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Digital Video Recorder Stocks Seen Up


By Hal Plotkin
Silicon Valley Correspondent

Analysts say digital video recorder (DVR) stocks will get a lift, as skyrocketing demand puts DVR makers in position to become a key platform for the next generation of value-added Internet-based interactive-television services.

Last week, Dain Rauscher Wessels analyst David Lee Smith initiated coverage of DVR maker TiVo Inc. {TIVO} with a “buy-aggressive” rating and a $32 12-month price target.

San Jose, Calif.-based TiVo went public last Sept. 29 with shares initially priced at $16 each, $3 above the range originally targeted by the company.


Post-IPO chart for TIVO

Like its competitor, Mountain View, Calif.-based ReplayTV Inc., which is slated to go public sometime in the next few weeks, TiVo is focused on the emerging market for DVRs, which are sometimes called personal video recorders.

The new tapeless devices offer couch potatoes a variety of convenient new features, such as the ability to pause a program in mid-broadcast, say to answer the phone, and then resume watching it a few minutes or even days later without missing a thing. Programs are recorded on a large computer hard drive embedded in the boxes rather than on video tape, a feature that allows the units to simultaneously play and record, making it possible to watch a program from the beginning, even while its final moments are still being broadcast.

Although there are some differences between competing DVR products, the circuitry inside most DVRs models also creates electronic programming guides that make it much easier to find and record programming for viewing at more convenient times, a process called “time-shifting.” As an added bonus, some DVRs can also be programmed to automatically skip commercials when programs are replayed.

Both TiVo and ReplayTV sell their technology to other manufacturers, who embed it into their own video recording devices. Koninklijke Philips Electronics N.V. {PHG}, more commonly known as Philips Electronics, for example, makes a TiVo powered unit while Panasonic Consumer Electronics Co. {PCEC}, a division of Matsushita Electric Corp. of America {MECA} is now selling a recorder that uses technology licensed from ReplyTV. Many other manufacturers are expected to begin offering similar products, most likely licensed from one or the other competing DVR players, before too long.

Overall sales of DVRs are expected to skyrocket to more than 7.7 million by 2003, up from 290,000 last year, according to International Data Corp., based in Mountain View, Calif.

“We’re very optimistic about the category,” says Kevin Hause, an analyst at IDC. “The features are very compelling to consumers. We will see consumer interest grow very quickly as the cost comes down over the next year or two,” he predicts.

“This thing is going to ramp up huge,” agrees Smith, who says ReplayTV’s pending initial public offering is certain to cast more attention on the DVR sector, heightening awareness for both consumers and investors.

Smith gives TiVo the edge over ReplayTV in terms of technology, mostly because of what he says is a more-powerful recommendation engine built into the TiVo system.

TiVo units, Smith notes, come equipped with a “thumbs up, thumbs down” button on the remote control that lets viewers indicate their approval or disapproval of programs as they watch. The TiVo units use the information to formulate recommendations of other programs that might interest that particular viewer, say, a soccer match they didn’t know would be broadcast at 3 a.m. the following morning, or a cooking show that features recipes known to be of special interest. The programs can then be automatically recorded for viewing at more convenient times.

Smith says TiVo’s edge isn’t so significant, however, that he would recommend against purchasing ReplayTV’s stock when the company goes public, particularly if it can be picked up at a reasonable price.

“I don’t think it’s a negative thing to have Replay’s stock out there, too,” Smith says. “If there were eight or 10 of these stocks, I’d say we’re going to be saturated. But Replay’s IPO is not a problem. If anything, it validates the market.”

The biggest hope for these stocks moving forward, however, is that DVRs will prove so popular they will become the platform of choice for the provision of the next generation of interactive Internet-based television services. Proponents of this idea say the easy-to-use DVR technology is ideally suited for expanded applications, everything from measuring viewer habits and determining more-accurate program ratings for advertisers to selling goods and services in connection with TV broadcasts through on-screen menus and targeted marketing appeals coordinated by the DVR makers.

TiVo’s technology, for example, places an icon overlay on certain commercials that viewers can select in order to obtain more-detailed information about that product, or to be directed to the advertisers Web site. ReplayTV is also rolling out similar services.

“We believe that TiVo will be able to access several areas for increased revenue generation,” Smith wrote in his research note upgrading TiVo’s stock. “We also think they are in the lead.”

Some other analysts, however, say DVR makers may have a tough time capturing and holding the marketing high ground for interactive TV services.

“DVRs may well fall prey to other platforms,” says Tracy Swedlow, editor and publisher of Interactive TV Today, an industry newsletter based in San Francisco.

Swedlow gives the advantage to cable and satellite operators, which she says have the ultimate control over broadcasted material.

“When it comes down to it the cable and satellite companies are going to be the ones to deploy these interactive services,” Swedlow says. “Those are going to be the power brokers.”

Other analysts, however, say the leverage of cable and satellite operators to dictate terms for the provision of interactive-television services will diminish over time as viewers get more choices about where they obtain their television programming.

“The leverage is gradually shifting away from the cable and satellite operators,” Hause says. “A cable or satellite operator has that leverage only as long as they are the only way you can get television.”

Hause says that when viewers are more free to switch between competing providers of television broadcasting services the one constant will be their digital video recorder, which contains their personal viewing preferences and which also can be used in combination with any form of TV reception.

“Right now there seems to be a lot of leverage with the pipes,” Hause adds. “In the long run, though, that will change.”

Smith is in full agreement. He sees little threat coming from the cable and satellite sectors, mostly because firms in those markets are overwhelmed by the scope of the problems involved in helping viewers sort though the explosion of televised media now available.

“The people who own the pipes are now giving viewers something like 2 million program or show options a year,” Smith adds. “There really isn’t anything else on the market that comes close to helping to manage all that information. [The DVR companies] are filling a desperate need.”

There is, however, always the chance that cable and satellite operators will build DVR-like functions into their own set-top boxes, similar to the way Littleton, Colo.-based EchoStar Communications Corp. {DISH}, a direct-to-consumer satellite broadcaster, has already used technology from Microsoft Corp. {MSFT} to get a jump on the DVR makers.

“My best guess is that all three companies will continue to be involved,” Smith says. “You don’t eclipse Microsoft. But I think its size can be offset by a more-dedicated focus by these companies.” TiVo, and soon ReplayTV, are, he notes, the only DVR pure plays.

“The biggest challenge TiVo and ReplayTV have is not each other,” Hause adds. “It’s that their value-add will diminish if they just become another feature set in someone else’s system. That’s why they’re moving toward becoming a platform. They really need that. The ability to pause programs won’t be enough to keep them going.”

“It will be a real horse race to see whose service implementation wins out,” Swedlow agrees.

But Swedlow quickly adds that other analysts who expect to see just one, or even a handful, of new winners emerge don’t seem to understand the nature of the dawning market for interactive television.

“The Internet is still developing,” Swedlow says. “I don’t think it will ever settle into one platform as television did. The Internet enables multiple platforms, and we’re going to continually see them develop and evolve. You’re never going to have stasis in this industry.”

That, she says, creates plenty of opportunities for companies that offer products and services that address real consumer needs.

“DVRs certainly fall into that category,” Hause says. “In the end, consumers are most loyal to content. DVRs give them the freedom to more easily find and view the content they want when they want it. It will take a few years for the huge scale to develop. But if we know anything, we know people like watching TV.”

On April 19, TiVo, which commenced volume unit sales late last year, reported a first-quarter loss of $24 million on revenue of $424,000, as compared with a loss of $5.5 million on zero revenue for the same quarter a year earlier.

ReplayTV’s pre-IPO filing indicates the company had a first-quarter loss of $22.3 million and zero revenue, as compared with a loss of $3.4 million, also on zero revenue, for the same period a year earlier.

Sales of the first products containing the ReplayTV technology began in early May. The IPO is currently expected later this month or early in June, depending on market conditions.

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