Shares of China Digital TV (STV) sold off again this past week after reporting earnings on May 14th that handily beat street estimates by $.03. What seems to have spooked analysts and investors alike is that the company did not raise its full year revenue guidance. This left many to believe the company sees challenges throughout the rest of 2008.
Since reaching a peak of $55.31 shortly after going public in early October 2007, the company’s share price has been in an unabated free fall to the mid-teens, reaching a low of $15.02 on 3/11/08 and then retesting the low again on 4/15/08 when shares fell back to $15.20.
The shares now trade at a 60% discount to their trailing revenue growth rate and more than a 50% discount to the projected 2008 revenue growth rate. Based on the most recent share price of $17.54, the company now has a trailing price to earnings ratio of 26 with trailing revenue growth of 65% for Q1 and projected revenue growth of over 50% for full year 2008.
I don’t think you’ll find another publicly traded company on any of the US exchanges that trades at such a discount...
Overall the market does not place a valuation premium on conditional access providers as it does with other sectors like solar, search engines and virtualization. In fact, NDS (NNDS), one of the largest conditional access providers in the world, trades at a slight discount to its trailing revenue growth rate. The company’s current price to earnings ratio is 19.3 times trailing earnings while the company posted revenue growth of 20% for Q108. While nothing close to the discount for STV, it illustrates the value Wall Street assigns to such companies. Compare this to search engine Baidu (BIDU), which has a trailing p/e of nearly 170 and posted revenue growth 108% for Q108 or VMware (VMW), which has a trailing p/e of nearly 126 and posted revenue growth of 69% for Q108.
Analysts view the conditional access sector as a “high tech commodity” similar to the view given to chip makers like Intel and AMD (AMD). In the recent earnings call, STV management did mention that price competition in China was intense and that some of their competitors were pricing smart cards at a significant discount, however this did not impede the company from signing new contracts. In fact, during Q1 the company was successful in winning 6 out of 9 new cable provider contracts that were signed during the quarter and now has contracts with 170 of the estimated 300 or so cable companies in China .
Though price competition in the industry is fierce, conditional access contracts are exclusive. So once the conditional access provider and a cable or satellite company enter into a contract, the relationship is exclusive for the term of the agreement. This mitigates the threat of price devaluation and margin pressure for existing contracted customers. Pricing will continue to be a factor with future contract negotiations, however a majority of the large cable companies in China are already under contract.
On the cautious side, there are only so many smart cards that will be needed, even in a vast country like China . At the end of 2007, China had approximately 152M cable TV households out of 378M total TV households. The number of cable households is expected to grow at steady pace over the next 3 to 5 years as China ’s population continues to migrate from the rural areas into the metropolitan cities.
Estimating STV will have 50% market share of the potential 152M existing cable TV households and discounting the 15M smart cards they have already shipped, that leaves a 61M potential smart card shipments from existing cable TV households. Factor in another 2 to 3M per year for new cable customers and the company has a potential market of 76M smart card shipments over the next 5 years.
To diversify their sources of revenue and drive future growth, the company is looking to develop international markets and expand into the areas of PC-TV services and electronic program guide advertising platforms. They recently established a subsidiary Beijing Novel- Super Media Investment Co., Ltd., to develop the previously mentioned PC-TV services and electronic program guide based advertising platforms. According to the company the PC-TV products are in trial phases with five cable operators and the EPG-based platform is in use with several cable operators.
Overall, I continue to remain positive on the future growth of the company and the long term appreciation of the share price from current levels, however I do not share the same robust share price predictions as analysts from Piper Jaffray, Morgan Stanley and Susquehanna Financial, all who have issued price targets above $33.00.
As I’ve stated in a previous Seeking Alpha article, the share price has basically been controlled by short sellers since the Q407 earnings announcement in February. Since that time the share price has fallen from over $26 in after hours trading to the lows in the $15.00 range established in March and April.
The most recent short interest report indicates the short position has decreased from a high of over 3.5M to under 2.3M and the most recent put/call ratio has fallen back into the 20s from a high of 59. Both indicate bullish trends, however the shares remain thinly traded, although trading volumes over the past week have doubled, and institutional investment remains minimal. These factors, combined with the effect of short sellers, leave the shares vulnerable to dramatic price swings and possible further downward pressure.
I see the shares rebounding back to low $20’s just prior to the Q2 earnings report in August with an outside chance the shares could approach $30 by the end of the year should the company handily beat and raise future earnings and if the market valuation for conditional access providers changes. The latter could happen as the sector will come into greater focus over the next 6-9 months with the approaching February 2009 US digital broadcasting mandate.
In the meantime, the company needs to do a better job explaining to Wall Street their dominant competitive position in the China conditional access market and future growth opportunities. The also need to convince institutional shareholders that STV is a great investment for the future. The company will get the opportunity to do so during the week of May 19th, as their CFO Mason Xu is presenting at conferences hosted by Brean Murray, Oppenheimer and Goldman Sachs. Any positive news from the conferences could send shares back to the $20 level and provide a platform for future appreciation, while negative news could have the opposite effect.
Disclosure: The author currently has an actively traded long position in shares of China Digital TV.