Digital Growth Makes Dolby Labs Look Even Better

Updated from 10:23 a.m. EDT

Dolby Laboratories(DLB - Cramer's Take - Stockpickr) has announced some positive news, and we would like to give readers an update on the stock, which closed at $43.65 Monday.

The company is a stock in the model portfolio of TheStreet.com Breakout Stocks, a service that I manage here at TheStreet.com. Much of this article was released this morning to our subscribers, but the news is still applicable to readers of TheStreet.com. (To receive all my alerts, click here for a free trial to TheStreet.com Breakout Stocks.)

Now let's take a closer look at Dolby. Before the market open yesterday, the company announced that it had signed deals to supply its digital systems to Shanghai Film Group and UFO India Limited, which -- as their names suggest -- operate in China and India, respectively.

We consider this deal to be a significant positive for Dolby, as increased business in its digital cinema business will augment the diversity of the company's various revenue streams and make it less reliant on consumer electronics.

Shanghai Film Group will be purchasing for its movie theaters 100 Dolby Digital Cinema systems, which are complete digital systems for storing, managing and playing back digital movies. These systems allow Dolby to profit from the film industry's transition to digital movie formats, which are much more secure than traditional film because traditional film can be stolen or damaged.

In addition, digitally stored films offer theaters vastly increased flexibility in terms of scheduling. UFO has purchased a limited number of Dolby Digital Cinema servers, with an option to purchase additional ones.

We believe these deals are positives for Dolby from a strategic standpoint. Most importantly, the movie theater business is struggling to increase profitability. One way to do that is to use Dolby's Digital Cinema solution, which increases theater efficiency, picture quality and reliability all at the same time. In addition, Dolby's 3D Digital Cinema systems offer theater operators another way to attract customers, and we expect more deals on that front to be announced this year.

Overall, we remain quite positive on Dolby. While the broader consumer electronics landscape is fairly unpredictable, Dolby is mostly levered to key segments of the market that are exhibiting fairly strong growth -- namely notebook PCs and HDTVs. Dolby is also seeing incremental growth from sales of products such as video-game consoles and certain mobile phones, while also beginning to penetrate new markets such as camcorders.

In addition, we believe the company's Dolby Volume product, which equalizes volume levels on consumer electronics products, could generate significant revenue for the company in the coming years. Lastly, Dolby would stand to benefit from the success of next-generation Blu-ray DVD players should sales begin to take off this year.

Financially, Dolby remains in very good shape with its abundant free cash flow, which amounted to an impressive $182 million in calendar 2007. In addition, the company's balance sheet is very strong, with about $500 million in net cash. We expect that balance to grow significantly this year, absent any major acquisitions. As far as the competitive environment goes, Dolby is much better-positioned than rivals such as DTS(DTSI - Cramer's Take - Stockpickr) and SRS Labs(SRSL - Cramer's Take - Stockpickr) in key markets like notebook PCs, and has a broader array of technologies.

So while the stock isn't cheap at 30 times expected full-year earnings, Dolby's impressive history of surpassing analysts' expectations, its strong financial position and its long-term growth opportunities keep us positive on the name.

Dolby Laboratories is a stock in the model portfolio of TheStreet.com Breakout Stocks. Michael Comeau writes regularly about relatively unknown stocks -- such as Energy Conversion Devices(ENER - Cramer's Take - Stockpickr), American Apparel(APP - Cramer's Take - Stockpickr) and Central European Distribution Corp.(CEDC - Cramer's Take - Stockpickr) -- that appear likely to have a spike in their share prices.

Know What You Own: Dolby operates in the diversified electronics industry, and some of the other stocks in its field include Sony (SNE - Cramer's Take - Stockpickr) and Matsushita Electric Industrial (MC - Cramer's Take - Stockpickr). These stocks were recently trading at $43.78 and $20.84, respectively. For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.