At first listen, something might not sound right about audio technology company DTS Inc.
The company’s net income for the first three quarters of 2009 fell 31 percent below last year’s, yet the company’s stock price has climbed 69 percent in the same period.
Management at the Calabasas company, which develops and licenses audio technology to consumer electronics manufacturers, has this explanation: The company has lightning in a bottle because it owns sound technology that’s required for Blu-ray disc players, which in the coming years will replace DVD players.
During the most recent quarter, DTS revenue from Blu-ray technology increased 133 percent compared with the previous year.
“Everybody is excited because we are a mandatory technology for Blu-ray, meaning every Blu-ray device is required to have a piece of DTS technology,” Jon Kirchner, DTS chief executive, told the Business Journal.
And as more people buy Blu-ray players, licensing fees will be rolling into the company faster and faster.
“We believe ultimately Blu-ray discs will succeed DVD as the media of choice,” Kirchner said. “The upside for our business is that Blu-ray becomes as big as DVD is today.”
Kirchner attributed the earnings slump to a sudden increase in expenses to service the boom in Blu-ray manufacturing. Another factor was the lag time for payments, as manufacturers often don’t pay license fees until months after machines are shipped.
Ralph Schackart, an analyst at brokerage William Blair & Co. in Chicago, credits high expectations for Blu-ray as the major factor in the stock surge for DTS.
“Falling Blu-ray prices will drive adoption, with the holiday selling season looking strong,” Schackart wrote in a recent report on DTS. “We believe current share price levels reflect only modest upside potential.”
He forecasts that sales of Blu-ray players will accelerate in 2010 and investors should start buying DTS shares now. He gives the company an “outperform” rating with “aggressive” growth potential.
The company’s good fortune grows out of an agreement the company signed with the Blu-ray Disc Association in 2004 that made DTS audio coding a requirement for all Blu-ray machines.
Additionally, Schackart predicted that Blu-ray drives will become more common on PCs, allowing consumers to watch Blu-ray movies on their computer screens and to store large amounts of data on discs. This development could open a larger market for products requiring DTS technology.
“We believe the PC will represent one of our biggest markets for growth,” Kirchner said.
But the path to a Blu-ray future won’t be a straight upward line for DTS, analysts agreed.
The company previously provided sound technology for DVDs. For now, most of DTS’ revenue comes from royalties on DVD players. And with the arrival of Blu-ray in stores, sales of DVD players have slumped.
“Even if the adoption of a new technology is rapid, as the old one passes there’s likely to be a period where the absolute levels of sales will be lower than in a stable market,” said James Gross, a senior investment analyst at Barrington Research Associates in Chicago.
Goss rates DTS at “market perform,” a downgrade from “market outperform” earlier in 2009 because the stock has reached his price target.
The question over DTS’ future is whether Blu-ray technology will jump from the players to computers and other platforms, such as video games and car consoles. The company believes that will happen, but early signs aren’t entirely positive.
“The PC side of the Blu-ray adoption didn’t accelerate in the back half of the year as we had hoped,” Kirchner said. “Based on industry reports, we now believe significant acceleration of Blu-ray adoption for the PC is expected to begin in the latter half of 2010.”
Also, Schackart noted that sales of Blu-ray players are tracking lower than DTS anticipated. But the shortfall has not had a financial impact because the company is getting higher royalties per unit than originally expected.
Gross, the analyst at Barrington, thinks the jump in DTS’ stock price can be viewed as a bounce-back from the dark days of late 2008, when consumer-sensitive sectors such as advertising, automotive and electronics stock prices plummeted amid the economic meltdown. However, as the economy moves ahead he expects improving consumer confidence will work in DTS’ favor.
“There’s the expectation that for DTS and consumer electronics in general, the outlook will improve,” he said.
