|Sigma Design is the global leader in decoder chips used in IPTV set top boxes. IPTV is an alternative distribution medium to cable TV and satellite which uses existing telephone wire infrastructure to deliver high definition TV content. In order to accomplish this, the signal must be compressed at the point of transmission and decompressed or decoded where it is being watched. |
Microsoft has developed their own software platform that helps companies efficiently deliver high definition TV that not only minimizes the amount of computer hardware that would be necessary on the transmission side of the equation, but also includes software tools that enables 2-way interactivity along with sophisticated digital rights management software (DRM) that protects the high quality digital content from being hijacked.
Sigma Design is the only company in the world that is currently certified as a Microsoft Mediaroom development partner owing to the fact that the company aptly foresaw this trend years before anyone else and was directly responsible for the birth of the industry because their sophisticate system on a chip (SOC) design allowed them to sell the decoder chips for around $25 which in turn allowed the cost of a set top box to fall from $500 to $150.
IPTV is a global phenomenon owing to the fact that most countries outside of the US do not have cable TV systems. Adding to this, telephone companies around the world are hard pressed to develop alternative revenue sources to generate a return on their previously invested capital. As we all know, telephone service has commoditized to the point where it is practically given away.
Recent forecasts show worldwide IPTV subscriber growing form 24.4 million to 92.8 million from 2008 through 2012. It is important to understand that not all subscribers are in the high definition market which utilizes Microsoft Media room or High-Def Linux platforms , both segements that Sigma dominates. This year decoder chip growth in units is expect to grow to 16 million units from 12 million in 2008. The company anticipates that it will garner approximately 75% share. This is very admirable growth in the face of=2 0the most severe worldwide recession since the 1930’s. I t appears that the IPTV market is resistant to the global recession for obvious reasons.
Last year the stock took off to ~$70 based on strong IPTV growth along with the anticipation that Sony Blue Ray DVD platform would capture the DVD market and that one of Sigma’s chips would be used in virtually all of them. Unfortunately, the company was delayed with their next generation Blue Ray chip causing them to lose the mafority of their Blue Ray market share.
Further frustrating the hockey stick type growth that the company experienced form 2007 to 2008 was an air pocket they hit when Motorola, supplier to the ATT U-verse account cut back their orders because they had overbought chips in 2008—a common practice among OEMs.
At the same time the short position began to climb as rumors surfaced that Broadcom was going to enter the market and take it away from Sigma. This deadly combination of a temporary flattening of revenues and earnings along with fears of pending competition eventually coll apsed the stock price. However, throughout this entire adjustment period, the company has not only remained EPS positive, it also has been generating roughly $12 to $20 MM in cash each quarter. Presently, the company has aaround $8 per share in cash after making 2 small acquisitions and after buying back roughly $80 million of stock. It still sports 40 to 55% gross margins—extraordinarily high for a chip company and there is no real competition on the horizon—perhaps until the middle of next year. Further depressing the stock price is the company’s reticence to issue definitive guidance. While they have actually beaten their rough projections for the last 2 quarters they rightfully have shied away from the predicting business.
Subtracting out the $8 per share in cash and with approximately $1.50 in earnings this year, the stock is ridiculously cheap especially given the tremendous potentially that lies ahead for the company. For all the brouhahas that the company was going to get put out of business by Broadcom, the more likely scenario in my opinion is that Sigma will wi nd up taking market share from them in Docsis 3 market next year—a market that is many times larger than IPTV. SIGM has always been realistic about the Telco market always demands second source supplier. But with a market growing at 15 to 25% per year, there is room for 2 players.
Recently, Broadcom has been underplaying IPTV as a source of growth and at a recent UBS investor conference, they didn’t even mention ATT as a customer next year further supporting the thesis that they still cannot solve the problem of making all the various codecs and the Microsoft DSM work in a seamless fashion.
Also during this time the Sigma has developed their next generation IPTV processor the 8654 chip and has developed their new Blue Ray chip. They have also partnered with Texas Instruments to develop an IPTV over coax Docsis 3 set top box that should begin to take market share from Broadcom in the cable market (a market which Broadcom has traditionally dominated). They also purchased 2 wireless companies that are leaders in their respective fields: Ultra Wide Band, and Z-Wave, a wireless RF protocol designed to control and read devices in residential and light commercial environments.
The number one concern for investors over the last year and a half has been the pending competition from Broadcom. This has been very much overstated and misunderstood and largely driven by short sellers. For example, a few months ago analyst Todd Cooper from Stephens & Company reported that Broadcom would begin shipping in May of this year. A similar story followed by the analyst from Lazard. This caused the stock to plummet from $16 to $10. One can only assume that either they had clients that were heavily short or they failed to grasp that even if Broadcom were to get certified today, Microsoft would require 6 months of seasoning before allowing the chips to be sold. They reported this while other20reliable industry sources were saying that Broadcom was still having problems with the chip (rumored to have heat problems).
Also what has continued to confuse the issue is the failure of some analysts to understand that the Broadcom 7405 chip as well as Sigma’s next generation 8654 are both designed for the next generaton Telco installations and they won’t be implementing until next year at the earliest. So even if the chip were ready to ship, there really wouldn’t be much of a market for it until next year. One thing is absolutely certain—the longer Broadcom delays, the more difficult it will be for them to overtake Sigma in the IPTV market.
Here is an overview of the worldwide market for IPTV:
North America: ATT U-verse 1.3MM subscribers
Canada: TELUS 100,000 subscribers, MTS Allstream 85,000 and Sasktel 62,000 subscribers
Europe: 16 Telcos in deployment: Free, France Telecom, Neuf, Deutche Telecom (added 120,000/600,000), British Telecom (added 25, 000 / 555,000) , Belgacom (added 49,000 subs/423,000), Protugal Telecom, Swisscom (added 21,000 subs /139,000), Telefonica, Ya.com, PBC Telecom Italia, Fastweb, wind and T-Com affiliates.
ASIA: 10 Telcos: Korea Telecom, Hanro, China Telecom, China Netcom, USEN, KDDI, Chunghwa Telecom (added 10,000/686,000), PCCW, LG Dacom (85,000 IPTV subs out of 2MM installed customers), Singtel (added 19,000/78,000) ,MTNL and Guangzhao. In the meantime, Asia is beginning to accelerate deployments with Korea really taking off with Taiwan and mainland China on the way.
In India Sigma is partnered with Reliance and they could begin implementing soon.
In Europe, England, France, Italy and Spain are also accelerating deployment.
In my opinion, the trend is unstoppable and Sigma is going to ride the next wave.
If you figure 12.5 million units growing to 16.5 million this year and an average ASP of $16 I arrive at a revenue number of $198MM based on a 75% market share (not all installations are high20def) and add to that approximately $50MM in various other sales, this fiscal year (January 2010) could approach $240MM. Most street estimates are in the $180MM range. Assumng a 45% gross margin, would get you to $108MM operating earnings which would get you to $48MM pre tax and after an estimated 20% tax rate it is possible to arrive at $39MM in earnings or approximately $1.56 per share.
After subtracting out $8 per share in cash, I arrive at a PE on this year’s earnings of roughly 5 which is extraordinarily low for a cash generating company poised to renew strong growth in a market growing around 25% per year and with a huge Docsis 3 growth opportunity that is not in anyone’s forecasts. Other opportunities like building Docis Blue Ray players into High Def TVs; new markets for Digital Media Adapters; new products based on Ultra Wide Band and Zensys . A more appropriate multiple would be at a conservative 20x on next year’s which will likely grow around 25% a perhaps more if they g ain any meaningful market share in the cable TV market. Consider that there are more than 2 billion set top boxes around the world that will need to be replaced once the new standard takes hold. My base target for the stock is $40 next year.
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