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Rising Video Tide May Not Float SeaChange's Boat

A post-rate-cut rally has breathed new life into the stock, but ample challenges lie ahead.
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The rising tide of lower interest was lifting all boats among technology stocks Wednesday. But for two firms in the young business of allowing cable system customers to order up movies out of a virtual video store, the good news about interest rates doesn't wash away fundamental challenges over the next year.

Video-on-demand infrastructure companies

Concurrent Computer



SeaChange International

(SEAC) - Get SeaChange International, Inc. Report

have been sinking since Dec. 27, when Concurrent's post-Christmas revenue shortfall warning made investors woozy about the shifting winds in the VOD market. Both stocks recovered somewhat after the


announced its surprise interest rate cut on Wednesday. Yet after the giddy feeling induced by the rate cut subsides, investors will still have to sort through the questions of whether SeaChange is subject to Concurrent's current problem, and to what degree both are at the mercy of their customers.

On Wednesday, SeaChange's shares rose 11% to close at $18.13, and Concurrent's rose 14% to close at $4.94, both reversing earlier intraday slides. The rallies continued Thursday, with Seachange advancing 23% and Concurrent jumping 16%. Before the rate cut, both stocks had lost more than a third of their value since the Concurrent warning.

Less Demand?
Seachange, Concurrent suffer before rate cut

While all tech stocks have suffered of late, it's clear that investors didn't take too kindly to Concurrent's preannouncement, in which the company said that instead of the $7 million to $7.5 million in sales the company was expecting to report in the second quarter ended Dec. 31, sales wouldn't crack $2 million.

Concurrent called the shortfall a "short-term delay" in three orders expected from "a major domestic cable operator," and said it expects to book the revenue in its fiscal quarter ending March 31. But investors lopped off nearly half of Concurrent's

market cap in a single day and 29% of SeaChange's value in two days, ignoring a release from SeaChange reaffirming its previous guidance to analysts for its fourth quarter ending Jan. 31.

SeaChange CEO Bill Styslinger says the market's selloff of his stock because of Concurrent's preannouncement is an "irrational response." The company is confident, he says, that it will meet expectations for both its VOD business -- about $10 million for the current quarter -- and total revenue.

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Perhaps the company will meet the current quarter. But it's by no means irrational for investors to assume that if a slowdown has hit Concurrent, it will hit SeaChange, too, says Larry Marcus, general partner at


, a venture fund that focuses on broadband and enhanced television. The problem for the VOD companies is a perennial one for all suppliers to the local cable system market, where the few large customers who dominate the industry understand the fearsome market power over the vendors vying for their business -- and commonly play hardball by demanding concessions from suppliers motivated to close sales by a quarter's end. "Quarterly delays ... should be expected as the norm," Marcus says. "It's going to happen to SeaChange, too, sooner or later." Marcus doesn't hold SeaChange stock, and bought Concurrent after its recent fall.

In fact, SeaChange has a bad recent track record for meeting expectations, says one money manager who is a former short-seller of the stock. The short-seller, who spoke on condition of anonymity, points out, for example, that the company missed third-quarter revenue and earnings estimates. "I don't know why people are so charged up about the name," the short-seller says.

To get a vivid picture of the kind of muscles that customers can flex in the VOD world, all an investor had to do was listen to Concurrent CEO Jack Bryant talk in a conference call Wednesday about some of his company's current cable industry deployments. Concurrent shipped 10 of its VOD servers to an unnamed customer in its second quarter and plans to ship 14 more in the third quarter, but the company won't transfer title on them, or declare any revenue, until the fourth quarter. Another customer,



, received five of Concurrent's servers in the second quarter, but, similarly, won't be invoiced for them until the fourth quarter. Bryant attributed the terms of the unnamed deal to the "nature of winning this market."

On the bright side, says Marcus, VOD is "absolutely one of the key killer apps" that cable operators can offer consumers as they compete against entertainment such as satellite TV and personal video recorders from companies such as


(TIVO) - Get TiVo Corp. Report

. "I'm definitely very bullish on the video-on-demand industry," he says.

Yet, says Marcus, that doesn't mean a quick rollout for VOD, because the cable industry's attention is elsewhere nowadays. "We are many quarters away from an explosion-deployment phase in video-on-demand," he says, "because there's still so much on cable operators' plates with digital and high-speed Internet deployment, and, in some cases, telephony."

Video-on-demand bulls aren't giving up hope. Monica Graham, general partner of SeaChange shareholder

Graham Partners

, says it's reasonable to project that SeaChange will have VOD revenue of $1 billion per year. Pricing that part of the business at 10 times sales implies a market cap of $10 billion -- well above the $330 million at which the market is valuing the complete company.

Of course, Seachange reported quarterly revenue of $24.2 million for the three months ended Oct. 31, 2000. That's up 12% from the three months ended Sept. 30, 1999, but a far cry from $1 billion a year. But the company has been in "heavy investment mode," Graham says, and "finally, that investment mode will start to pay off."

Lots of people are waiting to see that change.