SeaChange International Inc. SEAC
May 28, 2008 - 7:50pm EST by
2008 2009
Price: 7.02 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 218 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Cable, telephone and satellite TV companies are fighting a multiple-front war for viewers and SeaChange International sells two of the most popular “weapons” in this battle: video-on-demand (VOD) and ad insertion. Cable companies can no longer count on a monopoly-like position to sell TV-services to consumers and ads to advertisers as they have to fight off the threat posed by satellite and telephone companies along with the disruptive forces of the internet, mp3 and video players and digital video recorders (DVRs).

Linear TV has lost some of its appeal to consumers that have grown accustomed to the convenience of DVRs and internet content on demand. Cable companies need to evolve beyond the linear broadcast of programming at set times or risk alienating viewers who choose to access the content at another time through another media outlet that is more convenient such as iTunes or the Internet.

On the traditional TV front, there is a race to provide more high definition (HD) content. After a spending binge on HD TVs, consumers want their money’s worth for the additional fees they are paying for the HD TV service. Cable companies would face daunting upgrade projects if they were to add HD as regular programming because each HD signal takes up to four times the space that a regular digital signal takes in the network. It is much easier for satellite companies to deploy one more satellite in space to increase capacity than it would be for a cable company to lay down more cables in the ground.

In the advertising space, Paul Woidke, SVP of technology for Comcast’s Spotlight, commented that the cable industry and newspapers were losing a combined $12 million a day in advertising revenue to the Internet. Paid search and online advertising continues to draw more advertising dollars because it is assumed to be more context relevant (thus better targeted) and easier to track. Besides, you can ignore a banner ad or the paid search results, but you cannot fast forward through them like you can with content that has been recorded in a DVR.

SeaChange International Inc. is the VOD market leader with over 100 deployments and what is considered the best software platform. The company’s VOD system includes the MediaCluster video storage servers, the Axiom video operations services software, SPOT advertising systems, and real-time record system (which provides DVR-like functionality). The system is designed to support interactive services that enable networked digital video recording, targeted, and interactive advertising and DVD on demand services.

Terrestrial providers of TV services (cable and telcos) have adopted VOD as their answer to time-shifting demands from their customers and the traffic numbers seem to validate that answer. Video-on-demand was widely deployed in North America between 2003 and 2005. The numbers today are staggering. Comcast customers select On Demand more than 100 times per second with about 275 million views monthly. Rentrak reports that cable customers increased their year over year VOD viewing by 59% in the first quarter of 2008. In the first quarter of 2008, consumers increased their viewing of VOD programming by 185 million hours versus the first quarter of 2007, driven in part by a 36% increase in the amount of VOD content available to consumers. The demand for VOD is the reason why VOD-enabled homes in the Americas are expected to increase from 34 million at the end of 2007 to 42 million by the end of 2009 with similar or faster growth expected in other regions of the world.

Of course, more choices drive more VOD requests since there is a higher likelihood that there will be appealing choices for more customers. This cycle drives demand for SeaChange’s products in two ways. The first is storage. More titles have to be stored which require MediaCluster servers and these servers are spread out across the provider’s network, essentially creating similar libraries all over the network to allow for faster response times and libraries that are better suited for each region. Secondly, as more choices are available, more people may choose to access the library at the same time, but each server is limited in the number of users it can serve concurrently. So, more concurrent users require more servers to “stream” the content.

Cable companies, and telephone companies to a lesser degree, have turned to video-on-demand to address time shifting and the need to pump more content through the same “pipe” without having to go through very expensive, long upgrades. HD signals may tie up too much of the available network infrastructure, but many of those signals sent may go unused. HD VOD allows companies to only send out the signals that are actually being viewed by customers.

VOD streams save precious space in the network, but they also have upside for advertising purposes. The streams allow for targeted, context relevant ads. With the request for a VOD stream, the advertiser has valuable information. It knows the general demographic information of the viewer, it knows the TV tastes of the viewer and it knows how many people are viewing the ads (as opposed to relying on Nielsen audience ratings for general broadcasts). Thus, their ads are definitely more valuable. Recently, Unilever commented that the click-through rates they were getting on a 2006 interactive ad test they ran on several cable video-on-demand channels far surpassed the ones they received online.

At the close of fiscal year 2003, which was the starting point of Comcast’s initial deployment of VOD technology, SeaChange was trading at $7.57 and 0.8x EV/Sales. Comcast clearly signaled their intention to deploy VOD over their systems in the U.S. and continued to confirm the data points in its conference calls. SeaChange’s share price closed the next fiscal year at $20.2 as sales rose in FY2004 and FY2005.

At the close of the 2008 fiscal year, Comcast continues to be SeaChange’s largest customer, accounting for over a third of its sales. At the 2008 Consumer Electronics Show, Comcasts’s CEO Brian Roberts announced Project Infinity. This is a major upgrade of the current VOD library with an eye-popping 1,000 HD titles by the end of 2008 and 6,000 movies, 3,000 in HD, slated for every library in 2009. Despite this announcement and clear data points supporting the VOD deployments by Comcast and many other terrestrial providers, SeaChange trades at $7.02 and 0.76x EV/Sales. This is despite a proven technology, a clear ramp up cycle coming along due to new technologies and a replacement cycle of servers deployed in the initial 2003 ramp up.

SeaChange now is a superior company to the one that began the path to commercial viability for VOD in 2003. It has its grown revenues from $133M in F2003 to $180M in F2008 with a larger portion of the revenues coming from less volatile services, software licenses and maintenance. Its dependence on Comcast, while still vital to the company, has been lessened as it has added a marquee list of names around the world (Time Warner, Cox, Verizon, NTT, Virgin Media to name a few). SeaChange is in the early stages of another ramp up cycle and, just like in the previous cycle, investors seem unaware of a very attractive technology company with little exposure to the U.S. consumer. Trading at forward 0.7 EV/Sales and 6.9x EV/EBITDA with $2.96 a share in cash, no debt and poised to grow EBITDA per share over 300% over the next two years, I believe SeaChange is an undervalued small cap gem. Assuming a conservative forward 2x EV/Sales, SeaChange could be trading at $16 instead of the recent $7.02.

Wall Street Estimates (December Fiscal Year-End) in millions

2008(actual) FY2009 FY2010

Revenues $180 $194 $212.75

EBITDA 4.8 17.97 19.6

Operating Profit (8.0) 4.22 5.97

EV/EBITDA 28.46 7.5 6.9

EV/Sales 0.76 0.7 0.6


1. Comcast’s Project Infinity VOD rollout
2. Upgrade cycle for technology deployed in 2003 cycle
3. Library buildout for additional HD content
4. Streaming capacity build for additional HD content
5. Broadcast sales for Ad insertion technology rollout
6. Interactive TV / Advertising pilot programs
7. Additional software development and applications to be sold on top of the Axiom software (Restart, Affinity, etc)
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