Gemstar: H & Q Report
As Posted on Yahoo:
Gemstar reported fiscal fourth quarter (Mar.) results of $54.0M/$0.46/sh which
exceeded our $52.6M/$0.44/sh estimate. As expected, revenue growth was driven
by deeper penetration of VCR Plus+ and improved fees associated with the EPG
products sold into the CE, set top, and PC markets. Importantly, F4Q results
included advertising revenue from Guide Plus Gold+, reflecting the beginning
of this significant new revenue stream. During the CC, management
acknowledged that it was in negotiations with AOL to license its EPG for AOL TV.
March Quarter Top and Bottom Line Ahead of Estimates
GMST reported sales and earnings of $54.0 million and $0.46/sh which exceeded
our $52.6 million and $0.44/sh estimate and reflected 27% top and 24% bottom
line growth. As in past quarters, revenue was driven once again by deeper
penetration of GMST's core VCR+ technology which amounted to about 50% of
sales, and by the continuing integration of EPG technology into consumer
electronics platforms such as TV's and Web TV's, cable set-tops, DBS
receivers, and PC related platforms. Significantly, GMST reported $150
thousand of revenue from advertising activities generated from its newest EPG,
Guide Plus+ Gold, which only began rolling out last October. While modest in
size, the commencement of advertising revenues represents an important
milestone in progress of GMST's strategy to expand beyond the licensing of its
technology, to address the enormous advertising and e-commerce opportunities.
Clearly reflecting the powerful leverage inherent in GMST's business model,
operating expenses dropped to 34.9% of sales from 40.1% in F3Q98, resulting in
an increase in net margins to 49.4%, from 45.6% in the year ago period. In
addition to improving versus last year, GMST's operating expenses were also
well below our 36.3% expectation. While each expense category increased
sequentially in dollar terms, each category fell by at least 180 basis points
when viewed as a percentage of sales. Net income increased 36.9% Y/Y, while
EPS improved at a slower rate of 24.3% due to a 7.6% jump in diluted shares
outstanding.
FY00 Estimate Unchanged; Initiate CY00 Outlook
Our FY00 sales and earnings estimates of $215 million and $1.70 p/sh are
unchanged and we are initiating a preliminary CY00 estimate of $261 million
and $2.20 p/sh. We continue to believe advertising and the penetration of
Gemstar's EPG in DBS and cable set-tops, remain the critical swing factors in
our estimates for FY2000 and beyond.
Reiterate BUY-FOCUS
Gemstar is increasingly being valued more like an internet "portal" play as it
successfully executes its strategy of licensing its EPG technology across
multiple platforms. We maintain our belief that ongoing litigation will
ultimately be resolved with terms favorable to Gemstar, thus allowing
investors to concentrate on its unique growth potential resulting from EPG
licensing fees and the associated potential for advertising revenue related to
the guide.
Portal Driven Advertising Model
Even with the deployment of GMST's Guide Plus+ Gold EPG just beginning, the
potential for massive and rapidly growing advertising revenues is abundantly
clear. Like popular websites, we believe GMST's EPG will attract significant
"eyeballs". Reasonable assumptions result in each Guide Plus+ Gold enabled
platform generating 90 thousand "page views" per year (7 hrs of tv per
household per day x 4 guide hits/hr x 3 pages deep per hit x 3 ads per page x
365 days). With management confident that it will have its Guide Plus+ Gold
deployed in over 2 million televisions by the end of C99, GMST will be
reaching more eyeballs than most popular websites.
Given GMST's penetration of nearly every major CE manufacturer, and annual TV
shipments in the US of 25 million per year, we expect TVs alone enabled with a
GMST advertising capable EPG will increase exponentially over the next three
years. Cable and DBS set-top boxes, Win CE for TV's , and Web TV devices will
further accelerate the ubiquitous deployment of GMST's technology and expand
its page view potential. However we continue to conservatively estimate
roughly $5 million in advertising revenue in F00 since we believe GMST will
need to have a significant number (roughly 2 million) of ad capable guides
deployed in order to attract additional advertisers. Currently, GMST has
signed NBC in the US, which along with Thomson, is also its partner in its TDN
advertising joint venture.
Microsoft's Agreement To Provide WIN CE To AT&T's Cable System Should
Generate Future Guide Royalties
We continue to believe that AT&T's agreement to use Microsoft's
(MSFT,$80.50,BUY) WIN CE operating system on up to 10 million new digital open
architecture set-top boxes will ultimately drive per unit payments from
Microsoft to Gemstar, for the use of its EPG technology. Our belief is
grounded in the fact that Microsoft licensed Gemstar's total portfolio of
intellectual property and subsequently used it to perfect the operation of an
interactive program guide within its WIN CE operating system. Though
Gemstar's guide is included in Microsoft's "TV package" for WIN CE, and this
package may not be adopted by AT&T (T,$60,NR), we nevertheless believe it is
unlikely that Microsoft will deliver 10 million units of WIN CE specifically
for a set-top application and not pay Gemstar a royalty. After investing $5
billion in AT&T to facilitate WIN CE's deployment in set-top applications, it
seems unlikely that Microsoft will hesitate to spend a further $75 to $100
million to keep its intellectual property position relative to the guide above
reproach.
AT&T is also likely to be attracted to the concept of limiting its downside
risk in current and future litigation with Gemstar (at Microsoft's expense) by
taking the TV package even if it dosen't use it. Under this scenario AT&T's
liability is reduced since Microsoft is paying Gemstar a per unit royalty,
while the larger and more important long term issue of sharing advertising
revenue remains unresolved or subject to a future global settlement. Helping
to resolve this issue for AT&T will be its assessment of the outcome of the GI
arbitration, since if GI loses the arbitration, it will also be paying Gemstar
a royalty. Since General Instruments is AT&T's largest digital set-top
provider, AT&T may arbitrage the per unit royalty rate (assuming only one can
be collected), attempting to indirectly pay the lowest amount per set-top, or
off loading the payment altogether on one or the other of it's primary set-top
system vendors. These overlapping relationships continue to prompt us to
believe a negotiated global settlement between the various cable interests and
Gemstar is inevitable.
AOL And Gemstar Negotiate to Incorporate EPG In AOL TV
Management acknowledged in the conference call that Gemstar is engaged in
ongoing negotiations to incorporate its EPG technology into AOL's
(AOL,$138,BUY-FOCUS) recently announced AOL TV initiative. AOL partner Direct
TV is already a licencee of StarSight/Gemstar, as is Philips. We believe that
AOL is unlikely to deliver a "WebTV like" product, including a guide, to its
many subscribers without first resolving the potential intellectual property
issue related to its version of the guide. Gemstar's negotiations with AOL
are also complicated by its relationship with Microsoft who currently
possesses significant negotiating leverage due to its expanding relationship
with AT&T. These cross currents are likely to prolong both the resolution of
Microsoft's use of Gemstar's guide in the AT&T deployment, and AOL's decision
on its use in AOL TVWireless Guide Plus+ Gold Capabilities Ahead of Plan
We believe Gemstar's patented wireless version of its EPG technology, which
uses the paging network to receive programming data in consumer electronic
applications, eliminating the necessity to receive this data over-the-air or
via cable via the VBI (Vertical Blanking Interval), will enable greater TV
interactivity, including e-mail and e-commerce. The PageNet 900 MHz network
is expected to be operational later this year and will likely be available to
consumers in CY2000. We believe this wireless capability provides GMST with a
strategic defense against threats by the cable industry to strip the VBI of
GMST's programming data. We believe this alternative data transmission
system, apart from the VBI, strengthens Gemstar's chances of obtaining a more
acceptable settlement of its ongoing patent disputes with various companies in
the cable industry.
Status of Litigation
The General Instruments arbitration has concluded with a verdict expected in
three or four months. Gemstar remains confident and anticipates an outcome
similar to that in the Scientific Atlanta arbitration, which resulted in a
very large settlement agreement and payments for set-top boxes previously
shipped with a "native" guide, as well as payments for guide enabled set top
boxes shipped in future periods. Regarding the ongoing litigation with TV
Guide Interactive (formerly United Video Satellite Group), we believe GMST and
TVGIA are engaged in ongoing court mandated settlement negotiations.
The Pioneer and Scientific Atlanta patent litigations continue, and are not
expected to reach a decisive stage for possibly years to come. However in the
case of Scientific Atlanta, its current agreement with Gemstar terminates this
July, opening up the potential for further patent litigation if a new
agreement is not entered into to replace the former. Scientific Atlanta is
particularly vulnerable since it currently pays Gemstar a royalty on all of
its set-top boxes which include a electronic program guide as a consequence of
losing a prior arbitration verdict which concluded that its guide technology
was based upon an earlier agreement with Gemstar's StarSight subsidiary.
Since Scientific Atlanta has already implicitly acknowledged the origins of it
guide technology, it seems unlikely that it will prevail in an injunction
hearing to halt the future shipments (after July) of unlicensed set-top's,
which utilize the StarSight technology and also infringe upon the Gemstar
patents.
We believe all of these cases are interrelated and primarily hinge upon the
cable industries reluctance to 1) pay a licensing fee for incorporating
Gemstar's guide technology in a set top box, and, 2) share with Gemstar the
tremendous potential advertising revenues which may be associated with an EPG
since it is the key navigational "portal" on the set top, and the natural link
to other interactive services such as pay -per-view, internet access,
videophone, and telephony. Obviously, since the guide becomes a must-have
feature in a digital TV environment of 100 channels or more, and is also the
logical navigational hub of a multi-functional cable service offering, the IPG
is also at the center of AT&T's strategy of leveraging its acquisition of TCI
into a multi-functional bi-directional broadband pipeline into the home.
A settlement with Gemstar seems increasingly likely since the number of ways
Gemstar can penetrate the cable arena are multiplying with the end to solely
proprietary set top boxes scheduled for July 2000. Under the OpenCable
initiative set top boxes manufactured by traditional consumer electronics
manufacturers will be available at retail, and will be compatible with all
cable system head-end's via a removable "POD" (point-of-deployment) module.
These boxes will have an EPG built in. To the extent that the open set top is
manufactured by a Gemstar licensee such as Sony, Gemstar will receive a fee.
Since Gemstar has licensed its EPG to most of the large CE companies who are
also likely to get into the open set top business, Gemstar's guide will
proliferate without the active cooperation of the cable industry, just as it
is in TV's. The integration of the open set top into the TV platform (with
the set top built in and a slot for the POD) will culminate this trend. Other
ways for Gemstar's guide to reach the set top include Microsoft's OS products,
the integration of Web TV, or the consummation of Gemstar's ongoing
negotiations with AOL to incorporate its guide into AOL TV. |
