This was originally sent to subscribers of TheStreet.com Stocks Under $10 on March 20 at 2:36 p.m. EST. For more information on this newsletter, click here.We have Gemstar ( GMST), a potential turnaround play, on our radar screen, but aren't taking any action just yet. We want to monitor the company's restructuring efforts for another quarter or two before determining whether the owner and distributor of TV Guide and TV Guide Online is on the path to a sustainable recovery in earnings. Gemstar operates in three segments: publishing, cable and satellite, and consumer electronics (CE) licensing. The publishing business represents about half of Gemstar's sales and includes TV Guide and TV Guide Online. The cable satellite division, which represents 39% of Gemstar's sales, is made up of the TV Guide Channel and TVG horse racing network. Gemstar's licensing business is 14% of total sales from licensing its technology for interactive television programming to cable and satellite companies such as Comcast ( CMCSA). After watching the circulation of its flagship product, TV Guide magazine, decline over the past few years, Gemstar announced a redesign of the publication in October. The revamp added color to the once black-and-white publication. In addition, Gemstar increased the size of the magazine to a full-size standard magazine format that includes more feature articles, photos and behind-the-scenes information on television programs and actors. Thus far, the redesign appears to be a success, with total subscribers rebounding to 4.9 million for the first 11 issues through the beginning of January, or 50% ahead of its advertising rate base of 3.2 million subscribers. In addition, circulation at newsstands showed early improvements as well, quickly reaching 400,000 copies, or 35% higher than the year-ago period. As part of a plan to revamp the entire publishing segment, Gemstar stopped printing its money-losing Inside TV magazine in November, which was launched in April 2005. Also, the company sold its SkyMall business to investment firm Spire Capital Partners for $52 million in December 2005. This should improve Gemstar's margins in the print business and keep management focused on opportunities to grow TV Guide.
In addition to an improving publishing business, the company's recently announced deal with Cox Communications ( COX) signals a broader strengthening at Gemstar. In January, Gemstar announced that Cox will add Gemstar's Interactive Program Guide (IPG) and TV Guide SPOT, an on-demand network that previews on-demand programming, to already-offered Gemstar content such as the TVG horse racing network and TV Guide Channel. No financial details were disclosed, though the deal could be worth $7 million in annual revenue based on Wall Street estimates. Despite this positive news, we remain guarded in the near term for a few reasons. First, Gemstar has a history that is tainted by high management turnover and corporate scandal. Former CEO Henry Yuen remains under investigation by the Securities and Exchange Commission and has had charges pressed against him by the Department of Justice related to accounting scandals. And on Jan. 20, CFO Brian Urban was fired after being appointed to his post under another former CEO, Jeff Schell, in 2003. No replacement has been announced for Urban, which could stretch management thin in the near term as CEO Rich Battista handles dual management roles. Continued SEC and DOJ investigations create enough headline risk to warrant a cautious near-term view. On the positive side, though, News Corp. ( NWS), led by magnanimous Rupert Murdoch, continues to hold a 41% stake in Gemstar. While there is no reason to believe Murdoch intends to add Gemstar to News Corp.'s portfolio of companies at this point, the potential for cross-promotional deals should lend support to shares. Also, Gemstar's decision to shed money-losing publishing assets and redesign TV Guide may have a positive impact on profitability in the second half of 2006 and 2007. Gemstar reported fourth-quarter earnings results March 8. The company earned 3 cents a share on revenue of $129 million. More importantly, though, Gemstar reaffirmed its guidance for a total loss of $100 million to $110 million in 2005 and 2006 from its magazine business, which implies management is confident that its earlier forecasts are attainable and the redesign is having a favorable impact on advertising and circulation trends.
From a valuation standpoint, Gemstar's stock is supported by $1.10 a share in cash and the potential for improved EBITDA (earnings before interest, taxes, depreciation and amortization) results. However, the company's 4.4% EBITDA margin for the 12 months ended in September was markedly lower than the 8.9% EBITDA margin for 2004, so some cost controls are needed for profitability to improve in the near term. Despite the declining EBITDA results, Wall Street is valuing Gemstar on a "sum-of-the-parts" analysis that applies an industry average multiple to each one of Gemstar's businesses to come up with a total value for the company. Using JP Morgan's sum-of-the-parts analysis, Gemstar could be worth as much as $5.63 a share, or 90% higher than the current quote of $2.96. This assigns a majority of the company's value to its print media business, which is showing signs of stabilization. Even with the compelling upside potential, we believe investors should remain on the sidelines in the near term to see if the positive impact from the magazine redesign can carry over into 2006, when the company will end a promotional pricing period. In addition, there continues to be headline risk associated with the firing of the CFO, and waiting until a new CFO is appointed is prudent, in our view. We will update subscribers before taking action in this name.