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TiVo: Bound to be bundled?

Analysts say the company, which hasn't yet turned a profit, is likely to become takeover fodder or wither away, but TiVo maintains that it can stay independent.

When Raymond Padilla recently returned home to San Francisco from a tiring business trip, he knew his TiVo digital video recorder had also been working overtime.

A boxing fan, Padilla switched on the TiVo to find a recording of his favorite fight, the 1975 "Thrilla in Manila" between heavyweight champ Muhammad Ali and challenger Joe Frazier.

"The best part is that my TiVo can figure out what I like and surprise me with gems like that fight," Padilla said.

It's this sort of personal treatment that has won TiVo the loyalty of close to 230,000 consumers across the United States. Yet the company is just one of an increasing number of those making digital video recorders and jumping into a promising but unproven market.

Digital video recorders are similar to VCRs in that they allow consumers to record TV shows. But unlike VCRs, they store programs on a hard drive instead of a videotape. In addition, the digital devices can fast-forward or search through parts of shows or program shows weeks ahead of time.

Although TiVo's technology is sound, that doesn't mean it's assured of market success. The technology sector is littered with companies--WordPerfect, Netscape and Lotus, to name a few--that had great ideas but fell flat because of business problems or cash concerns.

Analysts say that TiVo--which hasn't yet turned a profit--is likely to become a takeover target or simply wither away in the face of more aggressive competition. TiVo executives maintain that the company can survive, but analysts are doubtful.

"The long-term future of TiVo is very much open to debate," said David Lee Smith, a Dain Rauscher Wessels analyst. "This may be a case of functionality masquerading as a company. There may be a lot of revenue streams here, but it's a question of whether they accrue to TiVo.

"In the end, every set-top box could offer TiVo capability," he added.

TiVo is feeling the heat from Microsoft with its UltimateTV player and Sonicblue with a resurrected ReplayTV. Microsoft earlier this year launched its UltimateTV service for DirecTV receivers, which offers digital video recorder capabilities.

On Wednesday, Sonicblue acquisition ReplayTV re-entered the digital video recorder box business. Sonicblue will address the high end of the market with its boxes and the low end with licensing agreements, such as the five-year deal it signed with Motorola in May.

TiVo's projected growth chart

Yet neither TiVo nor any of its competitors has been successful at drumming up demand and shipping the volumes that had been expected. Analysts had projected shipments of digital video recorders in the millions of units, but sales haven't hit 1 million.

On a recent conference call, TiVo Chief Executive Michael Ramsay was steadfast in his belief that the company will be able to dominate, predicting more than 250,000 subscribers soon. "Overall, I'm very happy with our progress," Ramsay said.

Analysts argue that TiVo will also face increasing competition from cable set-top box makers such as Scientific Atlanta. In about 12 to 18 months, video on demand will offer personalization features similar to those currently offered by TiVo.

TiVo is also expected to license its technology, but analysts frown at such plans as the company would have to share revenue with multiple partners.

Some good tidings, some bad
Those doubts about whether TiVo will eventually make it as a standalone company have cast a cloud over a spate of good news from the digital video recorder pioneer.

The company recently raised $51.2 million from private investors and existing partners, such as Discovery, NBC and British Sky Broadcasting. TiVo also topped financial estimates, recording a second-quarter loss of 82 cents a share on revenue of $4.1 million.

During the earnings announcement, Ramsay touted TiVo's still-unclear plans to garner advertising revenue and its recent service upgrade allowing subscribers to watch and record two shows at once.

Analysts acknowledge the positives but still have doubts about TiVo's prospects. The company's recent cash infusion staved off worries about the company's balance sheet, but only for a year. Dain Rauscher Wessels' Smith estimates the company will still have to raise more cash sometime in 2002.

Even with recent moves to cut costs, the analyst expects TiVo to burn through $40 million to $50 million through the balance of the year.

TiVo's cash position is a major issue, largely because the company is expected to post losses at least through 2003. And revenue still remains slight. Although the company posted big percentage gains, second-quarter revenue was still below expectations.

How TiVo hopes to make money
Ramsay says the company's cash should help it break even on a cash-flow basis, a measure that excludes many expenses. TiVo plans to live on subscriber fees, licensing fees for its intellectual property (which is expected to generate revenue in 2002), and advertising.

As of July 31, TiVo had 229,000 subscribers, and it expects to land an additional 40,000 to 45,000 subscribers in its third fiscal quarter.

Analysts said the economics of selling TiVo boxes has limited the company's growth.

A TiVo box costs anywhere from $199 to $599 depending on whether it is bought through TiVo partners Philips Electronics, Sony or DirecTV. TiVo recently convinced Philips to cut its price of an entry-level box; Sony agreed to offer a $100 rebate. Analysts estimated that TiVo sold the majority of its boxes through DirectTV last quarter.

Once the recorder is bought, customers have to "activate" TiVo's service by buying its software or program guide for a one-time fee of $249, or $9.95 per month. It's a heavy investment for increasingly budget-conscious consumers who can buy a VCR on the cheap or wait for personalized video on demand from cable companies.

Those economics are a big reason why TiVo is beginning to talk about its advertising and licensing efforts, both of which are in the early stages.

Ramsay said TiVo's advertising plans have been hampered by a small number of subscribers and a lack of products. "However, we continue to see great interest," said Ramsay, who added that the company has landed BMW and Coca-Cola as charter advertisers. "Stay tuned for more announcements this quarter."

Analysts still aren't that impressed.

"To us, TiVo's service-based business model remains hard to understand," said Peter Ausnit, an analyst at Deutsche Banc Alex Brown, who added that the company may struggle through a rough market before it gets any revenue outside of subscriptions. "We expect a difficult holiday selling season."

The future
Although Ramsay is convinced that TiVo's future is as an independent company, most analysts have pegged it to be acquired by one of its big backers, such as AOL Time Warner, Sony or major cable companies.

Josh Bernoff, an analyst with Forrester Research, argued in a recent report that AOL is the most likely--and perhaps only--candidate to acquire TiVo.

According to Bernoff, AOL could buy the 82 percent stake of TiVo that it doesn't already own for less than $250 million, just above TiVo's market value of $207 million. AOL also has right of first refusal on any acquisition.

And other partners, such as Comcast and Walt Disney, couldn't justify a TiVo acquisition to their shareholders. Companies such as Philips wouldn't want TiVo because they would want to retain a choice of personal video recorder partners.

A deal with AOL would make sense since it would give the buyer an instant strategy for its on-demand TV plans, technology to use for AOL-TV and another weapon to battle Microsoft with. "With TiVo, AOL would get the top brand name for on-demand television and a service that many operators are already considering," Bernoff said.