The Rapid Evolution of the Home Entertainment Industry

Victor is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

After cinema and cable TV, ways of delivering multimedia content continued to evolve. First, there was satellite TV; later, systems that integrated digital video recording; and finally, Internet streaming. Below I will look into one company of each kind, Dish Network (NASDAQ: DISH), TiVo (NASDAQ: TIVO) and Netflix (NASDAQ: NFLX), in order to elucidate which ones stand a chance of succeeding in a constantly evolving environment and, thus, comprise good investments.

Dish Network: Satellite TV

Dish Network offers, among the three firms that will be analyzed here, the oldest of technologies: satellite TV. However, the management is aware that this industry has already peaked and will probably start to decline soon. It has started a bidding war with Japan’s Softbank to acquire Sprint Nextel (NYSE: S), the third largest U.S. communications carrier, in order to diversify its business. Nevertheless, the outlook does not look very promising, especially after the Committee on Foreign Investment in the U.S. (CFIUS) cleared the proposed merger between Sprint and Softbank. Although the deal is not sealed and Dish has still got some cards to play, its chances are not many. Then again, this is not necessarily bad. Even though business diversification looks like a wise choice for Dish, analysts believe that the Sprint bid was a little too risky.

Going forward, one can expect traditional TV to be around for a while. Nevertheless, growth opportunities aren’t many, and competition in the U.S. continues to increase as other communications companies like AT&T and Verizon enter the cable business. Moreover, as producers demand higher prices for their multimedia content, Dish’s margins will be hit again.

The company has also tried to cope with the maturity of the TV market by introducing innovative products, the latest of which is an HD Digital Video Recording set that allows fast-forwarding through commercials in prime time TV shows. In addition, its low-cost product offering positions it ahead of its competition and generates client stickiness. Furthermore, improved operational metrics and the launch of a nationwide satellite-based broadband service should drive growth in the upcoming quarters.

Notwithstanding the aforementioned pros and a 422% return on equity (versus the 18.4% industry mean), I’d recommend a HOLD on Dish for now, not only due to its limited growth prospects, but also on account of its high valuation at 35.3 times its earnings, over double the 14.8x P/E industry average.

TiVo: Digital Video

TiVo started one step ahead of Dish. It was the first company to offer digital video recorders to individuals. At a time when Internet streaming did not exist or wasn’t widespread, TiVo appeared as an innovative option that allowed users to record TV shows, pause them and fast-forward through commercials. Over the years, the brand name became a slang noun used to describe the action of recording a transmission.

After mixed results in the last reported quarter, missing consensus estimates by a few cents but coming ahead of the bearish expectations, the stock price started rising and now trades very close to a 3-year high. Trading at a much more expensive valuation than its peers in relation to its earnings and sales, but expected to deliver an annual average EPS growth rate around 56% over the next five years, is this stock still a BUY? I’d say it is; below, some extra reasons to feel confident about the firm’s long-term future.

From my point of view, the main driver of TiVo’s growth in the upcoming years will be its innovative products that include the TiVo mini and TiVo Stream devices, which have offered encouraging early results. Furthermore, the company holds several partnerships with content creators, media and advertising companies like Comcast, Conax, Technicolor, Gemstar, NBC, CBS, Com Hem (Sweden), Cablevision (Mexico), Seven Network Limited (Australia), ONO (Spain), Virgin Media (U.K.) and Canal Digital (Scandinavia), which provide plenty of growth opportunities in overseas markets, helping relieve the pressure excreted by decelerating subscription rates in the U.S. In addition, the firm still has plenty of space left to develop its advertising business; the recent acquisition of TRA, an advertising analytics company, sure is a step in the right direction.

Netflix: Home theater

Netflix is the newest of these companies and came to revolutionize the way of watching movies and TV shows. However, it already holds roughly ¼ of the U.S. market share, exceeding 29 million subscribers (up about 6 million year over year) and holds over 7 million other affiliates overseas (a figure that was less than half last year). With easier and cheaper access to international markets and plenty of original content, Netflix seems poised to outperform its peers in the entertainment business, delivering an amazing service for relatively low fees.

This last feature is probably one of the company’s strongest points. Its pricing power seems so strong that price upsurges will almost certainly result in larger incomes; even if people were to respond poorly to little ($2 to $4) upsurges in subscription fees, which hasn't been the case in the past, the firm would still collect massive profit gains that could create a 2,000% upsurge in earnings, to $10-$20 per share.

Expected to deliver growth rates around 20% over the upcoming years, I´d say that this stock is still a buy, even in spite of its extremely high valuation. Its business model is simple and profitable, and even in the worst of cases, revenue will continue to increase for a few years yet. Another initiative expected to drive growth over time is the firm´s incursion into the mobile and tablet segment, which has already proven quite profitable (but is still in its early stages).

Although some analysts are concerned about increasing competition and low barriers to enter the industry, I believe that Netflix's brand name will help it prevail over its peers and continue to expand globally. Aggressive international expansion plans are being implemented as well, providing further development prospects, especially in Latin American, Caribbean, British and Nordic markets.

Bottom line

Although overvalued in relation to its peers, I like TiVo and, especially, Netflix. Providing sophisticated multimedia broadcasting systems to a market with ever-increasing demand, these firms are poised to deliver above average growth rates, outperforming conventional competitors like cable TV and satellite TV operators. I'd say BUY AND HOLD upside should be plenty in the upcoming years. 

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Victor Selva has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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