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A Clear View of Blu-ray's Victory

The format war is over, and here's a look at which companies should gain the spoils.

After a speculation-filled weekend, Japanese consumer-electronics giant Toshiba announced today that it will drop its support for the HD-DVD next-generation DVD format, handing victory to the competing Blu-ray format. Blogs and tech sites were lit up with discussions over the death of HD-DVD over the past couple of days, and with Toshiba's decision now official, it's time to dig further into Blu-ray and talk about related stocks, and whether it even matters.

First of all, what is Blu-ray? Basically, Blu-ray is a newer format of DVD with superior visual quality and storage space compared with standard DVDs. Blu-ray players are also fairly expensive, running from about $400 on up, and the discs themselves cost $25 or more but can sometimes be found cheaper on sites such as

Amazon

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. Blu-ray is also the storage format for the

Sony

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PlayStation 3 video-game console.

The main question investors need to ask is whether Blu-ray even matters. The answer, for me, is no, since Blu-ray is going to have an awfully tough time becoming a mass-market technology. There is no denying that Blu-ray's picture quality is phenomenal. However, there are several obstacles, even aside from the prime premium relative to standard DVD, to Blu-ray really hitting the big time.

The first is that with a decent DVD player and television, standard DVDs, especially newer ones, look good enough to the average person. That person is probably pretty unlikely to be willing to shell out for a Blu-ray player until the price premium shrinks significantly.

In addition, many consumers are generally confused about HD in general and often don't even know that buying an HDTV doesn't automatically mean they're watching HD content. Just last weekend,

The New York Times

quoted statistics from the Leichtman Research Group showing that 50% of HDTV owners don't watch any HD shows, but 25% of them think they are. So while Blu-ray isn't a tough sell to home-theater nerds and technophiles, it is a tough sell to the casual folk.

On top of that, all physical media formats are under assault from the Internet, which has made many a consumer conditioned to getting movies 100% free via illegal downloads. Movies downloaded from the Internet may not have 1080p resolution or surround-sound encoding, but again, they're free.

In addition, paid movie download/rental services such as those offered by

Apple

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and Amazon present competition for Blu-ray.

Now, let's look at Blu-ray-related stocks.

Sony is a rare company that may actually benefit from Blu-ray's success, mainly because higher production of Blu-ray players could reduce component costs for the PlayStation 3, driving improved profitability for Sony's all-important video-game unit. However, I'd stay away from that stock for now, considering the weak U.S. dollar and consumer slowdown.

I still firmly believe retail giant

Best Buy

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is a short. Best Buy needs new product cycles, and I don't believe Blu-ray will be strong enough to offset the slowdowns in areas like mp3 players and home theater.

Also, I believe GPS will be a lousy category going forward, as evidenced by the weakness we've seen in

SiRF

(SIRF)

and

Harman International

(HAR)

. In addition, Best Buy bulls tend to be emphatic that the company will benefit from the demise of

TheStreet Recommends

Circuit City

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, but barring a serious economic collapse, Circuit City is not going out of business within the next few years.

On the component side,

Sigma Designs

(SIGM)

should benefit, as it produces processors for Blu-ray players in addition to its IPTV chip business. However, Sigma Designs is one of the worst-acting stocks on the planet, because of constant rumors regarding competitive pressures from companies such as

Broadcom

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and

STMicroelectronics

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. So I'd wait for Sigma to report its next quarter before playing around with that one.

So what we really need to look for is a company that is already doing well but could benefit from Blu-ray emerging as a hit product category. However, there are some interesting plays on the audio side, particularly with

Dolby Laboratories

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, which is a pick in the

Breakout Stocks

newsletter. Along with

DTS

(DTSI)

, Dolby's surround-sound technologies are integrated within Blu-ray, so Dolby receives royalties for each unit produced.

Even without Blu-ray, Dolby is seeing enormous revenue momentum, given its inclusion in two versions of

Microsoft's

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Vista operating system. However, if Blu-ray actually does take off, Dolby could see a boost in earnings power, because with sky-high 45% operating margins, revenues fall very quickly to the bottom line.

In keeping with TSC's editorial policy, Michael Comeau doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Comeau is a research analyst at TheStreet.com. In this role he performs stock analysis for

TheStreet.com Breakout Stocks

, and is also a regular contributor to RealMoney.com. Prior to his arrival at TSC in June 2004, Comeau worked as a Consultant to Toyota Motor North America, performing in-depth research on automotive industry issues, primarily in the areas of alternative engine technologies, competitive analysis and macroeconomics. His primary market interests include consumer technology, specialty retail, and small-caps. Comeau received a bachelor's degree in Finance from Brooklyn College, and has completed Level 1 of the CFA program.. He appreciates your feedback;

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