For two years, U.S. investors endured a drought of initial public offerings (IPOs). Those few that we did see were largely uninteresting. This year, we haven't seen all that many, either, but new issues have been fairly well received. Most are even outperforming the S&P 500.
This might bode well for Digital Theater Systems
A sound business
If you enjoy hearing movies in remarkable clarity and at an ear-splitting volume, and savor being enveloped in sound until you feel a part of the action, then DTS is for you. The company produces digital multi-channel (surround sound) audio technology, products and services, both for consumers and the entertainment industry.
Founded in 1990, DTS emerged on the Hollywood scene with its first multi-channel audio soundtrack -- for Steven Spielberg's 1993 Jurassic Park (I can still hear that T-Rex roaring). Today, DTS licenses its sound technology to every major film distributor in the country, and its playback systems for DTS-formatted soundtracks are installed in 22,000 theaters around the globe.
And theater isn't even the company's largest business. Consumer retail claims that honor.
In 1996, DTS launched a consumer division to license its sound technology for use in DVD players, home theater systems, and audio/video receivers. The company signed licensing agreements with "substantially all" major consumer audio electronics manufacturers, including Sony
Licensing businesses are attractive primarily for their high margins and repeat business. They're especially attractive when based on protected products with wide demand and high barriers to entry. DTS has all that.
In yet another business arm, DTS itself licenses well-known titles and remixes them in digital multi-channel format to produce multi-channel DVDs and CDs . The company has remixed classical music, along with the likes of Sting, the Eagles and Queen. DTS' digital technology is also heard in video and software games, car stereos, PCs, digital satellite, and cable -- all growing businesses. Finally, DTS is rolling out new subtitle, caption, and descriptive narration technology for films.
The sound of money
Sales and net income -- that's right, DTS has net income -- are growing. Revenues rose from $25 million two years ago to $41 million in 2002. Net income last year clocked in at $6.2 million, up from $3.9 million the year before, on 73% gross margins. Take a look.
2000 2001 2002 Sales $25,062 $28,748 $41,056Gross Profit 16,173 18,696 30,420Net Income (99) 3,908 6,250
This 13-year-old Californian business is in a healthy position to go public, and with the IPO market feeble at best, today's valuations out of the gate sound reasonable.
DTS intends to raise $46 million, selling 3.4 million shares to the public. Following the offering, the company will have 12.6 million common shares outstanding. At $15 per share, that values DTS at approximately $190 million, or 4.6 times last year's sales.
For the year, I see the company earning in the area of $0.45 per share, putting the $15 stock at 33 times this "guessed" estimate, which assumes modest earnings-per-share growth, while accounting for new share dilution. It likewise involves tremendous uncertainty.
DTS plans to use nearly half its IPO proceeds ($21 million) to redeem all outstanding shares of its redeemable preferred stock. The remaining cash (more than $20 million) is slated for operations and to grow the business. Any new investments in the business might lower profitability in the near term, and in the long term adds to the risk of new initiatives failing. That's part of the risk of IPOs: Going public itself usually heralds business changes and new initiatives.
Turning up the risks
IPO investing is inherently risky: The history of the company is often lacking, while its ability to run itself as a public company is untested. New issues are characteristically volatile. We don't recommend that novice investors consider IPOs. Only experienced investors should entertain the notion of jumping on a new horse out of the gate, and even they should have a clear understanding of what they're buying. Read the IPO's SEC filings first -- there you'll find a detailed discussion of the business.
In the case of DTS, you'll read that Dolby is the major competition, but there are others, including partners such as Sony. Competition in the industry is intense and is likely to remain so, while pricing power is likely to decrease -- it usually does in technology. DTS faces these risks and several others.
Overall, an IPO worth a listen
Typical uncertainties aside, Digital Theater Systems offers a compelling long-term business and management that has demonstrated an ability to grow sales profitability. The company will have nearly $30 million in cash and zero debt after the offering. Its solid financial standing, strong backing (Universal Studios owns 13%), diverse customer and product base, and the growing DVD and home theater markets (among others) make DTS an IPO story that deserves a listen.
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