Two Coins Tossed the Other Way
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In the article, Dolby - A Solid Brand with Solid Fundamentals, I talked about 4 coin toss directions that could make or break Dolby (NYSE: DLB). 1) Microsoft’s (NASDAQ: MSFT) agreement to include Dolby technology in Windows 8 computers will flop due to lack of adoption for the new Windows 8 operating system. 2) Dolby’s underperformance in its product division could continue. 3) There will be increasing competition from DTS, Inc. (NASDAQ: DTSI). 4) Obsolescence of products that utilize Dolby’s technology such as the decline of DVD and Blu-ray sales. The earnings announcement that came out Aug. 2 confirms that two of the coin tosses went in the wrong direction at least temporarily.
Coin Toss #2 Confirmed - Dolby’s Underperformance in its Product Division Continues
Dolby continues having a difficult time meeting the changing needs of the cinema industry according to the latest earnings announcement and form 10-Q. Dolby’s product revenue is down 25% for 9 months ending June 29, 2012. Dolby has not been able to come up with a solution for the digital cameras that are being adopted in the industry. Digital audio technology is more open thus commoditizing a product that Dolby specializes in. Dolby plans to have a digital solution in the 2012 calendar year.
Coin Toss #4 Confirmed - Dolby Faces Obsolescence in the Technologies that House Dolby Technology
Both Dolby and its competitor DTS, Inc. face obsolescence stemming from DVDs and Blu-rays. Dolby’s portion of licensing revenue stemming from DVDs and Blu-ray players is at 19% for 9 months ending June 29, 2012. It was 21% in 2010. Dolby says they are making strides in technologies designed for audio delivery over mobile devices and through the internet. As more people adopt mobile technology this should boost license revenue. Dolby’s portion of license revenue involving mobile, gaming and automotive technologies is at 19% for 9 months ending June 29, 2012. It was 18% in 2010.
Coin Toss #1 Unconfirmed - The Adoption of Windows 8 will Flop Jeopardizing Dolby’s Growth
The fruits of Microsoft’s agreement to house Dolby’s technology won’t be known until the first part of calendar 2013 or later. Windows 8 won’t be released until October 26, 2012. It remains to be seen whether this will pan out. Personal disclosure: I own stock in both companies so I have two stocks in my portfolio whose future return is riding on the release of one product. The fortune of Dolby and Microsoft is dependent on the success of Windows 8.
Coin Toss #2 Unconfirmed - Increasing Competition from DTS, Inc.
DTS is having its own struggles with DVD and Blu-ray obsolescence. This may hinder DTS more because they have a less diverse revenue stream than Dolby. Until we see the outcome of their acquisition of SRS Labs, Inc. and how they deal with obsolescence and adopting technologies this too will remain an unconfirmed coin toss.
Dolby’s Excellent Fundamentals Should Carry Them Through
Dolby has excellent cash and short term investments to its stockholder’s equity position of 57%. If you factor in long-term investments that percentage goes to 74%. Its free cash flow is at $263 million as of June 29, 2012. Operating cash flow actually grew 6% and the total debt to equity ratio is 12% (mrq). This should help fund future research and development expenses especially in preparation for the Windows 8 rollout. Also Dolby’s excellent cash position should help future expansion into emerging markets. Despite the decreases of 1% in revenue and 1% in free cash flow Dolby still has plenty of savings to help pull itself out of a slump. Maybe at some point they could start paying a dividend.
Conclusion
Dolby has excellent potential in the emerging economies and the mobile and internet spectrums. I also think the deal with Microsoft has the potential to pay off big if people adopt Windows 8 like the previous versions. DTS is a smaller competitor that is suffering from waning demand in DVD's and Blu-ray's which could be a good thing for Dolby in the long run. Dolby has the cash to take advantage of any opportunities, weather any storms, and pay a dividend. I think in the long run, say 3-5 years out, this company will emerge as a superior investment.
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