This post is a fuller analysis of my investment recommendation of TranSwitch Corp. (TXCC).
THE VIDEO INTERCONNECT MARKET
The video interconnect is an important part of my business, and I know it well. This market has historically been divided into two segments: consumer electronics (NYSE:CE) such as TVs, DVD players, set top boxes and gaming consoles, and the personal computing (PC) market. For the most part, the CE and PC markets have used different standards for video interconnect, although some standards such as DVI have been used by both.
Over the years, different standards have come and gone as the required technology needs have changed. One of my personal peeves was the S-Video connector, which was popular in the late 1990s, but was singularly unreliable because its delicate pins were continually getting jammed. For PCs, the most popular connector remains the VGA connector with its huge installed base, although the bulkier DVI connectors are popular as well.
S-Video Connector VGA connector
In 2003, the HDMI standard was introduced, and since then it has become the dominant video connect standard for the consumer electronics markets. It features a compact, reliable form factor that carries both video and audio, thereby eliminating that incomprehensible tangle of wire behind your audio/video system. Consumers love it because of its remarkable picture quality and “plug and play” simplicity. Content providers love it because it has built in HDCP content protection which combats piracy, and manufacturers love it because of its ubiquity and the continuing evolution of the standard. Over 600 million HDMI enabled devices were shipped in 2011 and the installed base is now over 2 billion devices. By 2015, that installed base will more than double to at least 4 billion devices.
A similar revolution started last year in the PC world, where the DisplayPort standard is rapidly replacing both VGA and DVI, which have long been the dominant standards. VGA is a 25 year old analog standard that has simply lost its relevance in a digital world, and the industry recently announced that it will stop supporting the standard by 2015, by which time it will be effectively dead. DVI is a digital standard, but the standards body self-terminated long ago and the technology is more than ten years old. While DisplayPort shipments only really got started in 2010, there is now virtually no doubt in the industry that this is the future standard for most of the PC world, including all Apple products.
HDMI Connector DisplayPort Connector
Without getting into a highly technical discussion of HDMI or DisplayPort, let’s just say that they are both a response to consumers’ demands for an enhanced video experience. Screens sizes are getting larger, resolutions are becoming higher, colors are becoming deeper and refresh rates are increasing. Importantly, both HDMI and DisplayPort have active standards organizations that continue to evolve the standard in response to advancing technologies and consumer requirements. For example, in the case of HDMI, the latest version of the standard also provides a path to 3D, and in the case of DisplayPort, the latest standard allows daisy-chaining of multiple monitors, which is important for corporations.
The TranSwitch presentation shows some nice slides showing the forecast evolution of the HDMI and DisplayPort markets. For HDMI, annual shipments are expected to grow from 600 million in 2011 to more than 1 billion in 2014. DisplayPort shipments are just getting started, but are expected to grow rapidly as VGA and DVI die out. By 2014 more than 400 DisplayPort enabled devices are expected to ship annually.
Clearly, it is going to be a world where multiple video standards are being whittled down to just two—HDMI and DisplayPort. Going forward, HDMI will be the dominant standard for consumer electronics, including consumer-focused PCs, and DisplayPort will be the dominant standard for the balance of the PC world as well as all Apple products. Pretty much nothing else will matter. USB 3.0 is a relatively new high speed standard, but it wasn’t designed for video and will always be inferior when used for that purpose. Thunderbolt is an expensive but potentially important new standard that was developed by Intel, but in reality it is a combination of DisplayPort and PCI-Express, so it is just DisplayPort by a different name.
But here’s the rub. While we now have two dominant technologies, both of which have pretty much the same aim—to transport video signals—they are two entirely separate and incompatible ecosystems that can’t talk to each other without a translator. Now, maybe a few years ago that might not have been such a big deal. You had your TV and its accessories, and you had your PC and its peripherals, and for the most part they didn’t need to talk to each other. It was a pre-convergence world. But along came the iPhone, and then the iPad, and all of a sudden it’s a mobile, post-convergence world where your TV is connected to the internet and it isn’t so clear anymore what is a CE device and what is a PC device.
Imagine two villages, each separate and apart with its own language and customs. There is no need for communications, but each village keeps growing and growing and one day they begin to grow into each other. All of a sudden the ability to communicate in another language becomes increasingly important. That’s what’s happening here and the two charts above are going to be replaced by the one chart below. In short, the red bars are going to want to talk to the blue bars. Maybe not all the reds will want or need to talk to the blues, but enough of them will, and the translation business will be a good one.
THE TRANSWITCH SOLUTION: HDplay
TranSwitch’s new HDplay products solve this compatibility issue and now a single port can be both an HDMI and a DisplayPort one, simultaneously and automatically. Previously, the only way to achieve this result was by using some sort of active conversion cable, and these were very expensive. These kinds of solutions are all about cost, and TranSwitch’s solution is very elegant. They have integrated HDMI and DisplayPort capabilities not just into a single chip, but into a single physical layer, so their chips can essentially be sold at the same price as an HDMI-only chip.
The dominant competitor in the HDMI chip market has historically been Silicon Image (NASDAQ:SIMG), with Analog Devices (NYSE:ADI) a distant second. I believe TranSwitch is about to gain some significant share from both of them. Silicon Image is a founding member of the original HDMI standards body and they are closely identified with HDMI. Too closely, in fact, and what was once their strongest selling point may now become a vulnerability. DisplayPort is in many ways a rival standard to HDMI and Silicon Image has spent the better part of the last few years downplaying its importance. But it’s 2011 now, and there is no doubt that DisplayPort is about to become a very important standard. Currently, Silicon Image does not offer any DisplayPort products and while in theory they could eventually do so, it might involve a somewhat embarrassing about-face. As a pre-convergence company, Silicon Image is going to have to figure out a way to navigate the post-convergence world, and it is highly unlikely they will maintain the same sort of dominance. One of the big drivers of this post-convergence world is going to be the desire of TV and monitor manufacturers to offer built-in connectivity to Apple products, without the need for expensive adapter cables. Apple is currently the largest installed base of DisplayPort and, according to TranSwitch, a survey of the industry revealed that the ability to offer iPhone and iPad compatibility was deemed extremely important on an almost universal basis. For this reason, and this reason alone, I think that TranSwitch’s HDplay product can get not just a 10% market share, but perhaps a 20-30% market share, or more. In fact, if one could offer HDMI/DisplayPort compatibility for the same price, why wouldn’t everyone ultimately offer it?
But there are other perhaps equally compelling reasons for manufacturers to choose TranSwitch’s HDplay products as well. HDMI silicon has been stuck at the 2.25 gbps speed for some time, but bandwidth needs are increasing and the industry is about to transition to 3.0 gbps speeds. This will allow, for example, full high definition 3D TV at a 60Hz refresh rate.
TranSwitch was the first to announce 3.0 gbps chips and, even though Silicon Image and Analog Devices have subsequently announced faster versions of their old 2.25 gbps chips, TranSwitch remains the clear speed leader. Recall, they were shipping 3.4 gbps HDMI 1.3 IP licenses in 2007, a time when the rest of the industry was still at 2.25 gbps. Also, while Silicon Image and Analog Devices may both have announced chips, that doesn’t mean they are actually shipping these chips. Pushing higher speeds is a very difficult task and it isn’t yet clear what kind of performance these chips will offer. In the case of TranSwitch we know their chips are based upon the same IP that they licensed to Samsung, so you can be pretty sure they are as advertised. (At 14:08 in this webcast, Ali gives a good description of the torture testing that Samsung put their HDplay products through.)
But other than speed and the potential for Apple connectivity, there are other factors that favor TranSwitch as well. I thought one of the most interesting charts in the presentation related to the power advantages of using the company’s HDplay chips. The new EnergyStar 5.3 ratings took effect on September 30, 2011, and as you can see in the chart below, they are much more stringent. The blue line shows the old EnergyStar standard and the green triangles and purple X’s are data points for individual televisions.
So what do we see? First, we see that lots of TVs fall under the blue line, which means they make the cut for the old EnergyStar ratings. That tells me EnergyStar label is really important and that many manufacturers have consciously restricted their power budgets so as to be able to claim compliance with the standard. Next, we see that most of these TVs do not fall under the red line and therefore would not make the grade under the new EnergyStar 5.3 rating. That tells me that manufacturers will be working hard to lower their power budget over the next year so as to be able to meet the new standard.
EnergyStar 5.3 calls for a much more stringent power requirements. For example, under the old EnergyStar standard, a 50” TV could use as much as 153 watts and still qualify, but under the new standard all TVs over 50” will be capped at just 108 watts. In other words, manufacturers will have to find LOTS of power budget savings. According to TranSwitch, their HDplay product uses about half the power of comparable products and manufacturers can save about one watt of power by switching to HDplay. That’s a pretty big deal for just one chip.
Finally, TranSwitch’s new HDplay chips offer built-in internet connectivity. The way you watch TV is changing and by 2013 40% of all new TVs will connect directly to the internet, allowing for over-the-top services such as Netflix or Hulu.
Over the next year or two, the industry is going to be shifting from 2.25 gbps speeds to 3.0 gbps speeds and this, in and of itself, is going to open a lot of sockets to competitive incursion. For the first time ever, there will be a superior and clearly differentiated competitive product on the market. When LG or Samsung or Sony thinks about what chip they should use for their next monitor, for the first time they will have a real choice. For some, it may be about a field-proven 3.0 gbps solution, for others it may be about power budget savings, and for others it may be about Apple connectivity or built-in Ethernet support, but my guess is that both Silicon Image and Analog Devices are going to be giving some of their share to TranSwitch.
With TranSwitch’s $60mm enterprise value, I think its HDplay products are more than enough to provide a compelling investment rationale, but the company is also focused on developing products for the huge mobile phone and tablet markets. These products haven’t been announced yet, but Quinn Bolton of Needham writes that he anticipates a product introduction in early 2012.
Video is increasingly becoming a critical component of the phone and tablet market. As Ali noted in a recent conference call, many of the newer models offer up to 12 megapixels of resolution, equivalent to today’s professional grade cameras, and they also shoot 1080p video on the go. Why wouldn’t any such phone feature a high speed video interconnect? According to TranSwitch, by 2014 over 350 million mobile phones and tablets will ship with either HDMI or DisplayPort capability, although this figure presumes a 25% attach rate which the company believes is extremely conservative.
This market is in its infancy and TranSwitch’s goal is nothing less than to become the leader in the market. They are promising a superior product, but without knowing exactly what that product will be, it is hard to gauge their chances for success here.
Currently, there is only one real competitor and that is, again, Silicon Image who has been pushing their MHL technology. With MHL, you can connect your mobile phone or tablet to a MHL-enabled TV or monitor. That sounds great in theory, but there are some real drawbacks to their solution. While Silicon Image is the originator of the MHL standard and is synonymous with the HDMI standard, MHL and HDMI are not one and the same. Some people think of MHL as a mobile version of HDMI, but that is not true at all. It is an entirely different standard and incompatible with HDMI. In order for MHL to be really useful, it can only be used with special HDMI ports that are enabled with MHL—that is, you need a phone/tablet with MHL and you need a TV/monitor with MHL. That creates a serious chicken and egg problem. Right now, only a tiny handful of televisions are outfitted with MHL-enabled HDMI, so there is not much of an incentive for handset makers to add an MHL port, and there are only a tiny handful of phones/tablets that support MHL so there is not much of an incentive for TV/monitor makers to add an MHL-enabled port. Add to that the fact that MHL can only handle 720p video (or 1080p video at half speed) and it is looking like just not such an attractive solution. Right now, the most attractive feature of MHL is that it is the only solution for the mobile market. But what happens when it isn’t?
I don’t know what TranSwitch has up its sleeve, but there is no doubt in my mind that MHL is vulnerable. If TranSwitch can offer a mobile chip with its HDP technology, real backward compatibility to HDMI (while also charging), plus true full speed 1080p support, there is no doubt in my mind that it will blow Silicon Image away. Of course, that’s a big if…
… but what if it isn’t?