Description
Seachange International, Inc. (SEAC @ $17.40)
SeaChange International (“SEAC”) is a compelling rifle shot on the long awaited coming of video on demand (“VOD”). SEAC develops and deploys digital hardware, software, and advertising insertion for television operators and telecommunication companies. To date, the hockey stick has been slow to develop but should change over the course of 2005 and into 2006. VOD is much more than pay-per-view movies!
Valuation
Trading at $17.40, SEAC has an enterprise value of $366 million ($487 million market cap. minus $121 million in cash). At face value, SEAC is trading at 34x EPS and 2.9x book and/or sales. Subtracting $4.30 in cash, the company looks reasonable at 25x trailing EPS and 2x sales for an emerging industry. By July 2005, SEAC should be on a dollar run rate in earnings or 13x (less the cash). SEAC spends approximately $30 million per year in research and development, more than all of its competitors combined.
Its shareholder base is concentrated with 64% of the shares held by 6 firms and SEAC’s founder/CEO William Styslinger. Eastbourne capital controls more than 25% of the float through two entities. The short interest is high at 18.5% of the float.
VOD
There are 72 million cable subscribers in the United States. Comcast is the only operator that has initiated a significant outlay for VOD. Comcast has 22.5 million subscribers of which 40% are digital (HDTV). Comcast’s goal is to have all of their subscribers converted to HDTV in the next few years. Since Comcast is the dominant company to date in VOD, I focus this report on their product offering and game plan to provide an outline of the invest opportunity.
To have VOD, you must first subscribe to High-Definition Television (HDTV). HDTV images allow a high-resolution picture that is several times the clarity of DVD’s and 5 times the resolution of a regular television picture. Therefore, subscribers must live in a town where digital television is offered, have a HD-ready TV, subscribe to the service, and get a Comcast HDTV receiver/ decoder. The receiver has a built in TIVO type functionality (DVR) and is made by either Scientific Atlanta or Motorola. The Motorola product just rolled out a few weeks ago; which delayed Comcast in several markets.
Instead of charging for selected VOD programming, Comcast gives it away for free to drive digital cable growth and to reduce churn. To date, the two most significant VOD markets for Comcast are Philadelphia and Boston. Each market started with a VOD library of 1,500 hours of programming, now has 3,000 hundred hours, and a goal of 20,000 hours. The VOD library offers much more than on demand movies (Pay-Per View). Let’s suppose that you subscribe to HBO. On a traditional cable or satellite, you must watch a specific event at the directed time. Listen carefully, VOD changes that experience! As a Comcast HDTV HBO subscriber with the appropriate receiver, you can pick out any of the 60 titles offered and watch any HBO movie for free at any time at no additional charge. Therefore, why would any VOD customer not stream content over being handcuffed to schedule programming? Other stream events may include local weather, news clips, or local sports. In Philadelphia, one very successful application is Dating on Demand. Instead of looking at a picture on Yahoo, you can watch a video on a prospective date. Other popular applications involve NFL and NBA total game review in 15-20 minutes. The point, VOD is a whole new spectrum that puts the subscriber in total control of content. As content is added and streams are used, more and more equipment is needed and software is upgraded!
According to MultiChannel News, Comcast VOD usage tripled in 2004, from 20 million streams in January to 58 million streams in October. The average Comcast customer used VOD an average of 23 times per month in October. Comcast has a goal of a billion streams in 2005! Comcast has approximately 4,600 free VOD titles available each month. Unlike its peers, Comcast has been aggressively adding content by participating with $300 million in the MGM deal that will give it access to 10,000 program episodes and by striking a deal with Sony it will have access to 35,000 series episodes.
VOD Investment Options
The breadwinners on VOD are the movie producers, equipment vendors, software companies, advertisers, and the television operators or telecommunication companies.
Until recently, Comcast was using a 50-50 split between two companies: SeaChange and competitor ConCurrent (CCUR). Comcast officials indicate that SeaChange is the preferred vendor with an end-to-end solution and is now being awarded 80-90% of all VOD related software and hardware purchases.
Engineers indicate that it is extremely complex to get a consistent VOD streams result in multiple markets. The library content arrives from many sources and must be configured to deliver a reliable high-resolution. In addition, the digital advertising insertion equipment (vs. analog) is completely different. Cable operators are migrating to a reliable one-stop shop, SEAC, which integrates all the functionality of hardware and software to a single vendor. Each local market must library house the hours of content, stream capability, and advertising insertion. Mixing and matching of equipment from various vendors’ leads to technical headaches for the operators.
We have all seen the yellow line that marks first down yardage needed in a football game. SeaChange’s equipment incorporates advertising insertion software on the content platform. Think of watching a replay of a football game in which the field has an imaginary soft drink.
Historically, Comcast configured each local market with the assumption of one stream per ten households during peak programming hours. As the adoption increases, the programming will move to one stream per eight, then one stream per six, etc. A bullish indicator, Comcast is now starting with provisioning new markets with 1-8 vs. 1-10 a few months back.
In summary, VOD and DVR combination is a knockout punch for the cables that gives the consumer the ultimate flexibility in viewing content. VOD gives the impulse viewing ability, and the DVR gives the option to record selected viewing. A few years out, this has the potential to significantly alter advertising and linear programming. As mentioned, VOD has significantly reduced churn for Comcast in Boston and Philadelphia. There is no comparable VOD experience described for satellite.
As streaming demand moves up, so does the need for SEAC’s three legs: additional equipment, software, and advertising. A rough estimate according to the IR department is that each add on equipment purchase is about 80 90% of the original outlay. As with building any new industry, the quarters will be lumpy (that’s providing the opportunity for visionary long term investors). Comcast engineers have strongly indicated that SEAC’s revenue should increase handsomely in 2006 as they roll out more VOD.
Bears vs. Bulls
New movie releases go the following route: (1) theater, (2) hotels/planes, (3) rental stores, (4) pay per view, and (5) major networks (NBC, ABC, CBS, etc). Producers control content; therefore, the operators are starved for content and SEAC will be left with one time orders. Additionally, Comcast is the only significant customer and others may or may not roll out VOD. The short thesis is a very stupid risk reward. There is 2-3 points downside risk on the lumpy quarter syndrome versus a big open ended story of contract wind or increased adoption. For this opportunity, the valuation is reasonable at two times adjusted sales, over $4 a share in cash, cash flow positive, etc.
My bet is simple. William Styslinger, the founder of SEAC, is not conveying the story well to Wall Street. Comcast is the industry pioneer; it is setting the industry standard for a paradigm shift. The next few quarters (by the SEAC’s own admission) will be lumpy. As mentioned, Comcast is now provisioning 1 in 8 in new markets and the average customer used VOD 23x a month in October. Currently, Comcast is focusing its efforts on content vs. near term stream equipment. Comcast still expects to have a billion streams next year. As the preferred vendor, SEAC is now cemented into Comcast’s platform and which makes it difficult for them to change vendors. SEAC’s revenues and earnings will win out over the second half of 2005 and 2006. In the interim, patience is a virtue. With numerous trials in the late stages of development, the risk is not purchasing SEAC now versus waiting for clearer visibility. SBC and Verizon recently expressed interest in the triple play.
Catalyst
Increased orders in second half of 2005 and 2006.