Dolby Laboratories and the Sound of Silence

Apr. 4.11 | About: Dolby Laboratories, (DLB)

Dolby Laboratories (NYSE:DLB) has suffered a reversal of fortune since the beginning of the year. On January 3rd, the stock sold for $67/share and has since gone south closing at $48 at the end of trading on April 1st. That's roughly a 30% haircut for the quarter. The primary reason for the demise is that management guided earnings lower for fiscal 2011 because of a slowdown in PC sales which is a large market of theirs. In fact, 10% of their business comes from Microsoft (NASDAQ:MSFT). Before you make a snap judgement and dismiss them as snakebitten, I'd like to take a look at the company because I believe that savvy investors with presence of mind may want to include Dolby Labs in a portfolio or watch list.

I'm old enough to remember when Dolby technology was introduced to the mass market back in the 1970s. It removed the hiss in the background of cassette recordings which was a major problem back in the day. Noise reduction in audio recordings is something we take for granted now with Dolby's de facto industry standard creating a much more enjoyable listening experience. Its technology is used in: "movie soundtracks, DVDs, television, satellite and cable broadcasts, video games and personal computers", as stated in the most recent ValueLine report. ValueLine's analysis also discusses Dolby's thrust into the new frontier of tablets and smartphones:

Management is focused on capitalizing on this emerging market, which should position Dolby for the long haul and lead to solid growth down the line.

Dolby Laboratories' most significant revenue stream is from the licensing of their technology to other companies. Although licensing was as high as 84% of total sales in 2008, it has since decreased in steady increments the last three years to 77% in 2010. The reason for this reduction is that their products division has grown at a brisk pace and accounts for 20% of business now. According to a 3/26/11 Standard & Poor's report:

Product revenues involve the sales of digital media servers, which load, store, decrypt and decode digital film files for presentation on digital projectors in theaters, as well as sales of digital 3D products.

The remaining 3% of revenues comes from the services division.

I think there is a lot to like about this company: plenty of patents, over 10% of sales is allocated to R&D, a global presence with 66% of revenues spread out internationally to 85 countries, minimal debt and then there is the valuation. Earnings per share for 2010, 2011 and 2012 as reported and projected by Yahoo Finance break down to $2.46, $2.72 and $2.96 with a 5 year CAGR of 17%. This gives them a current P/E Ratio of 17.6 and a PEG Ratio (price/earnings/growth) of one. That's very reasonable, however, the stock keeps falling and needs a catalyst to not only stop the bleeding, but to propel Dolby Labs higher. I'm of the opinion that this may come from their subsidiary Via Licensing with it's major foothold in Near-Field Communications.

Articles about Near-Field Communications (NYSEMKT:NFC) are beginning to spring up on the Internet because both Google (NASDAQ:GOOG) and Verifone (NYSE:PAY) are going to test market the technology in an unspecified urban area using Google's Android operating system on smartphones, and Verifone's point-of-purchase terminals. This is the science that enables you to make credit card purchases with your cellphone, among other capabilities. It's already in use in Japan and some parts of Europe, and it is inevitable that it will be adopted here, too. As reported in a recent Wall Street Journal article:

California-based market research group iSuppli predicts explosive growth for NFC technology over the next few years...iSuppli says that this year's worldwide shipment of 52.6 million NFC-equipped phones will quadruple to 220.1 million units in 2014. This means that 13.1% of all phones shipped will feature NFC, up from 4.1% in 2010.

Via Licensing will benefit from the uptake in the use of NFC because they provide patent licences for any company that utilizes the technology. They get a cut of every single NFC enabled phone that is sold. Via Licensing is able to do this from their position as patent pool administrator for several broadcast, wireless and audio technologies which include NFC, RFID MPEG2 and 802.11 based WiFi. A patent pool,

... is a consortium of at least two companies agreeing to cross-license patents relating to a particular technology

as reported by Wikipedia. It basically standardizes the industry. However, this does not necessarily mean Dolby Labs will earn huge amounts of money from this smartphone advancement, at least not at the outset, but may turn the tide on investor sentiment.

In the next 12 months, when NFC technology becomes more of a household name to the consumer, investors may boost up the stock prices of most companies that reside within the sector. Just look at cloud computing or wireless today. Even if you are a minor player in these fields, the P/E Ratios of equities that are in these industries are astronomical. The fortune of a stock's sector plays a significant role in the price of a security. It is a tide that raises all boats, if you will. I believe that when investor psychology kicks in, Dolby Laboratories will be a benefactor of the hype that will surround it. This is on top of the already great story they have to tell.

If you are a momentum investor, Dolby Laboratories is not the hot hand you want to be playing. As a value investor, a good, solid company that has lost its luster is something you might want to take a look at. I know I like it, but not at $48, because I believe the stock is still a falling knife and continues to slide. I am also out of the market right now and am of the school we still haven't experienced that long-awaited correction. Dolby is not the dog with the least fleas, but with its huge sphere of influence, it is best in show.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Am short the market with inverse ETFs.