and got the same info. Source is porting to the GI box, but is not there yet. ACTV is available now and has actually been deployed in a trial market. Next, Source declared their Colorado Springs pilot of the Interactive Channel a success. Not true, Century considers it a failure, which I will elaborate on a little later. Also, during the IC tests, the company was constantly hinting at carriage agreeements just around the corner, and of course they never materialized. Source also reports revenue in a strange manner. In their telephone business they have some barter arrangements. They calculate value of the barter and add it to revenue by calling it non-monetary revenue. This is done to make the company look bigger than it really is as the exact same number is then deducted in the cost of sales (they do seem to be easing away from this practice in recent releases).
Finally, the company has released info on a survey that talks about how interactive services greatly increases peoples willingness to buy digital cable. But according to GI, the survey actually said that if someone has advanced analog (with an already greatly expanded number of channels) they would need something like internet access to make them want to switch to digital (ie, they are mainly interested in more channels and then internet, not the interactive channel). Basically, the management of this company will say anything to help them raise money or increase their stock price.
2: Limited potential for the virtual modem. Source's product actually has a server at the head-end which is accessing the internet. It then sends addressable video frames to individual set-top boxes. It is not a direct link like a cable modem since your are acutually getting pictures from the server accessing the net. You cannot link a PC to it like @Home. To surf the web, you use a remote to select buttons or can use an on screen keyboard. This is impracticle for typing e-mail, chatting, playing on-line games or sharing files. Its real use is to check e-mail or general surfing. However, for e-mail, most people want it on their PC to keep addresses, type responses or print a hard copy. It is unclear if you once download e-mail to the Source server if you could then later download it to your PC. Compounding their problems is that the set top box makers have also said they may just build in a cable modem into the box.
I think some people would want the Source product. However, it must be someone who wants a high end digital service, wants to access the internet but doesn't have a home computer. This is an odd segment to go after as most of these type of people have a home computer or laptop they bring from work.
But, just to be optimistic, lets look at the numbers. 15,000,000 digital set-top boxes to be rolled out in next few years. Lets say 50% of the people who get those boxes want internet access, and 25% of those get it through Source Media's software. Source gets $.50 per month per subscriber. Do the math and you get a little over $11 million in revenue per year for Source. Last year Source lost $32 million and they are forecast to lose $35 million this year. Great, maybe they only lose $20 million per year.
3: The Interactive Channel was a failure. Despite the company's positive spin this was a real dissappointment. I refer to an article in the Colorado Springs Gazette-Telegraph on Feb. 5, 1998. The title is "After failing to dent market, Interactive Channel to sign off." Here are quotes from Century vice president Bill Shreffler about IC.
"It never lived up to expectations"
Said he doubted the $6.95 fee was too expensive, rather he speculated viewers wanted and Internet-like service, something that would allow them to surf sites like the world wide web.
"You had to spend a lot of time explaining what it was, maybe that added to the customer confusion"
This was a project Source called a phenomenal success. They were also constantly hinting at new carriage agreements during the pilot.
4: Overleveraged. The company raised $100 mil of debt at 12% interest and $20 mil of cumulative preferred. How did a company losing $30 mil a year raise this kind of money. Pay the investment bankers $6 mil. The bankers then put 2 years interest money in escrow so the bonds won't default for two years. The company already was greatly negative in cash flow, and now they have an additional $12 mil in interest payments.
Also, don't overlook the preferred stock deal. They get a 14% cumulative dividend payable in additional preferred shares. While this company probably goes bankrupt, if it survives, the preferred share holders will have most, if not all the equity.
4: The telephone business is actually declining. Source used the telephone business to help raise the debt. They bought two other telephone business for about 10x cash flow. They claimed that they could combine all of them together and through economies of scale dramatically increase cash flow. But if you back out all the acquisitions Source has made in the telephone business, you see it is actually declining (ie, the total is less than the sum of the parts). Also, both source and its acquisitions have historically had their costs fluctuate right in line with revenues, which does not indicated a massively fixed cost business. So while there should be some savings, I think they will fall far short of their very optimistic projections.
I will say this for they telephone business, the BriteVoice business was actually growing rapidly. It could be that it has managers who could correct some of Source's problems. But, with the threat the Internet poses to the interactive telephone business in general, I would not bet on it.
So, there you have it. Source reports earnings next week. I expect results to be below expectations (as they always are) with a very positive spin, and new agreements just around the corner (since the company is in "very active discusssions"). If nothing else, I hope my post encourages you to read their 10Ks and 10Qs and take a skeptical look at them. |
