A Way to Play the Video Revolution

05/19/2008 12:00 am EST


Michael Murphy

Former Editor, New World Investor

Michael Murphy, editor of New World Radar Report, says video is transforming the Internet, and he says one equipment supplier is well-placed to ride the trend.

We're on the edge of a worldwide video revolution, [and] I don't think "revolution" overstates the situation. Consider these facts:

  • Analog television broadcasts end on February 17, 2009
  • Video already accounts for half of the traffic on the Internet [and] is becoming common on e-commerce websites.
  • Cell phones are moving from including digital cameras to digital camcorders just as the ability to transmit and receive video is improving.
  • iTunes just announced they will distribute movies digitally the same day they become available on DVD.
  • Telephone companies are committed to upgrading to fiber optic networks to replace relatively slow DSL over copper lines.
  • Cable companies are rolling out an even faster data transmission standard, DOCSIS 3.0, which will provide a large, rapidly growing equipment market for many years.

As a result, video is one of the hottest areas in all of tech-land. Comcast (Nasdaq: CMCSA), for example, [is] tilting their spending towards high-speed Internet connectivity, in large part to handle video.

Comcast is rolling out the new, faster DOCSIS 3.0 [standard], intending to upgrade about 20% of its user base this year and continue the program for several years. [They will be]  reclaiming bandwidth by completing the conversion from analog to digital video across its network.

In order to do this, they need to deploy many more digital encoders, as supplied by Harmonic (Nasdaq: HLIT). Harmonic makes a device called an EDGE QAM that supports DOCSIS 3.0 for cable modem Internet access, switched digital video and video on demand.

Video on demand is another growing area that helps maintain customers and sign up new subscribers. Harmonic acquired Rhozet, a company that had transcoding technology to insert targeted ads into video. HLIT also acquired Entone, a maker of video servers. Comcast is not a customer for these two companies today, but Harmonic could win a share of the much larger future orders for this sort of equipment.

Comcast sees interactive advertising, which combines the ability to target ads to particular users, as a revenue opportunity with Google-like attributes. Harmonic offers real time ad insertion via its Rhozet products, and recently introduced a new Gator user interface to manage this process.

When Harmonic announced its results, they gave conservative guidance in part because they did not know what Comcast would say about its capital-spending plans. Comcast was a $50-million customer for HLIT in 2007. Comcast added almost half a million new broadband subscribers in the March quarter.

Since Motorola bought General Instrument, Cisco bought Scientific-Atlanta, and LM Ericsson bought Tandberg, Harmonic is one of the few major independents left. HLIT's future is very bright and the stock is at a ridiculously low price, less than 12x this year's earnings estimate. HLIT is a Top Buy up to $12 for my $18 target. (It closed below $9 Friday-Editor.)

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