Don't short this "story" 2002-08-07
A stealth VOD boom augurs well for two equipment providers
by Dave Sterman, equity research columnist
Investors have soured on "story" stocks—companies with scant present earnings that promise explosive growth down the road. For contrarians, that means it's time to look for compelling stories.
Concurrent Computer (CCUR) and Seachange International (SEAC), the leading purveyors of video-on-demand (VOD) servers to the cable industry, offer an interesting case in point.
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The VOD "story"
The delivery of content directly to consumers was supposed to revolutionize the telecom industry. Nearly a decade ago, Ivan Seidenberg, CEO of Bell Atlantic (predecessor to Verizon (VZ)), revealed splashy plans to build a video empire upon his telecom platform. And the crown jewel: VOD, where customers could watch any movie at any time.
Technology and money were in short supply at the time, forcing Seidenberg to abandon his dreams.
Companies mentioned in this article
Concurrent Computer (CCUR)
Seachange International (SEAC)
But his vision is now, belatedly, being realized by the arch-enemy: cable companies. They've begun to aggressively roll out service, and found a great deal of interest from consumers.
You'd never know it by looking at their stock prices, but Concurrent Computer and Seachange International are shaping up to be the direct beneficiaries of the coming VOD boom.
In the past year, Time Warner Cable, Cox, Comcast, and Charter have all started modest rollouts of VOD service. In selected markets, they've bought a few VOD servers, quietly spread word of its availability, and then watched to gauge consumer reaction.
Reports for further inquiry
RBC Capital Markets. Concurrent Lands Real-Time Deal with Aerospace Company.
Jefferies & Co. AOL Time Warner to Offer VOD To All Markets by YE02.
H.C. Wainwright. CCUR-Let's Get ready to Rumble.
H.C. Wainwright. Initiating Coverage on SeaChange with a Neutral Rating.
Their push into pay-per-view a number of years ago was generally underwhelming, so cable operators had reason to be dubious of consumer demand for VOD.
But their fledgling VOD has gained surprising traction. A series of articles in the July 15 issue of Multichannel News highlights the head of steam that VOD is building.
Cablevision, for example, has found that consumers have ordered an average of nine programs a month. And HBO, which offers its programming in a pay-as-you-go VOD format within selected markets, says that consumers are ordering up 12 hours of programs a month.
To further the value proposition for cable operators, they're finding that churn is dropping sharply in markets where VOD has been rolled out. And that's why they're giving away "free" VOD content as well.
It's important to note that VOD is catching on despite scant marketing dollars. As sentiment builds that consumers want-and will pay for-VOD, look for a more aggressive rollout in the quarters to come, triggering strong demand for Concurrent's and Seachange's VOD servers.
The picture slowly brightens
You can already see the demand evident in Concurrent's quarterly performance. Sales, which bottomed at $14.1 million last September, rose to $25 million in the March (third) quarter. (Growth would have been even more impressive were it not for the flat results posted by Concurrent's non-VOD division, known as Real-Time).
Reported EPS in that quarter was $0.04, trouncing the break-even estimate. CIBC's Alen Bezoza thinks Concurrent will again exceed estimates when it reports Q4 results on August 23.
Looking ahead at the fiscal year that has just begun, management has refrained from providing guidance. But a case can be made that strengthening demand for VOD systems should lead to 30-40 percent top line growth in that division, and 20 percent growth companywide.
For its part, SeaChange also looks poised to post heady growth. H.C. Wainwright's Lawrence Harris predicts that EPS will surge from $0.10 in Fiscal (January) 2003 to $0.47 in Fiscal 2004. Shares trade for just 12 times that 2004 estimate.
And each of these companies could see their growth trajectory stretch out for several years. That's because VOD has been rolled out in only on third of the major cable markets. And even where deployment has begun, additional servers need to be added to handle an expected surge in demand for VOD services.
As it stands, Concurrent and SeaChange International each control about a third of the VOD server market. Those shares could rise as privately held competitor Diva has filed for bankruptcy. (Charter, a former Diva customer, has recently become a customer of Concurrent).
Shares of SeaChange appear cheaper on a price/sales and a P/E basis. But many analysts think Concurrent has shown greater momentum in the VOD industry. CIBC's Bezoza tells Multex Investor that "Concurrent deserves to trade at a higher valuation than SeaChange, since they've already proven leadership in the space."
Nevertheless, both shares look very cheap in relation to their growth rates. That's because investors aren't buying "story stocks" right now. It doesn't help that the entire cable sector is going through one of its cyclical swoons.
And shares were also spooked by rumors that Sun Microsystems (SUNW) and Silicon Graphics (SGI) were eying the VOD market. But an entry by either of those firms would be difficult, as Concurrent and Seachange already act as first and second sources in almost every major cable account.
Cable operators have tended to have unique requirements, and have historically relied on a handful of equipment vendors such as General Instrument and Scientific Atlanta (SFA). VOD servers are tweaked to handle video, IP and other cable telephony protocols.
Lastly, cable operators have been dragged through the mud by Hollywood studios that want to ensure that they receive an appropriate slice of the revenue pie. Revenue sharing issues are now close to being resolved, which should act as a catalyst for higher spending on VOD equipment.
Hollywood's participation is becoming less relevant as more "free" VOD content becomes available. A wide range of cable networks are rolling out their own VOD packages for consumers.
And that's helping cable companies to showcase the appeal of VOD to consumers. As demand grows, look for the major studios to hop on, just as they did with DVDs once that medium proved successful.
In this current market, "story stocks" such as Concurrent and SecChange have become "show me" stocks. Later this year, they should dispel their doubters by posting very strong growth.
