5 prime-time HDTV stocks

[Gregg Lengling]

By Michael Brush





A huge TV upgrade cycle
That's big, and it's a trend that is only going to get bigger. In short, we're at the start of a massive, multiyear upgrade cycle in the world of televisions. As an investor, how do you play this trend?

Aside from the home electronics retailers such as Tweeter, Best Buy (BBY, news, msgs) and Circuit City (CC, news, msgs), at least five HDTV component makers should get a piece of the action. Chip designer Silicon Image (SIMG, news, msgs) could see the biggest lift, because it basically owns a key piece of technology behind HDTV.

But other players will see a significant payoff. They include Digital Theater Systems (DTSI, news, msgs), which supplies a key piece of the technology used in Surround Sound audio systems. Consumers typically buy these when they upgrade to HDTV. Other component makers that get smaller but significant portions of their revenue by selling HDTV components include: Microtune (TUNE, news, msgs), Zoran (ZRAN, news, msgs) and Sigma Designs (SIGM, news, msgs).

What's behind the screen
We'll get to more detail on these companies in a moment. But first, here's a look at the main drivers behind what will soon be an HDTV craze.
The government is pushing the change. Federal Communication Commission rules say that by the end of this year, half of all TV sets with screen sizes of 36 inches or more must have a digital tuner. By 2007, all TVs with a 13-inch screen or larger and all DVD recorders must be have digital tuners. That won't make them HDTVs, but the shift to digital will make the HDTV format more common. The format is also ramping up in many other areas of the world, including Europe, Japan, Korea and China, says John LeMoncheck, the vice president of consumer electronics at Silicon Image.


More programming is converting to HDTV. Sports fans know the full value of HD, because it makes following a ball or a puck so much easier. This means as more sports programming switches to HDTV, we'll see demand go up. Fox is already offering some National Basketball Association, Major League Baseball and National Hockey League broadcasts in HD (people with normal sets won't notice a difference). ESPN recently converted much of its broadcasting to HD, and NBC will be broadcasting much of the summer Olympic Games in HD. Much of prime time is already broadcast in HD. As the format spreads to other programming, demand for HDTV will increase.


The natural TV replacement cycle will spur demand. Once enough programming has converted -- and HDTV pricing comes down a bit more -- anyone replacing their old sets will be a sucker for the new format. Buying anything but HDTV will be like buying a black-and-white set today, says Tweeter's Richardson. He's got a built-in bias, of course. But he points out that in the United States there are about 250 million TV sets to be replaced in the next seven to 10 years. That's a huge changeover.


We've reached the tipping point. Last year, 29 million TV sets were sold in the United States. About 3 million of them were HDTV. That 10% level is a magic number. A look at past home electronics trends shows that sales of a new product -- like videocassette recorders or portable music devices -- tend to catch fire right after penetration hits 10%, says Carl Wiese, an analyst with Wall Street Associates, a money management firm. Michelle Abraham, at the technology research firm In-Stat/MDR, projects that HDTV sales in the United States will double next year, compared with 2003, hitting 6 million. She thinks international sales will hit 16 million in 2006, compared to 5 million last year.
Here's a look at some of the companies that should benefit.

Silicon Image
No one has a license to print money in the HDTV arena, but Silicon Image comes pretty close. It created the High-Definition Multimedia Interface (HDMI) standard used to link devices like set-top boxes and DVD players to HDTV sets. Not only does it sell chips with HDMI for use in digital consumer electronics products, it collects a royalty on the sale of each HDTV or any other electronic device using HDMI.

"That is what I like about, the intellectual property position," says Wall Street Associates' Wiese. "They benefit in two ways. They get a license fee and a royalty payment from chip makers that want to integrate HDMI into their product, and they are also a leader in supplying chips."

But won't bigger chip makers step in and steal market share? Probably. But Silicon Image finance chief Robert Gargus thinks his company can stay one step ahead. This makes sense, given that Silicon Image has often been on the cutting edge in developing communication chips.

"While our competitors are trying to get their first-generation HDMI silicon out, we are coming out with our next generation, and that will keep us ahead of competition," Gargus says. For example, his company is coming out with HDMI chips that will allow more devices to be connected to a TV. Besides, he says, new digital home entertainment products are on the way, which makes the HDMI-related market potentially huge. "I don't have to have a very big piece of that to do very well for our size company," he says.


Besides consumer electronics, which makes up about 35% of revenue, Silicon Image also designs silicon used in storage, devices that link PCs to flat-panel monitors and an emerging system for connecting devices to PCs, known as serial ATA (SATA). SATA will replace the parallel ATA storage connection systems in use now. A more powerful chipset for PCs known as Grantsdale, which will be released soon by Intel (INTC, news, msgs), will help force the switch to SATA, say analysts.

For a high-growth tech company with a solid niche, Silicon Image still looks fairly cheap. At around $12.66, it goes for 29 times 12-month forward estimates of 43 cents. That's a price/earnings multiple below its long-term growth consensus rate of 32.5%. High-growth tech companies often carry price/earnings to growth (PEG) multiples of 1.5 to 2. Wiese thinks the stock could trade for $17.50 in a year.

Digital Theater Systems
Let's face it, after you shell out a thousand dollars or more for a new HDTV, chances are you'll want a great sound system to go with it. "Basically if you are going to have a high-definition TV, you've got to have Surround Sound to complete your digital home theater," says Wiese.  


That is where Digital Theater Systems comes in. It licenses the software that goes inside chips that make Surround Sound systems work. (A private competitor named Dolby also plays in this space.) This means Digital Theater Systems gets a royalty of around 25 cents each time someone buys a Surround Sound system or another consumer electronics product that use its technology. That includes things like DVD players, audio-video receivers, stereo amplifiers and even PCs.

"We believe that the focus on HD display devices, and in particular the digital TV transition, bodes very well for our business," says Jon Kirchner, the chief executive of Digital Theater Systems.

The company also sells systems that show digital advertisements in movie theaters, and that create captioning for the deaf in movie theaters. Digital Theater Systems has $6 a share in cash. Given the demand trends ahead, Wiese thinks the company could earn $2 a share in 2006. Put a price/earnings multiple of 20 on that, and you have a stock that could reach $40 in a year, says Wiese. The stock recently traded for about $24.

3 more HDTV plays
We'll group these three together, since they get much less of their revenue from HDTV-related sales. First, Zoran, which makes chips used in image processing, gets just under 10% of its revenue from HDTV sales. But that will ramp up as HDTV takes off. "We expect the percentage to increase to the low teens next year, and over the next three years it could easily achieve 20% or more," says Camillo Martino, the chief operating officer at Zoran. The company also designs image processing chips used in DVD players, digital cameras, multifunctional printers and mobile phones.

The stock recently went for $17.25. Thomas Weisel analyst Jason Pflaum has a 12-month price target of $22. That seems reasonable, given that the stock carries a valuation below its 24% growth rate. At $17.25, the stock trades for around 20 times forward 12-month earnings of 86 cents.

Next, Sigma Designs produces chips that run advanced video decoding systems such as Windows Media Video 9 and H.264, two standards used in HDTV. But Sigma Designs gets only about 5% of its revenue from HDTV-related sales.

In contrast, the largest piece of its sales, or 60%, comes from Internet-protocol television (IPTV) set top boxes -- which convert TV signals sent over the Internet. This isn't popular in the United States, in part because DSL speeds are too slow. It's bigger in Japan and Europe, says Ken Lowe, who's in charge of business development at Sigma Designs. The company gets 35% of its revenue from the sale of chips used in DVD players. At $7.65, Sigma Designs trades for 15.3 times 12-month forward earnings of 50 cents per share. Needham & Company has a 12- to 18-month price target of $13.

Microtune popped to nearly $5 from $3.25 in June when C.E. Unterberg, Towbin picked up coverage of the stock with a buy rating. The stock has pulled back since, but strong HDTV sales may help the stock hit C.E. Unterberg, Towbin's $6.50 price target. Microtune designs chips used in tuners put in HDTV sets, as well as other products like set top boxes and modems.

[StarvingForHDTV]

Thanks Gregg.  Some of these will end up in my IRA account with the others.  Too bad Dolby isn't publicly traded.  I would prefer that to DTS as an investment.