If there's one thing that could get investors excited about owning shares of Dolby Laboratories (DLB +1.78%) again, it's the mobile market. But if a recent decision by Samsung (NASDAQOTH: SSNLF) is any indication, investors might be sorely disappointed.
Specifically, Dolby told investors during last week's quarterly conference call that they expect mobile revenue to drop to roughly 10% of total licensing revenue during its fiscal third quarter -- down from roughly 12% of licensing in the second quarter, and 15% in fiscal Q1. To explain the dip, Dolby CFO Lewis Chew elaborated:
Mobile is affected by seasonality and timing. In addition, we are currently working through our arrangements with Samsung regarding our mobile technologies, and at present Dolby Digital is one of several third-party features that were in the Galaxy S4, but not included in the Galaxy S5 just released in April.
To be fair, when prodded for clarity surrounding Samsung's decision during the Q&A session, Dolby CEO Kevin Yeaman insisted that "everything is still on the table." In short, he added, they're working through the details of their contract with Samsung, which has "come up for its natural renewal cycle."
However, that doesn't change the fact Samsung's Galaxy S5 doesn't include Dolby's flagship technology -- a move with which Dolby admits it was "disappointed" and means millions in lost mobile revenue.
Of course, this doesn't mean Dolby won't find its way back in, but I sure can't blame investors for worrying about the implications of Samsung's decision. What if, for example, Samsung decides Dolby's tech is no longer a worthy differentiating factor for its most popular mobile devices? Would that cause Dolby's other notable partners in the smartphone and tablet market to follow suit to save money? Then again, perhaps others would view it as an opportunity to showcase the fact their own devices do have Dolby inside. In any case, it's a risk worth noting.
Mobile's nice, but ...
Don't get me wrong. This isn't to say Dolby is a floundering business otherwise, as its other promising growth markets are still holding up well.
Broadcast licensing revenue, for example, grew around 9% year over year on a comparable basis. That was driven by Dolby's increased presence in emerging markets like India and China, where roughly 60% and 65% of all HD channels are now broadcast in Dolby Digital Plus, respectively. Dolby's gaming revenue also drove a 28% boost in its "other" segment, thanks to its inclusion in both PlayStation 4 and Xbox One consoles. Dolby is also seeing solid traction with its new Dolby Atmos cinema technology, though it's still not growing quickly enough to offset lower revenue from Dolby's more mature Digital Cinema offerings.
Without providing much detail, Yeaman also stated Dolby is seeing "good early adoption" with Dolby Voice, with which it aims to reduce cost and improve quality of enterprise voice conference services. In addition, Dolby has one particularly interesting iron in the fire with Dolby Vision, a video technology that it first demonstrated in January and now expects to see shipping in televisions by the end of this year. Both Voice and Vision are still in their early stages but represent significant growth opportunities down the road.
Finally, Dolby shares might not look particularly cheap, trading around 22 times next year's estimated earnings. But keep in mind that Dolby has a fortress-like balance sheet with no debt and nearly $960 million in cash and investments -- or roughly a quarter of its entire market capitalization. Back that out, and its forward P/E drops closer to 16. In the end, even given Dolby's potentially fledgling mobile growth, that's a premium I think long-term shareholders should be more than comfortable paying.
