Salomon Smith Barney report on GMST>
GMST: Mtng With Chairman/CEO Dr. Yuen Reinforces Our Bullish Stance
Gemstar Intl GRP Ltd -Usd(GMST)*
Rating: 1H
As of 05/31/2000
Last Changed 05/04/2000
Salomon Smith Barney ~ May 30, 2000
05/30/00 Gemstar International Group (GMST $34.50,1-H,Tgt $66.00) Niraj
--SUMMARY:--Gemstar International Group--Interactive Television
** Merger with TV Guide on track for 2Q closing (catalyst 1)
** Distribution agreements with cable and DBS operators expected to
follow (catalyst 2)
** Stock likely to remain volatile, as jockeying/posturing between
distributors and Gemstar/TV Guide creates uncertainty in the marketplace
** However, we believe company remains exceptionally well positioned to
be worldwide leader in the interactive program guide market, based on the
strength of its patent portfolio
** Gemstar expected to report Fiscal 2000 results this week
** Strongly reiterate 1H rating; 12-mo. price target unchanged at $66,
(90% potential price appreciation); our bear case scenario conservatively
assumes no additional cable distribution and offers 40% price appreciation
05/30/00 Gemstar International Group (GMST $34.50,1-H,Tgt $66.00) Niraj
--PER SHARE ESTIMATES-------------------------------------------------------
FYE 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year
Actual 03/99 ATCF $N/A $N/A $N/A $N/A $N/A
EBITDA $N/A $N/A $N/A $N/A $N/A
Previous 03/00 ATCF $N/A $N/A $N/A $N/A $N/A
Current 03/00 ATCF $N/A $N/A $N/A $N/A $N/A
EBITDA $N/A $N/A $N/A $N/A $358E
Previous 03/01 ATCF $N/A $N/A $N/A $N/A $N/A
Current 03/01 ATCF $N/A $N/A $N/A $N/A $N/A
EBITDA $N/A $N/A $N/A $N/A $495E
Previous 03/02 ATCF $N/A $N/A $N/A $N/A $N/A
Current 03/02 ATCF $N/A $N/A $N/A $N/A $N/A
EBITDA $N/A $N/A $N/A $N/A $635E
Footnotes:
05/30/00 Gemstar International Group (GMST $34.50,1-H,Tgt $66.00) Niraj
--FUNDAMENTALS--------------------------------------------------------------
Current Rank........:1H Prior:No Change Price (05/26/00)....:$34.50
P/ATCF Ratio 03/00..:N/Ax Target Price..:$66.00 Prior:No Change
P/ATCF Ratio 03/01..:N/Ax Proj.5yr ATCF/FCF Grth:0.0%
Return on Eqty 99...:N/A% Book Value/Shr......:N/A
LT Debt-to-Capital(a)N/A% Dividend............:$N/A
Revenue (00)........:N/A Yield...............:N/A%
Shares Outstanding..:462.0mil Convertible.........:No
Mkt. Capitalization.:15939.0mil Hedge Clause(s).....:
Comments............:(a) Data as of the most recently reported quarter.
Comments............:
05/30/00 Gemstar International Group (GMST $34.50,1-H,Tgt $66.00)
--OPINION:------------------------------------------------------------------
1) OVERVIEW. This past weekend, we met with Gemstar Chairman and CEO
Henry Yuen. Dr. Yuen indicated that the merger with TV Guide is on track
for a second quarter close and that discussions with distributors were
progressing more or less as expected.
We recognize that Gemstar is a DCF story and that, in the current market
environment, companies deriving the majority of their asset value from
the out-years of a valuation model are being harshly punished by
investors. However, we remain quite confident in the company's strong
patent position and we regard the IPG as boasting one of the more visibly
attractive businesses for the long-term foreseeable future. We expect
Gemstar to be the leading player in the IPG area.
While the stock is likely to remain volatile in the near term, closing of
the TV Guide merger should eliminate some of the current uncertainty in
the market and lift both stocks. With regard to timing of merger
completion, Gemstar and TV Guide have substantially complied with the
second request for information from the DOJ, clearing the way for the
merger to close by the end of the second quarter. At this point, we do
not see or anticipate any material obstacles to merger completion.
Moreover, over the next six months, we expect Gemstar/TV Guide to gain
long-term distribution commitments from some cable and DBS operators,
which should also help the stock.
2) CONCERN OVER DISTRIBUTION AND ALTERNATIVES TO GEMSTAR/TV GUIDE.
Undoubtedly, some of the stock's weakness reflects growing concerns
related to potential competitive alternatives. Cable MSOs have been
quite outspoken in recent months regarding their desire to seek
alternatives to Gemstar/TV Guide and this has clearly impacted the
stock. To be clear, we expect certain operators to go their own way,
electing to take their chances with potential litigation and most
operators will simply try to hold out for better terms. This ongoing
posturing contributes a significant amount of perceived uncertainty to
the Gemstar story. Our expectation is that significant distribution
commitments will be made within as little as one to six months. All
distributors are awaiting the close of the merger.
The interactive program guide market is indeed a crowded field, with
competition provided by Scientific Atlanta, TiVo, Source Media,
Microsoft, AOL, among others. Despite the substantial number of
competitors that exist in this space, we continue to regard TV
Guide/Gemstar as the best-positioned player in this market. The company
is particularly well positioned with AT&T; CE manufacturers; AOL/TWX; and
Microsoft.
TVGIA has a ten-year exclusive contract with AT&T, which could put TV
Guide/Gemstar in 15.5 million AT&T digital cable homes over time. With
regard to AOL, assuming Gemstar's license agreement is broadened to
include Time Warner Cable, TV Guide/Gemstar could pick up another 12.6
million subscribers. Gemstar has already licensed its guide to AOL TV.
Under typical exclusive license arrangements, a subsidiary is required to
comply with the parent company's license agreement. We believe Gemstar's
current share price discounts this outcome.
Moreover, Gemstar's license agreement with Microsoft should put the guide
in a substantial number of international cable homes in coming years.
In the CE market, with a significant number of manufacturers having
licensed the Gemstar Guide technology, we expect the guide to ship in
over 50% of TV sets within three to four years.
Although agreements have yet to be signed with DirecTV and Echostar, we
expect both DBS operators to ultimately license the Gemstar IPG within
the next year. Thomson currently provides Direct TV with its IPG and,
Thomson has a license to make and sell the Gemstar IPG. However, DirecTV
does not have a license to "use" the Gemstar IPG and we would expect
DirecTV and Gemstar to reach a friendly resolution over time.
3) VALUATION AND INVESTMENT CONCLUSION. Since peaking out on March 9,
at $101 per share, Gemstar shares have retreated 2/3 or 67%,
substantially in excess of the overall market decline and the 36%
drop-off in the tech laden NASDAQ. Moreover, the nascent ITV sector has
been clobbered during this time period, with astounding 66% correction in
the group.
Based on current prices, Gemstar's pro forma market capitalization is $16
billion, down from the peak of close to $50 billion, and its total pro
forma enterprise value is $16.5 billion. If we adjust for net debt,
minority interests, and $8.3 billion in estimated value for all non-IPG
assets, we arrive at a combined implied residual value of only $8.2
billion or $18 per share for the IPG.
Our price target of $66 per share reflects our base case scenario, which
values the IPG at about $22.7 billion. We assume 100% share of the CE
market and 86% penetration of DBS subs (100% of non-stranded boxes). In
terms of cable distribution, we assume 100% market share of AT&T digital
subscribers (per the 10 year exclusive distribution agreement) and 50%
share of the non-AT&T digital cable market. To the extent AOL license
agreement is broadened to include TWX cable, our market share assumptions
could look conservative.
Under a bear case scenario, assuming no additional cable distribution
outside of AT&T and no international distribution, highly unlikely
scenarios, we still arrive at an IPG valuation which exceeds $14 billion,
suggesting a price objective of $49 per share, roughly 40% above current
levels.
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