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Technology Stocks : C-Cube -- Ignore unavailable to you. Want to Upgrade?

To: John Rieman who wrote (32110)	4/11/1998 4:16:00 PM
From: Ian@SI	Respond to of 50808

Lehman's Research report in case it wasn't posted... Headline: C-Cube Microsystems: Initiating Coverage; 2-Outperform; Part I of II. Author: M. A. Gumport, CFA Rating: 2 Company: CUBE Country: INI CUS Industry: SEMICO Ticker : CUBE Rank(Prev): NA Rank(Curr): 2-Outperform Price : $18 3/8 52wk Range: $35-16 Price Target: $27 Today's Date : 04/09/98 Fiscal Year : DEC ------------------------------------------------------------------------------ EPS 1997 1998 1999 2000 QTR. Actual Prev. Curr. Prev. Curr. Prev. Curr. 1st: 0.41A -.--E 0.24E -.--E 0.30E -.--E 0.40E 2nd: 0.20A -.--E 0.19E -.--E 0.30E -.--E 0.40E 3rd: 0.25A -.--E 0.27E -.--E 0.39E -.--E 0.44E 4th: 0.30A -.--E 0.35E -.--E 0.46E -.--E 0.51E ------------------------------------------------------------------------------ Year:$ 1.15A $ -.--E $ 1.05E $ -.--E $ 1.45E $ -.--E $ 1.75E Street Est.: $ -.--E $ 1.10E $ -.--E $ 1.31E $ -.--E $ -.--E ------------------------------------------------------------------------------ Revenue (1998E): 369.8 Mil. Return On Equity(97): 17.0 % Proj. 3yr EPS Grth: 20.0 % Shares Outstanding: 42.0 Mil. Dividend Yield: N/A Mkt Capitalization: 771.8 Mil. P/E 1998; 1999 : 17.5 X; 12.7 X Current Book Value:$6.23/sh; 2.9X Convertible: YES Debt-to-Capital: 2.0 % Disclosure(s): C, A Includes convertibles in equity ($86.3 mil.) and shares outstanding. ------------------------------------------------------------------------------ PART I OF II; INITIATING COVERAGE WITH A 2-OUTPERFORM RATING. CUBE TRADES AT A RECORD LOW VALUATION. OUR $1.05 '98 ESTIMATE MAY BE CONSERVATIVE. TARGET RANGE OF $23-$28 BY END OF 1998. DIGITAL VIDEO IS KEY DRIVER FOR CHIP INDUSTRY IN UPCOMING YEARS, AND CUBE'S MPEG VIDEO COMPRESSION LEADERSHIP POSITIONS IT WELL TO CATCH THIS WAVE. WE SEE NUMEROUS POTENTIAL UPSIDE SURPRISES. TWO EXAMPLES: 1) DIVICOM SUBSIDIARY TO CAPTURE 2ND MAJOR DTH CUSTOMER? 2) CUBE TO 2ND SOURCE KEY DIGITAL STB (SETTOP BOX)? ----------------------------------------------------------------------------- DIGITAL VIDEO PROMISES TO BE THE KEY FORCE DRIVING CHIP DEMAND OVER THE NEXT 10 YEARS. C-CUBE IS THE RECOGNIZED LEADER IN DIGITAL VIDEO ENCODING (RECORDING) CHIPS AND ONE AMONG SEVERAL TOP PLAYERS IN THE DIGITAL VIDEO DECODING (PLAYBACK) MARKET; TODAY'S ROUGHLY $488 MIL. MPEG MARKET LARGELY REFLECTS C-CUBE'S EFFORTS IN THE LATE 1980S TO SET KEY STANDARDS. C-Cube's 1997 sales of $337 mil. were 48% from MPEG-1 decoders serving the video CD (VCD) business in China (73% market share), 31% from video broadcast equipment system sales through the Divicom subsidiary (25% market share), 10% from MPEG-2 decoders principally for satellite/cable digital settop boxes (14% market share), and 6% from MPEG-2 encoders principally for the broadcast industry (57% market share). MPEG-2 encoders are C-Cube's most profitable business followed by MPEG-1 decoders. Overall, C-Cube enjoyed a 53% gross margin in 4Q97. OUR ESTIMATES ARE CONSERVATIVE. Rapidly falling consensus projections have focused on 1998's likely tough transition. But, with C-Cube now trading at record low valuations, we are more impressed with the likelihood of upside surprises. Our slightly below consensus $1.05 1998 estimate seems reasonably conservative, and we expect a strong EPS rebound in late 1998 to generate $1.45 in 1999 and $1.75 in 2000. (Cont'd) CUBE Part I (Continued) Page 2 2 RATING. A MOVE TO $23-28 RANGE BY YEAR END SEEMS LIKELY AS C-CUBE'S DIGITAL VIDEO LEADERSHIP IS EVIDENCED BY DESIGN WINS, ORDERS, SALES ACCELERATION, AND IMPROVED PROFITS. Sources suggest VCD unit volume in China is proving surprisingly robust. That should help establish a floor. Meanwhile, emerging opportunities later in 1998 for digital video disk (DVD) decoders and settop boxes (STBs) plus strong steady growth in the digital broadcast sector suggest more fundamental upside than downside. Reported interest by X86 vendors in graphics accelerator companies can only intensify a positive reexamination of C-Cube's value. ONCE NEAR TERM EPS RISK IS FULLY DIGESTED AND VISIBILITY ON BROADCAST, DVD, AND STB OPPORTUNITIES BECOMES MORE CERTAIN, WE WOULD BE AGGRESSIVE BUYERS. LONG TERM PURCHASE IS JUSTIFIED NOW. C-CUBE'S BUSINESS IS MORE THAN JUST VCDS; OTHER CORE OPERATIONS WILL STRONGLY BENEFIT FROM KEY SHORT AND LONG-TERM TRENDS. SHORT-TERM: C-Cube is well positioned to participate in the 1998-1999 wave of demand for MPEG-2 decoder chips for the DVD market. We believe DVD-ROM/TV sales will rise from about 0.7 mil. units in 1997 to 2.4 mil. units in 1998, and DVD-ROM/PC units will rise from roughly 0.2 mil. in 1997 to 12.1 mil. in 1998. The anticipated upsurge in the DVD market should boost C-Cube's 1998 sales by just over $35 mil. and fully offset the decline in VCDs. LONG-TERM: C-Cube circa 2001 has an opportunity to lead the market for MPEG-2 encoder chips (in which C-Cube has 57% share) including a drive into low cost consumer items such as digital VCRs and camcorders. C-Cube intends to reduce the cost of digital video encoding chips to $50 by mid 1999 from nearly $1000 today. That dramatic cost reduction should stimulate strong growth in a variety of new markets including digital VCRs and camcorders. BEYOND THE SHORT-TERM BULGE IN DVD-ROM SALES AND THE LONG-TERM POTENTIAL TO PLAY INTO THE DIGITAL VCR/CAMCORDER MASS MARKET, THE DIVICOM SUBSIDIARY IS BUILDING AN EXCEPTIONALLY STRONG FRANCHISE IN VIDEO PRODUCTION AND BROADCASTING. The success of DTH (direct to home) digital satellite broadcasting plus congressional mandates are pushing cable and over-air broadcasters to go digital. Divicom is already #2 worldwide in supplying critical compression gear to digital broadcasters. Divicom looks likely to show steady strong growth averaging over 30% annually. DIVICOM POSITIONS C-CUBE FOR 2 POTENTIAL FAVORABLE SURPRISES THIS YEAR. Our projections do not hinge on these events, but we see two possible 1998 upsides: 1) The eyeball battle between satellite, cable, and over air broadcasters suggests Divicom, now largely a vendor to Echostar, could capture the compression business for a second key satellite operator; 2) C-Cube could emerge as a key 2nd source for STBs to TCI. Primestar's selection of General Instrument's DigiCipher II conditional access technology for their digital STB rollout attracted considerable attention, and that attention intensified with TCI's selection of General Instrument as well. Less attention has been paid to the inclusion of MPEG-2 and the issue of future second sources. TCI's desire to maintain control of its equipment budget suggests C-Cube could be well positioned with its partner Panasonic to serve as a second source for General Instrument's future STBs. (CONTINUED: SEE PART II) BUSINESS DESCRIPTION: Leader in digital video compression technology, the key enabler for the emerging revolution in digital video. PART II OF II; INITIATING COVERAGE WITH A 2-OUTPERFORM RATING. BOTTOM LINE: EXPECT ABOUT 20% AVERAGE SALES GROWTH; GROSS MARGINS SHOULD REMAIN SLIGHTLY OVER 50%. ----------------------------------------------------------------------------- IN SUMMARY, C-CUBE SHOULD AVERAGE NEARLY 20% GROWTH OVER THE NEXT 3 YEARS INCLUDING AN ACCELERATION IN 1999-2000 AND ONGOING STRONG GROWTH THEREAFTER. Expect MPEG-1 decoder sales to fall from 48% of sales to just 24% of sales, but Divicom should move up from 31% to 41% of sales, MPEG-2 decoders should rise from 10% to 17% of sales, and the highly profitable MPEG-2 decoder operation should rise from 6% to 16% of sales. Total sales should rise from $337 mil. in 1997 to $572 mil. in 2000. Some margin pressure is likely, but the push into new, proprietary markets, most notably video compression markets, should still keep margins at a very respectable level. TABLE OF CUBE SALES SUMMARY 1997-2000 1997---------------- 2000----------------- Mkt Mkt 3-Yr --$--- -% Mix- -Share- --$--- -% Mix- -Share- -CAGR-Total Cube Sales $337.0 100.0% -.- $572.2 100.0% -.-% 19.3% MPEG 1 Decoder $162.7 48.3% 73.3% $137.0 23.9% 55.5% -5.6% MPEG2 Decoder $32.7 9.7% 14.3% $99.1 17.3% 15.7% 44.7% MPEG2 Encoder $21.2 6.3% 57.3% $88.6 15.5% 43.9% 61.1% Divicom 1 $103.1 30.6% -.-% $235.2 41.1% -.-% 31.6% Other 2 $17.3 5.1% -.-% $12.3 2.1% -.-% -10.7% 1-Divicom sales exclude estimated MPEG 2 encoder chip sales of $6.8 mil. in 1997 and $17.8 mil. in 2000; 2-Other includes MPEG1 encoders. Continued CUBE Part II (Continued) Page 2 COMPARABLE VALUATIONS OF PC DESIGN COMPANIES {table here for LB sales} CHART OF HISTORICAL BUY/SELL MULTIPLES {chart here for LB sales} BUSINESS DESCRIPTION: Leader in digital video compression technology, the key enabler for the emerging revolution in digital video. ------------------------------------------------------------------------------