The Drip Portfolio
First off, the market for cable network systems and set-top boxes is basically a "duopoly" between Scientific-Atlanta and General Instrument. General Instrument is the larger of the two and has shipped 40 million out of a total of 65 million systems. General Instrument provides two set-top boxes for broadband cable. The core interactive unit provides video on demand, Internet access, and e-mail and sells for less than $300. The upscale model, the DCT 5000+, has the following capabilities (according to the General Instrument website):
Return on Equity 8.40 16.32
Return on Assets 6.51 11.10
Gross Margin 29.06 28.82
Operating Margin 11.86 12.05
Profit Margin 6.74 8.43
Rev. Growth (5 yrs.) 11.74 10.47
Rev Growth (1 yr.) 12.68 5.25
Day Sales Outstanding 57 73
Invent. Turnover/90 Days: 2.4 1.7
Sometimes when I compare two companies' numbers, it seems obvious that one is being squashed by the other. This doesn't appear to be happening here. Let's get away from the numbers and look at some other interesting developments for General Instrument. The most important is that Motorola (NYSE: MOT) has acquired it.
Motorola is the leader in cable modems, according to Mr. Kanouff, and also will provide the core technologies for further development of set-top boxes and networking equipment. Also, Motorola has a strong brand name, which will be an advantage for selling their set-top boxes on the retail market. This merger will be complete in early 2000. What is interesting for us as Drip investors is that while General Instrument does not offer a Drip plan, Motorola does. We'll need to look at Motorola closer in the future.
Finally, our discussion went on to the cable business in general, and Mr. Kanouff confirmed everything I was told by the folks at Scientific-Atlanta. That is, there are some other competitors, such as Sony, coming into the set-top box arena. However, there are significant barriers to entry. The boxes have to be a system with the cable network, so unlike PCs, you can't easily build a set-top box in your garage. The network systems for the cable company are quite complex and require a high degree of competency. Both General Instrument and Scientific-Atlanta have strong relationships with their customers -- this makes breaking into the business difficult. Mr. Kanouff, however, did disagree with the Scientific-Atlanta folks about who made the better product.
What is my conclusion? We're into an opinion area here, since there isn't definitive evidence that one company is overwhelming the other. So far, it looks like Scientific-Atlanta is still in the running for a Drip investment. I'm also looking forward to studying Motorola. Next week we'll look closely at the numbers from Scientific-Atlanta and conclude this series. After that, I want to veer off the road from Pathfinder companies for a few weeks and write about something I'm intimately familiar with -- building supply companies such as Home Depot (NYSE: HD).