Motley Fool Staff
Nov 1, 1999 at 12:00AM
We can divide the market to cable providers into three areas:
-- Satellite Reception
-- Set-top Boxes
Satellite reception equipment picks up the signals from the satellites (obviously). Scientific-Atlanta does manufacture this equipment, but it is a minor competitor in this market. Where Scientific-Atlanta comes in as a powerful competitor is with the fully interactive network systems and set-top boxes. The company's recent introduction to this product line, called the Explorer 2000, works like a PC. Scientific-Atlanta is in a partnership with Peach Networks to provide PC applications that run on Microsoft Windows on the television. According to the press release, this is done by having the applications run from the server, while the set-top box displays the application.
In the past, we've seen some rather slow progress toward the move to broadband. Worse, we've seen some hyping of broadband cable without it actually existing. Many of us have cable companies that constantly advertise their broadband service, while we the subscribers are painfully aware that these services haven't reached our neighborhood yet. However, cable is starting to get some serious competition from direct satellite television, which I think will give cable companies more incentive to upgrade their networks in upcoming years.
An advantage to the market of providing broadband to the cable companies is that the barriers to entry by competitors is very high. The suppliers build long-term relationships with the cable companies and offer a number of services beyond providing equipment. The people at Scientific-Atlanta explained to me that a cable network is balanced, much like a domestic water supply system (forgive the civil engineer in me). In a water system, drawing off a certain flow in one area affects the volume and pressure in the whole system. So, in a complex system, the whole network of pipes must be analyzed for size and layout to assure that proper flow is provided to all branches. The same is true for a cable network. All of the equipment provided and installed must allow maximum efficiency and flow to all branches. Providing this analysis to the cable company requires a high level of expertise in a specialized business.
Now, what do we want to look at when considering Scientific-Atlanta as an investment? First, I'm concerned with the potential market expansion. While we can debate DSL vs. cable modems for Internet access, cable has the potential to bring the Internet to everybody that has a television. Not everyone understands setting up a computer and a DSL modem (if you can even get DSL -- I can't), but everyone understands a television. According to the National Cable Television Operators Association, 19.5 million homes were serviced by cable Internet in 1998, and that will expand to 67 million by 2005. That represents 19% annual growth, which isn't bad. The growth from analog cable to digital is even more phenomenal: 1.4 million households in 1998 to 38.6 million in 2006. Get this -- that is an annualized increase of 51%! OK, so we have growth in this industry.
The second question that concerns me is, what about competition? A number of businesses are just plain bad to get into -- the barriers for entry are so low, or the item sold is a commodity and price is the main concern. Providing to the cable companies is not a commodity, and there are some high barriers to entry. For Scientific-Atlanta, the competition appears formidable. Besides General Instrument (NYSE: GIC), Motorola (NYSE: MOT) and Sony (NYSE: SNE) have entered the market for set-top boxes. However, none of these competitors makes a set-top box with the PC capabilities of Scientific-Atlanta.
Just because behemoths like Sony and Motorola enter a market, it doesn't mean they are a threat. They don't have the experience or the agility of a smaller company that specializes in that area. I'd be more concerned with General Instrument. Unfortunately, General Instrument does not have a direct investment program, but we do need to look at them since they are the main competition. Since I probably won't make it to Scientific-Atlanta before next week, let's compare them with General Instrument in the next column. We'll wrap up with the prospects for future earnings and move on to other possible Pathfinder companies.
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Motley Fool Staff
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