OPTV Dealing with Comcast to Accelerate Growth

Year-end sell off in OpenTV (OPTV) has created an opportunity. OPTV performed poorly in 2H06 for a number of reasons, but fell precipitously late in the year. We acknowledge the pitfalls of 2006 and the challenges of 2007, but we believe the shares have reached their nadir. With tax-loss selling behind us and potentially positive catalysts ahead of us, we believe shares of OPTV are likely to recover rapidly from their current depressed levels. Here's why:

- We believe 2007 will be a big year for shares of OPTV. OpenTV exits 2006 in strong financial health and enters 2007 with new middleware customers expected to drive 15% to 20% growth. The company has been working closely with Comcast (CMCSA) to develop an interactive advertising platform for the U.S. cable business. We believe OpenTV will announce some sort of deal in the first half of the year that will serve as a positive catalyst for the stock.

- OpenTV is a leading company in a high-growth market, and is the leading provider of set-top box middleware. Digital TV penetration is expected to more than double, reaching 300 million households in the next three years. We estimate cumulative demand for set-top boxes will exceed 440 million units by 2010, and that the cumulative market opportunity for middleware and its related application will exceed $6 billion during this time period.

- We expect OpenTV to be cash flow neutral in 2006 on $100 million in revenue. The 80% of OpenTV's revenue from middleware has about a 45% contribution margin. The remaining 20% is from applications which are still in the development phase. OpenTV's balance sheet is very strong. The company had $67 million in cash and no debt at the end of 3Q06, and it will receive $20 million from Liberty within a year.

- We believe new middleware deals will positively impact financial results in 2007. In particular, three new customers: UGC (European Cable), Time Warner Cable (TWX) and Essel (Dish TV – India), will all begin to make a meaningful contribution by mid-2007, adding $500,000 to $750,000 each in recurring revenue per quarter by year-end. These new customers alone should drive a 15% to 20% increase in total revenue in 2007.

- Comcast's interactive ad deal would be a catalyst for application business. OpenTV has been involved in a lengthy process to develop an interactive advertising platform for Comcast. We believe a deal could be announced in 1H07 that would accelerate OpenTV's growth rates and set the stage for several years of profitable growth. Ultimately, we believe the market for interactive advertising could grow to be larger than OpenTV's middleware business.

- We reiterate our BUY rating and $5 price target on shares of OPTV. We value shares of OPTV with a DCF model. Our model employs a terminal multiple of 14.3x 2010 projected FCF and a discount rate of 14.5%. Our underlying forecast is based on the projected growth of only known middleware customers and a modest estimate for a contribution from interactive advertising and other application business.

- Investment in shares of OPTV should be considered speculative. While we think shares of OPTV currently look attractive from a risk/reward basis, and we see the potential for several positive catalysts in the near future, we also caution that an investment in OPTV is not for the faint of heart. OPTV was a significant disappointment in 2006 and with much uncertainty about its new parent, we think that some investors have put the stock in the penalty box.

OPTV 1-yr chart