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Description:

China Digital TV Holding (abbreviated CDTV) (STV) is a Beijing-based company, formed in 2004, that manufactures products and provides services related to digital television conditional access (CA) systems. Its major stream of revenue (90%) comes from the production and sale of smart cards, which are an integral component of the set-top boxes (STBs) television network operators use to provide and control access to their cable networks. Every television set that wants to access a digital cable TV network will require one STB, and each STB will require one smart card.

CDTV’s operations and customer base are entirely in China. The company currently carries no debt on its balance sheet, has a net profit margin of 60%, and carries about $140 million in cash and $70 million in medium-term bank deposits (this is after they distributed a special cash dividend to all common share holders of $1.00 earlier this year)—that’s a total of $3.66 per share in cash and medium-term cash equivalents. Additionally, the company’s total net income in the period from 2004 to 2007 was $48 million, and its total capital expenditure during the same period was $2 million.

Opportunity:

The PRC government has mandated that all television network operators convert from analog to digital cable by 2015. CDTV is a direct beneficiary of this transition since every television set in China will need a smart card to watch cable TV. CDTV is the current market leader in digital TV smart cards with 51% market share in 2008. There is significant reason to assume that CDTV will either maintain or grow this market share in the coming years due to the nature of the industry during this transitional phase. Most of the network operators in tier-1 and tier-2 cities in the PRC have already signed contracts with CA systems providers. Actual product sales lag the potential size of the contracts because the network operators still have yet to fully install digital TV into every neighborhood, but because the contracts are in place, and it would require the operator to go from door to door to replace existing STBs if they wanted to change their main CA system—those markets will remain fairly stable.

The only factors that can really materially affect smart card market share in the future would be contracts in tier-3 and smaller markets, or acquisitions within the industry. To address the first point, in 2008, CDTV signed 36 of the total 66 new CA systems contracts. To address the second point, CDTV is currently holding onto its massive cash reserves with an eye to ailing competitors during the market downturn.

Since the mandated transition to digital cable is still in its early-to-mid phases, only 30% of the total cable market has converted to digital. This chart projects a likely picture of CDTV’s income stream by 2013:

(millions except per unit number)

a. Total number of units sold, 2004-2008 (CDTV):

22.8

b. Average market share, 2007-2008 (CDTV):

49%

c. Total number of units sold, 2004-2008 (all): [a / b = c]

46.5

d. Number of DTV subscribers by end of 2008:[1]

45.1

e. Number of DTV subscribers by end of 2013 (projected):[2]

135

f. Potential total number of units sold, 2008-2013 (all): [e – d = f]

89.9

g. Potential total number of units sold, 2008-2013 (CDTV): [f * b = g]

45.0

h. Revenue per unit sold, 2004-2008 (CDTV):[3]

$7

i. Potential revenue, 2008-2013 (CDTV): [g * h = i]

$314.65

j. Average profit margin, 2007-2008 (CDTV):

60%

k. Potential net income, 2008-2013 (CDTV): [i * j = k]

$188.79

[1] http://www.digitaltvnews.net/content/?p=7127

[3] 7.3 million smart cards sold in 2007 generated revenue equal to $49.4 million, or $7 per card.

Since CDTV has historically needed very little capital expenditure to maintain its business, that $189 million is almost entirely pure cash profit. To put that in perspective, let’s first forget about the entire future of the company’s operations past 2013 and just imagine CDTV as a 5-year bond with a yield of 5% (which is currently the average 5-yr corporate A yield)—that’d mean CDTV would be worth $756 million, or $13.19 per share.

Conclusion:

At the current market price of approximately $7 per share, one would be buying at a 53% margin of safety to the company’s value for the next five years alone. The lucky investor also gets a free $3.66 in cash and deposits, and an ownership stake in all future cash flows of a company that is solidifying its position as the dominant player in China’s digital TV technology industry—all for the price of a single smart card.

Disclosure: Long STV.

Source: China Digital TV Holding: Hitch a Ride on China's Infrastructure Boom