Excerpts from analyst Todd Mitchell's comments on NDS Group's (NNDS)2Q07 earnings report.
NDS Group delivered a positive development message. NDS reported solid fiscal 2Q07 results and held an investor meeting that focused on R&D efforts aimed at broadening its markets. The company's presentation is compelling, its technology is strong and its strategy appears sound, but shares fail to respond. We think the issue is uncertainty with the time frame for the deployment, and eventual depth of penetration, of some of these services.
Fiscal 2Q07 results were solid, if modestly below our expectations. Revenue rose 8% to $165 million. Operating income was up 9% to $37 million, and EPS rose 17% to $0.52. Conditional access (NASDAQ:CA) and new DVR deployments were the clear growth drivers. CA revenues rose 12% to $98 million, ahead of expectations for 10%. NDS added 1.1 million new DVR in the quarter, lower than our forecast for 1.3 million, but enough to drive a 25% increase in New Technology revenues. Management adjusted guidance only modestly for the Jungo acquisition.
It looks like NDS' business is getting broader faster than deeper. We believe fiscal 2Q07 results foreshadow two trends: 1) the core growth rate of NDS' CA business is accelerating as LCD customers come on line, and 2) the low-end offering these customers take is causing some degradation in NDS' ASP. We believe this was particularly the case for middleware where net adds were higher than expected while Licensing Fees were lower than expected.
Investor meeting used to explain and justify heavy R&D investments. NDS gave an overview of its product development road map for expanding its technology into new vertical markets by developing an integrated solution of CA and digital rights management [DRM] for a converged offering. The recent Jungo acquisition reflects this strategy as NDS believes that the Telcos will provision a multitude of services via a residential gateway including secured digital content services.
NDS gave investors a preview of its Fusion next-gen middleware. Fusion is a completely new middleware built by NDS to replace Media Highway. Fusion is differentiated from previous generation middleware by its ability to work on multiple programming standards (Java, HTML, etc.) and modular construction, which increases its capabilities and flexibility in deployment. NDS was frank about its goal of displacing OpenTV from NDS' CA customers now that OpenTV is aligned with Kudelski.
NDS is a leading technology supplier in a niche in a cyclical upswing. Given our projected outlook for NDS we think its shares are attractively priced at current levels, but do not see a firm catalyst. Qualitatively, we believe the issue is that the growth of the part of the business where the R&D is being spent is slower than expected, while the low end business has accelerated, putting downward pressure on ASPs. If the rate of advanced service penetration is slowed through the model it changes the ROIC equation pulling in NDS' valuation.
We reiterate our BUY rating and $57 price target for NNDS. We value NNDS at $57 based on a DCF analysis. Our analysis employs a terminal multiple of 22.5x 2009 FCF discounted to present at 12.5%. At our price target of $57, shares of NNDS would trade at just 12.8x 2007E EBITDA and a P/E of 23.3x. We consider NNDS moderately risky