Takeaways From Gemstar TV-Guide International's Recent Earnings: Shares Undervalued But Risk Remains

Gemstar TV-Guide International (GMST) reported its 3Q06 results November 2 after the close. Following are excerpts from our comments on Gemstar's results (full comments available):

• Investors could be facing a false rally on outwardly strong 3Q06 results. Shares of GMST were up sharply in the aftermarket after the company reported better-than-expected results yesterday. However, much of this upside was due to one-time benefits. Even more troubling, management raised its outlook for losses at the TV Guide magazine for 2007, and disclosed it now does not expect it to reach profitability for the next two to three years.

• Consolidated results for 3Q06 exceeded expectations. Revenue of $148.9 million, EBITDA of $21.3 million and EPS of $0.04, compared to our estimates of $135.5 million, $9.0 million and $0.01, respectively, which were, for the most part, in line with consensus. Upside to our revenue estimate came from Publishing and CE segments, offset somewhat by lower-than-expected Cable & Satellite revenue, while EBITDA was better than expected for all three segments and was buoyed by lower-than-expected corporate expenses.

• Upside to expectations was largely due to one-time benefits. At first glance, it appears Gemstar blew away expectations for 3Q06 on all measures. However, upon closer examination it becomes apparent that nearly all of the upside reported in the quarter was due to one-time benefits. We estimate that, excluding these items, revenue would have been approximately $138 million, or modestly higher than expected, and EBITDA would have been about $12 million, also only slightly better than our $9.0 million estimate.

• Management raised its guidance for TV Guide magazine losses in 2007. Management reiterated its outlook for $50 million in EBITDA losses for TV Guide magazine this year, but raised its outlook for EBITDA losses in 2007 to $30 million from a previous pledge to have the magazine at breakeven by year end. It also pushed out its target for profitability to the 2008/2009 time frame, due to a longer-than-expected period for gaining traction with advertisers. We believe it is just as likely the illusive target is paying subscribers.

• We have updated our model and are maintaining our estimates for 2007. We now look for 2007 revenue of $621 million, EBITDA of $110 million and EPS of $0.14, which compares to our prior estimates of $612 million, $109 million and $0.14, respectively. Our new estimates reflect the aforementioned higher losses from the TV Guide magazine and a modest reduction in our outlook for Cable & Satellite results, offset in part by a sharp increase in CE segment revenues and EBITDA from recent licensing agreements.

• We are maintaining our BUY rating and $4.25 target price. 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 value Gemstar's media and IPG assets at approximately $4.00, assume no value from publishing, and back out $0.75 for corporate costs, for $3.25 per share, plus $1.00 per share in cash, for a price target 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.

GMST 1-yr chart: