Gemstar TV-Guide Earnings Preview: Growth, Improved Profitability Should Power Shares Higher

Gemstar TV-Guide International (GMST) will report 3Q06 results today after the close. Here are our pre-earnings notes:

• We are approaching 3Q06 results with our usual trepidation. We project total revenue of $135.5 million, EBITDA of $9.0 million and EPS of $0.01. Consensus estimates are $135.9 million, $7.9 million and $0.01, respectively. Last year, results were $151.1 million, losses of $17.2 million, and $0.07. Revenue is off due to the contraction of the TV Guide magazine, as is EBITDA improvement, while 3Q05 EPS reflected a one-time tax benefit.

• Cable & Satellite growth should help offset Publishing declines. Total revenue is expected to be off 10% with a 41% drop in Publishing, due to TV Guide magazine revenues falling to $30 million from $56 million a year ago, offset by a 14% increase in Cable & Satellite revenue to $77 million from $68 million, underpinned by a 21% increase in IPG licensing and 9% growth at the TV Guide channel. CE segment revenue should be flat at $21 million, as gains in CE IPG are offset by declines in VCR+.

• Improved profitability due to lower losses at TV Guide magazine. We look for a $26 million swing in EBITDA to $9 million, due principally to lower losses at TV Guide magazine. We expect Publishing segment EBITDA losses of $12.5 million, down from losses of $30.5 million a year ago. We look for C&S EBITDA of $32 million, up from $29 million a year ago, and for the CE to show a modest improvement in EBITDA margins. We expect improved segment profitability in 3Q06 to be partially offset by higher corporate expense.

• Key businesses face headwinds that are hampering their recovery. We recently lowered our estimates though 2007 to reflect 1) lower advertising revenue and higher programming expenses at the TV-Guide channel, 2) lower newsstand growth and higher incentives at TV Guide magazine, 3) the failure to close two deals for VCR+ that were expected to positively impact 2H06 results, and 4) higher investment in new business development.

• Losses of legacy businesses weigh heavily on valuation. This year Gemstar won important deals with Cox and Charter, demonstrated its next-gen IPG, and launched a mobile IPG that could become an important new category. In 3Q06, Gemstar relaunched TVGuide.com and expanded TVG into the U.K., and it is slowly recasting TV Guide magazine and channel. We believe the cost of these efforts is factored into Gemstar's valuation, but not the benefits.

• We reiterate our BUY rating on shares of GMST and $4.25 price target. We believe GMST is undervalued on a sum-of-the-parts basis, reasonably valued on the basis of current financial performance, and carries the option value of being successfully broken up or repositioned. We conservatively value Gemstar's media and IPG assets at $3.75, assume no contribution from TV Guide magazine, and back out $0.55 for corporate overhead, for $3.20 per share, plus $1.05 per share in cash, for a target price of $4.25.

• Investment in shares of GMST should be considered speculative. Gemstar is in transition. After watching the company for over six years, we believe that it is clear the company is turning itself around. However, this process is neither easy nor certain, and investors should be aware that hiccups are likely to occur along the way. Negative implications may come from a weak macro environment, poor execution or competing technology.

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