Gemstar-TV Guide: Four Catalysts For The Share To Rise

I purchased shares of Gemstar-TV Guide International, Inc. (GMST) at the end of August at a price of $6.00 per share. As of the close on Thursday (9/20), the shares were trading at $6.50, not all that far from their 52-week high of $6.92. The current relatively high valuation notwithstanding, I believe there are four important factors that will positively impact the share price, such that it is likely to be substantially above the 52-week high before long, provided there isn't some macro-related event that roils the financial markets (e.g., further credit market meltdowns, etc).

Factor One – Guidance Technology and Solutions Business

Gemstar's Guidance Technology and Solutions unit, which provides on-screen television programming guides, experienced strong revenue growth in the most recent quarter, up 40% from the prior year's quarter. This growth is likely to continue for the foreseeable future as a result of the continuing migration of cable and satellite subscribers from analog to digital services. Additional growth is also coming from overseas, as Gemstar continues to sign new foreign customers like British-based BSkyB (BSY), which became a client in 2006, and Spanish-based Veo Television S.A., which was signed earlier this year.

Much of the revenue associated with guidance technology comes from licensing Gemstar's interactive programming guide [IPG] patents to multiple system operators (e.g., Time Warner Cable (TWC) and digital broadcast satellite providers (e.g., DirecTV (DTV) so they can deploy IPGs from other vendors. As a result, the margins associated with this business are robust, as evidenced by the fact that the unit's adjusted EBITDA in the last quarter was $46.8 million on revenue of $70.7 million.

Going forward, I envision Gemstar also potentially benefiting from advertising opportunities related to the continuing deployment of its own IPGs. As more and more subscribers transition from analog boxes to digital video recorders, it is common knowledge that they are fast forwarding through advertisements at an unprecedented rate. This ad skipping phenomenon is likely to accelerate further as growing numbers of subscribers make the switch to DVRs. So the question for advertisers becomes "how do we reach viewers who are skipping our commercials?" One possible solution is to place ads directly into the interactive programming guide itself since viewers have to use the guide to both find and record programs of interest. The number of potential "impressions" resulting from an ad placed on an IPG can run in the billions each month. As such, there appear to be untapped monetization opportunities related to IPG-placed advertisements.

Furthermore, Gemstar is working on the deployment of remote programming features which, when released, will enable users to remotely program their digital video recorders from locations other than the home, including via mobile phones. This is a potentially huge market opportunity with respect to both licensing fees and advertising revenues and Gemstar is about as well-positioned as a company can be to take advantage of this substantial opportunity.

Based on a multiple of EBITDA alone, the Guidance and Technology Solutions unit is almost certainly worth in excess of $1 billion. When you consider the market dynamics and substantial growth opportunities on which the company has yet to capitalize, it seems quite possible that the unit's value could, in fact, be not just in excess of $1 billion, but far in excess of it (did anyone say $2 billion?).

Factor Two – Media Networks Business

Gemstar's Media Networks unit is comprised of two cable channels and the company's online properties. The crown jewel of the unit is TV Guide Network, Gemstar's widely-distributed cable television channel. With domestic carriage in excess of 82 million households and still growing, TV Guide Network (formerly known as TV Guide Channel) is a substantial cable network that offers the company tremendous upside opportunities.

Traditionally, the main reason viewers would tune in to TV Guide Network would be to get TV listings. However, the accelerating switch from analog to digital boxes among cable and DBS subscribers has forced the company to consider alternative programming for the network because this inexorable migration to digital means that fewer and fewer viewers need to use TV Guide Network's scrolling listing of programs. Instead, they just access digitally-available interactive programming guides like those licensed and deployed by the company. While this phenomenon has been a great boon for the Guidance Technology and Solutions business, it has necessitated finding alternative programming for TV Guide Network. However, in my opinion, that is not a bad thing. A change in emphasis to more popular entertainment-oriented offerings, from the more utility-based information guide, should lead to more viewers who watch for longer periods of time, which should in turn lead to higher ad rates and a subsequent increase in TV Guide Network's value.

As to what that value might be, I don't see how TV Guide Network with its nationwide distribution into 82 million households isn't worth a very substantial amount of money, almost certain to be in excess of $1 billion, and maybe far in excess of that amount if management is able to modify the programming mix to include more popular entertainment fare. While it's not exactly an "apples to apples" comparison, this valuation seems totally reasonable when compared with the rumored $3 billion valuation of the Yes Network – a relatively small, regional sports network with about 12 million subscribers that broadcasts New York Yankee baseball and New Jersey Nets basketball games.

The company also owns TVG Network, a niche horseracing channel that is available in 26 million homes domestically. While it's difficult to place an exact value on TVG, it is the leading horseracing network in the United States and does have a sizable and growing subscriber base.

Media Networks also includes tvguide.com which, according to Nielsen/Net Ratings, averaged 3.1 million unique users per month in 2006. The company reports that in January of this year that number jumped to 4.6 million. While a specific valuation cannot be readily attached to the company's online offerings at this time, the value clearly seems to be substantial given the number of, and growth in, users. Moreover, as Gemstar begins to offer remote DVR programming options which can be done from any computer with Internet access, the number of users of its online venues is likely to increase further still, resulting in greater advertising opportunities and a higher valuation.

The company also recently launched an online video guide that assists users in locating professional and independent video offerings on the web, including movies, TV shows and celebrity clips. As arguably the world's leading video guidance company, Gemstar is extraordinarily well-positioned to benefit from the accelerating migration of video entertainment to the web.

Factor Three – Balance Sheet

Gemstar has a terrific balance sheet with over $500 million in cash and equivalents and just $12 million in debt.

Factor Four – Likely to be acquired

On July 9th, the company announced that its Board of Directors had voted in favor of pursuing strategic alternatives. Then, on August 17th, in an 8-K filing with the SEC, Gemstar announced that it had "approved a Retention Program to promote the retention of current executives and other employees of the Company while the Company explores strategic alternatives, including a possible sale of the Company." Clearly, Gemstar is on a path to being sold. Given that in many ways Gemstar is a search company (video as opposed to text), I suspect that Yahoo, Google, Microsoft and possibly Time Warner/AOL will all be taking a serious look at a possible acquisition.

A sale to a private equity player is also a possibility, although interestingly Citidel, LP, the giant Chicago-based hedge fund that owns just over 8% of the company, sent a letter to the Board indicating that while it is not adverse to a sale of the company, it is not in favor of a sale to a financial investor. Citadel believes that a financial investor is not likely to compensate shareholders for the "tremendous strategic value inherent in the company's assets." In that same letter, Citadel further stated its belief that Gemstar "has the potential to realize several billion dollars of incremental equity value over the next years based solely on the company's strategic positioning and management's ability to execute on its strategy." Citadel's position is one with which I strongly agree.

Gemstar's largest shareholder is News Corp. And while News Corp. would probably be in favor of any reasonable deal, including a sale to a financial buyer, I suspect Citadel's activism is likely to result in a solid premium to the current share price.

Conclusion

At the current share price of $6.50, Gemstar's market capitalization is roughly $2.8 billion. However, if you believe, as I do, that the Guidance and Technology unit and TV Guide Network are both likely worth, at a bare minimum, $1 billion each, then the company's valuation based on those two businesses alone should be at least $2.5 billion (including the $500 million in net cash on the balance sheet). When you then consider that one or both of those businesses may be worth substantially more than $1 billion and that there is substantial value inherent in the company's online properties as well, it becomes easy to understand why Citadel is taking such an activist approach with respect to valuation. I trust that neither they, nor management, nor News Corp. for that matter, will sell out for anything less than a full and fair price – something likely to be far in excess of $6.50 per share. Even in the unlikely event Gemstar isn't sold, I believe, like Citadel, that there are billions of dollars in incremental value to be realized by shareholders in the next few years, which certainly bodes well for the share price. Postscript: As readers familiar with Gemstar will note, I have ignored the publishing unit (i.e., TV Guide magazine) in the above analysis. That's because I consider it to be a stagnating business that will have minimal impact going forward on the financial performance or strategic positioning of the company. In summary, it is, in my opinion, a non-factor in any assessment of the company's future prospects or value.

Disclosure: Author has a long position in GMST

Comments

[E1]

Thoughtful and thorough. A solid read with many points at least worth considering. The clarity of the piece is remarkable and is a valuable addition to any conversation on the company.