Editor's Note: Jon D. Markman writes a weekly column for CNBC on MSN Money that is republished here on TheStreet.com.


After four days without electricity in Seattle following a historic windstorm, I feel qualified to reveal the one power-required activity that is essential to modern life.

It's not light; candles did the trick. It's not heat; a wood fire and quilts worked fine. It's not phone service; cell phones with three-day battery life kept us in touch.

No, the one irreplaceable miracle of powered life we truly missed -- even while playing board games by firelight with the kids -- was our digital video recorder. Eighty-four hours without being able to time-shift a single show, are you kidding me? Thankfully, by sheer luck, Lost, 24 and Prison Break were all on winter hiatus.

What this episode of Powerless in Seattle illustrates is how dependent many consumers have become on enjoying filmed entertainment in their homes with souped-up plasma TVs and speaker systems. Back in September, I recommended that you start to buy the companies most highly leveraged to this trend -- broadcasters Viacom ( VIA), CBS ( CBS), Walt Disney ( DIS) and cable giant Comcast ( CMCSA) -- and they're up 14% as a group since.

In Demand

Now I would like to take this one step further and contend that one of the most profitable entertainment trends of 2007 is likely to be the long-delayed and much-anticipated arrival of video-on-demand, or VOD, as a major source of income for major motion picture makers.

Video on demand -- the viewing of new movies over a cable or broadband network at the whim of the consumer -- is one of those holy grails that entertainment experts have told us was on the verge of a breakout for years. Now, don't laugh, it really is.

And the surprising beneficiary turns out not to be the telecom carriers or cable companies that will provide the shows to customers for a fee similar to what they're paying for DVD rentals. Instead, the winners are likely to be the long-abused content providers, as they will earn a much larger percentage of revenue from this distribution channel than they ever have from DVD rentals.

Video on demand, in fact, may be the technological savior of Hollywood, keeping actors and producers in Prada and Bentleys for years to come. Theatrical releases will remain the most profitable channel for blockbuster moviemakers for some time. But video on demand -- which until now has been impaired by slow delivery speeds and lack of prime and timely content -- could add as much as 4 percentage points of profit margin to the likes of Lions Gate Entertainment ( LGF), Marvel Entertainment ( MVL), Viacom, Disney and even Sony ( SNE).

It should also give a boost to the world's largest maker of pay-television software, a smallish British firm called NDS Group ( NNDS).

Piece of the Video Pie

Distribution of video-on-demand through cable and broadband networks emerged as a $1.1 billion business this year, and industry experts estimate it will grow 35% annually into a $5 billion business by 2012, taking market share away from DVD retailers and intensifying carriers' ambition to bid for the best shows.

Here's how VOD will help to pay Hollywood's elephantine budgets: At the moment, filmmakers earn only 30% of the proceeds of a DVD rented via Blockbuster ( BBI) or Netflix ( NFLX).

But because so many parties are begging to be their partners in this new distribution channel, content producers turned the tables and negotiated to earn a whopping 70% of the revenue earned on every on-demand showing.

As a result of this gigantic swing in pricing power, according to a new report by analysts at Thomas Weisel Partners, the impact of VOD on studios will be much greater than just a pickup in sales. If demand for all forms of home video -- DVD rentals, DVD sales and on-demand -- grows only 3% annually to $10.3 billion by 2012, studio home video revenue will grow 14% a year to $5.4 billion.

The difference is the much higher margin earned via the on-demand channel, and it is likely to transform the market's view of movie producers from volatile, hit-dependent cash cows into above-average growth companies akin to specialty retailers. Lions Gate -- a specialist in horror flicks such as the Saw series -- has told investors that there are 29 companies negotiating for its digital VOD rights.

The bidders are all the companies bidding to be your video supplier of choice, including not just Comcast and broadband/Web-based TV provider Verizon ( VZ) but also Amazon.com ( AMZN), Apple Computer ( AAPL) and Wal-Mart Stores ( WMT).

The case of regional Bell operating companies Verizon and AT&T ( T) is particularly intriguing because they are likely to try to use video-on-demand to acquire and retain customers for their new foray into living rooms via fiber-optic lines, according to Weisel analysts.

That is why these brand new players on the movie distribution scene are more willing to pay much more attractive splits to movie studios for VOD rights. They don't mind paying a few dozen more cents per movie if it means they can wrest control of movie watchers from their cable competitors.

Two Years, 20%

I think you make a lot of money over at least the next two years by betting on the stocks of content providers like Viacom, Disney, Lions Gate, Time Warner and Marvel. Look for the shares of each to advance at least 20% over the next 18 months. My favorites are Lions Gate, Disney and Viacom.

Video-on-Demand Stocks
12/19 price Market cap
Lions Gate Entertainment $10.47 $1.1 billion
Viacom $39.34 $27.5 billion
Walt Disney $34.85 $72 billion
NDS Group $48.03 $2.7 billion
Marvel Entertainment $27.42 $2.2 billion
Time Warner $21.92 $87 billion
Gaiam $12.94 $350 million

Weisel also recommends Gaiam ( GAIA), the nation's leader in fitness and nontheatrical home-video products. The company creates and distributes 95% of its own media with a direct-to-consumer distribution strategy focused on yoga, Pilates and personal-improvement titles. It also sells a lot of videos to LodgeNet Entertainment ( LNET) for use in hotels.

Another less well-known winner in video-on-demand and pay TV will be NDS Group, which is a unit of News Corp. ( NWS) that trades separately from its parent. It's the leading maker of digital content protection technology, with 64 million active subscribers.

This technology, also called digital rights management, will help service providers provide premium content over multiple channels by getting the content creators to loosen their grip. If the service providers can prove that content will be secured, they can more easily and inexpensively provide entertainment to their consumers.

NDS' system, dubbed VideoGuard, allows total control over content, including redistribution rights and number of plays. VideoGuard also offers pay-TV protection, called "conditional access," through which companies can control subscription and pay-per-view services. It is very possible that television networks will increasingly go to a pay-per-view model if advertisers desert them. You are already seeing this from DVD sales of popular television programs such as Lost and 24. As people become more comfortable with the idea of paying for television -- and not having to watch commercials -- this area could become big.

NDS' technology also works with its own DVR product, XTV, allowing downloaded content to be kept in its original, protected and encrypted format. This ability is not offered by any other company, and it enables customers to download programs but only pay for them when viewed.

So if you're not sure what movie you want to watch tonight, no big deal -- download a bunch for free while only paying for the one you view. VideoGuard will also protect content as it moves to mobile phones, computers and portable media players.

From an investment perspective, NDS is a profitable, high-return business that is expanding its subscriber base rapidly (up 14% in 2006) and moving into emerging markets, with recent acquisitions in India and Israel. The company is sitting on $500 million in cash, eyeing acquisitions up to $100 million in value and looking to grow in the mobile and broadband areas. My target for NDS in 12 months is $64 and $82 in 24 months, which would be up 32% and 70% from the current quote. I like it a lot; tune in now.

At the time of publication, Markman owned shares of NDS Group, although positions may change at any time.
Jon D. Markman is editor of the independent investment newsletter The Daily Advantage. While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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