Lower Target Liberates Cable Stock From Big Hopes

Better late then never.

Long after most analysts scaled back their expectations for Liberate Communications (LBRT Quote), Dain Rauscher Wessels analyst David Lee Smith cut his price target on the interactive TV software company Tuesday, to $19 from $33.

Smith's target cut comes in spite of what he and other Liberate followers interpret as good news for the company: the Monday announcement that two new cable operators are planning to deploy the company's "middleware" software, which is used to coordinate multiple interactive services on cable systems and other networks.

Smith's diminished hopes for the stock, and the timing thereof, reflect how in this bearish tech market, lowering price targets is like clearing leftovers out of the fridge: All analysts do it eventually, but some people perhaps wait too long to dump a lost cause. Liberate hasn't moved above $12 for the past four months and is assigned a price target of no more than $15 by most other analysts covering the stock.

Even Smith admits he has been a little slow in moving: The analyst said last Friday that he realized a few weeks ago that the $33 target he'd been publishing for Liberate in notes as recent as last Thursday was no longer realistic. The $33 target is "a vestige of other times," Smith said Friday. "At one point it did seem to be a reasonable target. I don't think it's a reasonable target today."

Liberate's stock rose 38 cents Tuesday to $8.68. The stock, which has a 52-week high of $39.75, closed as high as $128.53 in December 1999.

Smith, who cut his 12-to-18-month price objective for Liberate to $33 from $70 in early March, rates Liberate a strong buy; his firm was an underwriter of a Liberate stock offering last year.

Soaking

Target prices don't simply reflect the qualities of a particular stock, of course, but also are driven by marketwide trends and perceptions.

"Valuations changed for the whole market," says Randy Scherago, interactive media analyst at Prudential Securities. Scherago has a buy rating on Liberate, for which his firm hasn't been an underwriter. The Prudential analyst, who had a $50 target on Liberate last fall, cut it from $30 to $10 in April as part of a firmwide reset of price targets. At the time, the firm said that many of these adjustments did not reflect any changes to analysts' fundamental outlooks for individual companies, "but simply to be more realistic in the face of these ongoing, broad-based pressures." Scherago nudged his Liberate number up to $13 in early May.

Liberated Cable box stock since its 1999 IPO

Scherago says his current estimate is based on a five-year discounted cash flow model. That's a valuation based on various forward-looking assumptions, including Liberate's cash flows over the next five years, the multiple of cash flows at which the company will be valued in five years, and a choice of the discount rate used to reflect risk and the cost of capital. Smith, who like other analysts bases his price target on discounted cash flow analysis, says he got from $33 to $19 by increasing his discount rate, not by changing any assumptions about the company's cash flows.

Liberate, which ended its fiscal year on May 31, will report an operating loss of $68.1 million on revenue of $50.6 million, Smith forecasts. The company reported an operating loss of $53.9 million last year on revenue of $28 million. The company develops software used by cable operators and other network providers to coordinate the offering of multiple interactive services, such as video-on-demand and telephony over cable. The company enjoyed a boost earlier this month after indications that cable customer AT&T Broadband, a unit of AT&T (T Quote), was favoring its software over that of Microsoft, which competes with Liberate.

Though analysts whose firms have underwritten stock offerings for a company have been known to be more optimistic than those analysts whose firms did not, Dain Rauscher Wessels' underwriting for Liberate doesn't easily explain Smith's sticking with the $33 target after he says he knew it should be lower. Fellow underwriter U.S. Bancorp Piper Jaffray has a $13 price target on Liberate; Banc of America Securities wasn't an underwriter, but BofA analyst William Bean has a relatively optimistic $30 price target on the stock. Other investment banks that have worked with Liberate -- Credit Suisse First Boston and Hambrecht & Quist (now absorbed into J.P. Morgan H&Q) -- don't publish target prices for Liberate.

Sticking With It

Despite Smith's comments about his target no longer being reasonable, he's still relatively bullish on Liberate and says some of his fellow analysts may have erred by setting price targets too low. "The world of interactive media and video-on-demand is here," he says. Liberate's middleware product -- the rough equivalent of an operating system for interactive television services -- will enjoy increasing demand, he says, from large operators of cable television systems, known in the trade as multiple system operators, or MSOs.

"The market's going to begin to look up and say, 'Hey, the interactive media companies are selling to the MSOs, who are moving along in the deployment of interactive functionality,' " Smith says. "It may not happen as instantaneously as once was expected, but it is going to happen. ... And there's a host of functionality that's going to follow video-on-demand, and they all require middleware."

Liberate "has done basically everything they said they were going to do and then some," Smith says -- that is, meeting quarterly financial expectations and winning meaningful contracts. Saying that some of the other analysts' estimates are too low, Smith says the stock could move up over the fall and winter. As people begin to understand the development of the interactive TV world, Smith asked last Friday, "Can [Liberate] move well into the mid-to-upper teens, perhaps even north of 20? I think it can."