Glenn Cutler: China Digital TV (STV)

"China Digital TV Holding (NYSE: STV) the #1 provider of conditional access systems in China’s digital TV market is our top 2010 pick," says Glenn Cutler in Special Situations Reports. "

"China Digital TV Holding is based in Beijing, China and was founded in 2004. They are in a strong position to leverage their current 50% market share in China. Of 375 million TV households across China, 168 million are cable subscribers with an additional 10 million added each year.

"With only 54 million smart cards shipped industry wide, there is ample opportunity for growth, market share expansion and royalties and revenue sharing with cable operators. They have over 225 customers, with roughly 30 of them providing over 1 million subscribers each.

"Currently, their CA systems consist of smart cards (90% of revenue) and head-end software for television network operators, as well as terminal-end software for set-top box manufacturers.

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"They enable digital television network operators to control the distribution of content and value-added services to their subscribers and block unauthorized access to their networks.

"The company also licenses its set-top box design to set-top box manufacturers and sells advanced digital television application software, such as electronic program guides and subscriber management systems to digital television network operators.

"There are several reasons why the stock price has been trading near its annual lows. Recent revenues have been under pressure and earnings have been soft due to the postponement of digital migration projects as cable operators wait for greater clarity with respect to industry consolidation and subscription fee adjustments in certain regions.

"The company has faced pricing pressures and they’ve reduced selling prices at times as a tradeoff for gaining new customers in less populated areas.

"These factors have led to downgrades by some analysts. Earnings for FY2009 are expected to be .42/share down from .72/share in FY2008. Expectations are low as earnings projections for FY2010 are estimated to be flat at .42/share.

"China Digital has a solid financial structure with $225 million in cash ($3.87/share) which was reduced by distribution of a $1 per share special cash dividend in Feb/2009. The balance sheet is solid with zero debt. They maintain a strong market position for continuing growth.

"The company intends as a policy to consider special dividends every two years. The current market cap is $348 million. Trailing 12-month profit margins are 54%.

"Book value is $4.25 a share. The P/E Ratio is 11. There are currently 58 million shares outstanding. The shares are trading close to their 52-week low, within a yearly range of $5.60 (low) to $11.80 (high). Return on equity is 12%.

"With expectations low, there is potential for upside surprise if digital migration projects start to accelerate. With shares trading at about $2 above their cash position, downside risk is partially mitigated. The company could use cash on hand to acquire productive assets should attractive opportunities arise to compliment their product offerings or consolidate their industry sector.

"I consider this a conservative idea to play the China market through an established company that dominates its business sector. This company offers an excellent low-risk technology angle for a 2010 stock portfolio. A good upside target range over 12-months would be $8-$10."