NDS Group, one of the leading suppliers of Conditional Access (CA) and middleware solutions to pay-TV operators, will see most of its revenue growth come from satellite operators throughout the next 12 months. That is the view of NDS’s new CFO Alexander Gersh who was giving his first interview since his appointment to this position at NDS. Gersh replaced Rick Medlock who was appointed CFO at Inmarsat. Gersh previously was CFO of Flag Telecom, a global network services provider.

Gersh told Satellite News, “An increased number of customers as well as an increased penetration of new services (that is, PVR, middleware) at DirecTV, BSkyB and Korean Cable just to name a few, will primarily drive our revenue growth in the next year.”

NDS supplies CA to a number of key satellite pay-TV operators such as BSkyB (U.K.), DirecTV (U.S.), Foxtel (Australia), Sky Italia (Italy) and Viasat (Nordic region). While a number of these companies have News Corp connections, NDS has still been a stellar performer in recent times. In its latest results, revenues for the second quarter, ended Dec. 31, 2004, were $142 million, an increase of 85 percent compared to the same period last year. NDS also had more than 51 million smart cards in use, making it one of the larger CA vendors globally.

Analysts’ View

The company is highly thought of by analysts. Mehrdad Torbati, a technology equity analyst at Deutsche Bank said, “They have had an excellent set of results. They have strong underlying growth and a nice execution. The cost base will go up in the future, but they are a high-growth company with high margins. They are doing a great job.”

Can Elbi, a technology equity analyst at CAI Cheuvreux commented, “In the last quarter, Abe (Peled, NDS CEO) has gotten more bullish on what type of top line growth he thinks NDS can create. In the last conference call, he said he thinks NDS can grow itself 20 percent per annum in the next 5-10 years, which is a fairly aggressive comment.”

Another technology analyst, Daniel Meron of RBC Capital Markets believes such aggressive growth is achievable. He told Satellite News, “The industry is growing at 25 percent compound annual growth rate (CAGR) per year based on subscriber bases. We have seen that the industry is growing at that level. So, that is one growth engine for NDS, growing with subscriber numbers. BSkyB and DirecTV are not growing at that pace, but in other countries, there is some strong growth. You can see NDS having double-digit revenue growth just based on that. The mid-teens would be a good estimate for NDS here. Also, when you think of the increased penetration of the set top boxes per households which is likely to go from an average of 1.2 per household worldwide closer to 1.9, there is another growth engine right there.”

The company had a number of highlights in the last few months. It announced that DirecTV will be using its MediaHighway middleware to create advanced TV applications. It also won a key deal with Shenzen Topway Video Communication (Shenzen TV) to help bring digital TV services to China.

Gersh takes over the CFO position at a time when the company is already performing strongly. It does not need major work on its balance sheet. With strong revenue growth predicted, capital expenditure ratios to revenues are also likely to come down. Gersh said, “We expect to continue to invest in research and development (R&D). However we expect the growth in R&D spending to be lower than our revenue growth. Our goal is to bring the total R&D spendings to 25 percent of revenue from 28 percent of revenue within the next three years.”

Asia Pacific

While companies such as DirecTV, BSkyB and Sky Italia will be the main revenue drivers for the company, NDS also is picking up business in other areas. It is working with satellite and cable pay-TV operators in South Korea and has signed a potentially very lucrative contract in China.

Gersh commented, “If you look at China, we have got five provinces and including a particularly notable one, Shenzen, which we announced last year. One of the important things about Shenzen is that they are the only ones that have foreign landing rights for programming in China. So, how quickly can they develop? Could they have 500,000 cards this year, a million the next? If you look at the population and the potential, it is enormous. How quickly it will develop to its full potential is hard to say.”

The company is also looking to the potential of direct-to-home (DTH) satellite television services in India, where again its News Corp connections could come in useful. Gersh added, “You look at India and the DTH platform where Space-TV should get the license soon. We have been doing a lot of work for them in preparation for the rollout of DTH services. It has huge potential.”

Analysts admit that Asia Pacific is likely to prove the next key battleground for CA players. Elbi commented, “In terms of its core market of selling CA systems, the company still has fairly good growth left in that market. There is some sort of saturation in the United States and I am assuming that it will not be able to tap cable operators there. There is some saturation in Europe. I think it is going to be difficult for it to sign additional U.K. cable operators. In Spain, there may be opportunities, as well as in the United Kingdom assuming there are RFPs from ntl and Telewest. However, most of the opportunities for the CA players will be in Asia where digital TV and pay-TV penetration is fairly low.”

DirecTV

While the company continues to build its position in Asia, the real key this year will be its work with DirecTV, the U.S. satellite pay-TV operator. DirecTV is one of the biggest satellite pay-TV operators globally and NDS hopes its technology will play a vital role in bringing the latest interactive applications to the DirecTV user base. In particular, an aggressive deployment of its middleware is something NDS will be banking on.

“We talk about middleware becoming a greater proportion of our revenues,” Gersh said. “The only caveat, I would say, to this year’s growth is how quickly our customers will deploy. Clearly, [DirecTV] will deploy to all its new customers. We have the capability to download our middleware onto most of its old set top boxes. Then there are a number of older boxes that need to be replaced. We will deploy our middleware [onto the replacements] as well. The question is how quickly.”

In terms of Personal Video Recorders (PVRs), Gersh said, “There is no question in my mind that PVRs will see a huge growth throughout the next three to five years. NDS currently has a subscriber base of approximately 52 million. The only question is the rate of PVR adoption.”

NDS is in a fortunate position. The fact that it is owned by News Corp means its technology will continue to play a key role in some of the fastest growing satellite pay-TV platforms worldwide. Strong revenue growth seems assured. However, it will continue to look to pick up contracts outside of the News Corp umbrella, although it seems unlikely there will be any major new customer in 2005 in developed markets. While the CA arena is crowded with players, NDS is one of the top performers. It is also very strong in the satellite pay-TV arena and the success of DTH platforms across the world will continue to underpin its growth going forward. If DirecTV is successful in the U.S. in terms of bringing new interactive applications as well as PVRs to its consumer base, NDS is likely to be a big winner in the U.S. pay-TV market.

While actual new contracts may be thin on the ground for NDS, particularly in terms of CA, its ability to generate strong revenues from existing clients will be key. Gersh has joined the company at a time where revenue growth seems a given. The challenge will be to continue with the success story and meet ambitious revenue growth targets.

–Mark Holmes (Can Elbi, CAI Cheuvreux, celbi@cheuvreux.com; Mehrdad Torbati, Deutsche Bank, mehrdad.torbati.db.com; Margot Field, NDS, mfield@ndsuk.com; Daniel Meron, RBC Capital Markets, Daniel.meron@rbccm.com)