United Kingdom-based NDS Group Plc (NNDS) supplies smart cards and set-top box software that enable broadcast or broadband platform operators and content providers to deliver content securely to subscribers for digital satellite, pay-television, and Internet services. The company's products help broadcasters manage customer access to various programs. Subscribers can record and view their chosen programs on a pay-per-view basis. The company has offices in Australia, Spain, Germany, South Korea, the United Kingdom, and the U.S. NDS Group is conducting research and development activities in India, China, and Israel, which helps to keep its costs low. News Corporation owns nearly 73% of the company's shares and has over 97% of the voting rights. NDS Group organizes its business under four segments:
Conditional Access (which generated 59.3% of the revenues for first quarter of 2008) - NDS Group enjoys a dominant position in the conditional access market, which is an essential component of the pay-tv platform. The company's products, sold under the name "VideoGuard", are compatible with all internationally accepted digital television transmission standards, and are integrated in the set-top box. It is important to note that NDS works closely with almost all the major set-top box manufacturers around the world, so that cable and satellite providers can look for the lowest-cost provider of the set-top box, and NDS can assure security. Once permitted the removable smart card access cards decrypt and display relative content on the television and allow secure return path communication. Smart cards store subscriber and access details in the memory, linking the customer to a program, and, thereby, facilitating the billing process. Since these cards are not recyclable, customers cannot reuse the cards (when they change to another system) hence, revenues are not as affected by subscriber churn rates. In addition to fresh card issues, the company earns revenue on the replacement of cards, which usually have a useful life of three to four years. Cards are also replaced, due to normal wear and tear or technology upgrades to include additional functions like shopping, banking, among others. Also, NDS earns a small monthly fee per smart card in use from its clients, which generates a healthy revenue stream on its own. Customers that use NDS's VideoGuard platform are DirecTV in the US, BSkyB in the UK, Sky Italia in Italy, Cablevision in the US, FOXTEL in Australia ,SkyLife in Korea and Tata Sky in India to name a few. The company's special relationship with News Corporation paves the way for significant growth of its subscriber base, which in turn, will also enhance its revenue growth. Revenues increased 31% year over year to $121.6 million in 1Q08 primarily due to the recognition of a portion of security services revenue previously deferred. Margins in this group are typically in the high seventies range although the company has discontinued the segregation of its cost of sales for any particular revenue category from the first quarter of 2008. With over 78.6 million authorized smart cards using NDS's technology, the company continues to see solid growth in its users across all platforms, and at the end of the first quarter, more than 80% of these smart-card users pay NDS a monthly fee, which implies a good source of recurring revenues that can be revised upwards at the management's discretion.
License Fees and Royalties (14.1%) - NDS derives license fees and royalties from licensing its middle-ware technology to broadcasters and platform operators and manufacturers for use in set-top boxes. The company charges license fees for different elements of its software at different rates, but include fees charged for MediaHighway, the company's middleware solution, and VideoGuard. The company derives royalties based on the quantity of set-top boxes manufactured by its customers. At the end of the first quarter of 2008, 69.9 million middleware clients have been deployed, giving the company added revenue visibility. Revenue increased by 19% year over year to $28.9 million due to higher number of middleware units shipped, conditional access and EPG royalties. License revenues are dependent on the ability of its customers to obtain new customers, or get customers to upgrade their systems.
Integration, Development and Support (5.3%) - This group derives revenues from activities such as software development and adaptation, design, implementation, and project management for broadcast systems. The company also provides ongoing support and maintenance of software and broadcast systems. These projects depend on the timing and size of managing integrations of new clients onto NDS's platforms with exsisting or new hardware. This revenue stream is typically sporadic and depends on the number of new clients, although the support aspect of these revenues is typically steady. Revenues declined by 41% year over year in the first quarter of 2008 to $11 million as there were no large new system integration projects this year when compared to Tata Sky launch in India a year ago. This division is integral in the company taking advantage of conditional access and license and royalty revenues, but has a much lower gross margin.
New Technologies and Other (21.2%) - NDS is consistently creating new technologies, that offer its clients the ability to increase their revenue per subscriber by developing new DVR (Digital Video Recorder) technologies, games and gaming technologies, interactive applications, OpenBet, a technology used to bet on sporting events in the UK, and Synamedia, a new technology to manage and control secure distribution of digital content via broadband networks. Revenues from this category are derived through development fees, license fees and royalties, and are earned differently for each product. In this group, margins tend to jump around a lot, but are typically around 20%. Revenues for this group increased year-over-year by 54% to $42.5 million in 1Q08, primarily due to the increase in DVR technology, as DirecTV in the US, Sky Italia, SkyLife in Korea, and ViaSat in the Nordic region are all launching or have launched DVR technologies in their latest set-top boxes, which generates a monthly revenue stream for NDS. There are currently only 8.8 million deployments of DVR boxes using NDS's XTV technology, and we expect that number to jump in the latter part of 2008 as these deployments move into full swing. Residential Gateway technology, the acquisition made in the prior year, also contributed strongly while CineMedia and the company's IPTV platform made progress compared to last year. The company is also working on solutions to guard and distribute content to mobile users, and into methods of securing and distributing radio content, which may be a growth area in the years to come.
During 2007, NDS has started several new initiatives that should help boost long term growth, including the above mentioned mobile and broadcast radio solutions. While these opportunities shouldn't generate significant revenues in the coming year, they represent interesting models that may gain traction, as the company s broadcast radio solution should eventually allow radio listeners a level of interaction not typically associated with broadcast radio. Additionally, the company has entered several new markets in 2008, for example with Bharti Airtel in India, Tianjin Broadcast & TV Network in China, Vision TV in Ukraine and Measat Broadcast Network Systems in Malaysia, which should help boost revenue growth going forward. The company's strategy of winning platforms in developing markets like Eastern Europe, India and China seems to be working well and continues to be the growth driver for NDS.
For the first quarter of 2008, NDS grew revenues by 30.9% and operating income by 30.7% year over year, and we expect the company to generate revenue growth of 16.9%, to around $830 million and operating income growth of 32.3%, or net earnings of approximately $2.89 per share for 2008 compared to 2007. For 2009, our estimates are for a year-over-year revenue growth of 13.3%, coupled with EPS growth of 10.1%. We believe the company is well-positioned take advantage of the transformation of TV and other forms of media to a more interactive experience, and benefit from the expansion of HD quality programs.