Tuned In, Turned On, Torqued Up - Scientific-Atlanta's stock is climbing, thanks to the popularity of its digital set-top boxes that make it possible to receive cable televison signals, and to send in requests for services - Brief Article

Kiplinger's Personal Finance Magazine, May, 2000 by Brian P. Knestout

STOCKS | As cable providers beef up their systems, SCIENTIFIC-ATLANTA reaps the benefits.

THERE'S A rocket engine propelling the shares of cable-TV device maker Scientific-Atlanta, and that engine is ... pizza. Well, maybe not pizza itself, but the idea of how products and services will be ordered in the future. The dream dinner of couch potatoes is a pizza in front of the tube. And if they could, they'd bypass walking to the phone to make it happen, by ordering with their cable-TV remote.

Such an indulgent world is no pipe dream to cable-TV companies. Hard-pressed to compete for customers against digital satellite TV and high-speed Internet access, they're overhauling their networks to increase the quality and quantity of services and programming offered via cable.

Scientific-Atlanta makes digital set-top boxes that deliver cable-TV shows to viewers and transmit requests for services (such as pay-per-view movies) back to the cable company. It also makes transmission equipment and software that cable companies use to send TV signals to homes.

In calendar 1999 (the company's fiscal year ends June 30), the company saw sales reach $1.4 billion, up 20% from a year earlier. Earnings nearly doubled, to 63 cents a share. The company's stock more than doubled over the course of 1999, and the announcement of the America Online and Time Warner merger--Scientific-Atlanta is Time Warner Cable's largest provider of set-top boxes--catapulted it to a peak of $78 a share, almost 400% above its price a year earlier.

Reasons to Invest. The rocket trip may not be over. Cable-TV providers are spending prodigiously to upgrade their networks. The largest U.S. cable company, AT&T, upped its spending fivefold over the course of 1999. Number-two Time Warner spent $1.6-billion-plus in 1999 to revamp its infrastructure, and will spend another $2 billion this year. Other cable companies are doing likewise.

Scientific-Atlanta stands to profit from the spending in several ways. About 45% of its sales come from its transmission equipment, which delivers signals from the cable-company station along the network and into your home. That part of the company grew 42% in the most recent quarter from a year earlier, as orders jumped nearly 60%.

The company's line of interactive digital set-top boxes is where the pizza comes in. Much of what cable companies are slated to spend is earmarked for the digital set-top boxes and cable modems that are inside people's homes. These devices do more than change channels: Each box is essentially a computer-network terminal that allows viewers to order and watch movies, and even "rewind" or pause them as if they had rented a DVD. Some cable networks offer e-mail and Internet access through the company's boxes--and one in Hawaii is offering the pizza-delivery option. A lack of manufacturing capacity held revenue growth in this segment to 14% in the latest quarter compared with a year earlier, but the company has bulked up production to meet demand.

Scientific-Atlanta also owns an 80% stake in PowerTV, which makes the operating software that drives the set-top boxes. PowerTV runs on other makers' boxes as well, giving it a broad user base, but its current impact on Scientific-Atlanta's profits is small.

Risks to consider. At $64, its shares go for 72 times its projected 88 cents in earnings per share this year, and 61 times next year's forecast of $1.05 a share. While analysts have consistently raised their earnings estimates for Scientific-Atlanta, the shares are clearly in the nosebleed sector and vulnerable to any bad news.

And there's another risk that comes with this stock. A lot of the spin surrounding Scientific-Atlanta is based on the notion that the cable box will become the personal computer of the masses--the preferred pathway for Internet access--making Scientific-Atlanta the next Intel or Microsoft. But it remains to be seen whether that prediction will come to pass--certainly, the computer and telephone companies won't let it happen without a fight. If it doesn't, those fancy set-top boxes could someday become musty old relics like Beta VCRs.

SPOTLIGHT | Scientific-Atlanta

[] Symbol: SFA (NYSE)

[] Headquarters: Norcross, Ga.

[] Recent price: $64

[] Price a year ago: $16

[] Chief executive officer: James McDonald

[] Dividend yield: 0.1%

[] Annual sales: $1.4 billion (1999)

[] Earnings per share: 1997: $0.43 1998: $0.33 1999: $0.63 2000: $0.88(*) 2001: $1.05(*)

[] Web site: www.scientificatlanta.com

[] Shareholder services: 877-473-2463

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