Are investors ready to tune in on interactive TV?

After several years of hype that ran well ahead of reality, interactive television is starting to attract viewers and investors.

Dawn Kawamoto Former Staff writer, CNET News
Dawn Kawamoto covered enterprise security and financial news relating to technology for CNET News.
Dawn Kawamoto
7 min read
After several years of hype that ran well ahead of reality, interactive television is starting to attract viewers and investors.

The convergence of television and Internet usage is on the verge of creating a major new sector, but finding the right investment can be as daunting as locating a "Seinfeld" rerun on a cable system with 500 channels.

The share prices of many companies operating in the sector are well below their 52-week highs but have shown signs of life recently. In addition, what has largely been a behind-the-scenes battle has become very public in recent weeks, thanks to concerns over the AOL-Time Warner merger and a high-profile setback for Microsoft.

The interactive television sector is expected to reach revenues of $48.2 billion by 2005 from an estimated $848 million this year, according to Forrester Research. The reason: 99 percent of U.S. households have TV sets and about 40 percent are connected to the Net, according to investment bank ING Barings. A more recent push has come from advances in set-top boxes, operating systems, upgraded cable networks and more compelling content.

To help understand this nascent market, analysts divide the industry into these segments: infrastructure companies, which include the digital set-top box makers, operating system companies and so-called middleware companies. In addition, there are several applications companies and a smattering of content providers. Finally, there are companies that are looking to offer services, such as America Online, Microsoft and Excite@Home.

Picking the winners
"Infrastructure providers that enable interactive services probably offer more revenue visibility in the near term. That's because equipment and software are required to enable interactive services," said Spencer Wang, an ING Barings analyst who recently published a report, "The Interactive Television Guide, Version 1.0.

He added that investors currently aren't sure which applications will prove popular with consumers, but in the future, these companies, along with content companies, will provide the best returns. These two groups have the greatest potential for capturing recurring revenues from subscriptions, advertising and e-commerce, Wang noted.

Industry and financial analysts caution, however, that although interactive television has made inroads, it still has a ways to go before it's clearly defined. Companies are undergoing rapid change, realigning their product offerings, and focusing on the part of the industry they want to own.

Nonetheless, for investors with a long-term outlook who don't mind some risk, here are some of the major, publicly owned companies worth considering:

Makers of set-top boxes
Motorola, which acquired General Instruments this year, and Scientific Atlanta are the largest companies in this field. Smaller players include Sony, Pioneer and Philips Electronics.

These digital boxes sit on top of customers' television sets and are connected either to cable or a satellite dish. The set-top boxes convert digital TV signals into a language that can be understood by analog televisions.

Currently, interactive TV is a small piece of Motorola's billion-dollar business. The former General Instruments accounted for 8.2 percent, or $768 million, of Motorola's $9.3 billion second-quarter revenues. But when it comes to the digital set-top arena, Motorola's broadband communications business is in the lead. The company shipped 1.4 million boxes in the second quarter and is on track to ship 5.5 million units for the year.

Interactive TV (3/18/00)
Scientific Atlanta, meanwhile, was a step behind Motorola. The company shipped 835,000 boxes during its fiscal fourth quarter that ended June 30. Analysts expect the company to ship roughly 4.3 million boxes during its current fiscal year. In the fourth quarter, Scientific Atlanta increased its production capacity to 1 million set-top boxes from 500,000.

Gary Lieberman, an analyst with Morgan Stanley Dean Witter, said in a research note that while he expects the company to ship approximately 1 million boxes in the fiscal first quarter, he wouldn't be surprised if the company surpasses his second-quarter estimate of 1.05 million as production increases.

Scientific Atlanta, meanwhile, generated nearly $553 million during the fourth quarter, a 56 percent increase over the year-ago period. It posted a net profit of $59 million, a 25 percent increase over last year. The company's shares, however, have since fallen by nearly a third since reaching a 52-week high of $94 a share in mid-August.

Operating sytems
While the operating system is a crucial component of the industry, from an investment standpoint there are no pure-plays.

Companies that offer operating systems to run these devices include software giant Microsoft, which has Windows CE, Sun Microsystems' Java OS, Scientific Atlanta's PowerTV, and Wind River Systems' VxWorks.

Prakesh Patel, an analyst with WR Hambrecht, estimated that interactive TV-related sales accounted for roughly 10 percent to 15 percent of Wind River's $101.3 million in second-quarter revenue.

"If you really believe in interactive TV, then you should invest in the pure-plays," Wang said.

That narrows the field to less than a dozen companies, including applications companies such as ACTV and Source Media, interactive program guide company Gemstar-TV Guide International, personal recording device company TiVo, video-on-demand companies Concurrent Computer and SeaChange, and Wink Communications, which allows customers to get additional information on programming and advertising via their remote controls.

Liberty Digital is considered a pure-play content company, while Liberate Technologies and OpenTV are some of the few pure-play infrastructure companies.

Middleware companies
Microsoft, Liberate and OpenTV are competitors in what is called the middleware market. Middleware operates between the operating system and an application, allowing developers to ignore the hardware and components when creating applications.

Last week, for example, Liberate announced it's poised to take some of Microsoft's AT&T business away. AT&T is gearing up to unveil set-top boxes for interactive television and is said to be frustrated by delays in Microsoft's technology.

"Liberate has the ability to scale with the demand of the Internet, especially at a time when Microsoft is not executing," Chase H&Q analyst Jack Ripsteen said.

The AT&T deal, along with a similar deal with UPC, have helped drive Liberate's stock up about 91 percent since mid-August. The stock closed at $32.44 on Friday, up $3.31, or about 11 percent. The shares, however, are still well below their 52-week high of $148.50.

The company also announced its fiscal first-quarter results last week, posting a 78 percent increase in revenues to $9.4 million from a year ago. Its pro forma net loss slipped to $9 million from $10.1 million a year ago.

Liberate, which counts Oracle as a major investor, also installed its software on more than 150,000 set-top boxes in the quarter, bringing its total to more than 300,000 worldwide. The company also has deals with 18 network operators.

OpenTV, meanwhile, announced last week that set-top maker Motorola was increasing its stake to 5.4 percent with a $83.4 million investment.

The company currently has a larger footprint than Liberate, with 1.5 million set-top boxes installed in the second quarter, bringing its total to 9.3 million. The company also struck alliances with 32 network operators.

During the second quarter, OpenTV reported revenues of $11.3 million, up 83 percent from a year ago. OpenTV's pro forma net loss, however, widened to $3.3 million in the quarter from $1.2 million a year earlier.

Meanwhile, shares of OpenTV have fallen more than 80 percent from their 52-week high, closing at $41.31 on Friday, up $1.63, or about 4 percent.

Applications companies
Among applications companies, analysts list Gemstar as a major player.

"We view Gemstar as one of the best-positioned companies in the interactive TV (iTV) sector, owing to its leadership position in the interactive program guide (IPG) business. In our opinion, the IPG is the first iTV killer application that is a must in an expanding multichannel universe," Wang's report noted. He added that along with the TV Guide brand, he envisions Gemstar's program guide to dominate as a TV portal.

The IPG allows people to find television shows by title, time slot or category via remote control. They also have the ability to use the remote control to find additional information about the shows.

Gemstar generates revenues from advertising, as well as license fees from manufacturers using eBooks, its portable, electronic reading device. The company reported a 40 percent jump in fiscal first-quarter revenues to $63.2 million for the period ending June 30, compared with last year. Meanwhile, net profits doubled to $28.9 million.

In July, the company acquired TV Guide for $14.9 billion--making it the largest U.S. TV program guide distributor.

The company's stock has more than doubled since late May, but at a current price of about $76 it's still well below its 52-week high of $107.43.

Interactive TV services
America Online launched AOLTV last June, setting the stage for a fierce battle with Microsoft's WebTV service. Both companies offer users email and Web browsing.

But AOL is expected to get the added advantage of tapping content from its planned merger partner and media giant, Time Warner. Also, Time Warner will give AOL the broadband access its been seeking, via its cable properties. Rivals are lobbying the Federal Communications Commission to place restrictions on the deal, such as ensuring competitors receive access to the cable network. Meanwhile, music companies are asking the European Commission to block the deal.