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PortalPlayer's heat-seeking IPO
Look for a big splash when the "Intel of the iPod" debuts this week. But watch for danger signs.
November 17, 2004: 2:26 PM EST
By Eric Hellweg, CNN/Money contributing columnist

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BOSTON (CNN/Money) - While surfing around the Internet the other day, I came across a VC's blog. There, in a post from a few months ago, the VC asked this question: "If the iPod is the PC for my kids' generation, who is the Intel in this story?"

His answer? PortalPlayer. It's a fitting analogy -- for now, anyway -- and sometime this week, investors will have a shot at getting in on the action when the five-year-old Santa Clara, Calif., company goes public.

Expect a frenzied opening whenever it debuts. The word "iPod" currently invokes investor passion the way "online" did in the late 1990s. In those days, if a company wanted a pop in its stock price, it could just issue a press release saying it was looking into online business models.

These days Apple gets the same juice when it talks about the number of songs downloaded or iPods sold. And PortalPlayer, the company that designs some of the software and hardware guts for iPods, as well as competing models from Philips, RCA, Samsung, and Virgin Electronics, gets a piece of each music-player sale.

A scorching market -- don't get burned

Obviously it's a very hot market. The market analysts at IDC estimate sales of hard-disc-drive audio players will grow to 25.46 million units worldwide in 2008, from 2.67 million units last year.

PortalPlayer's filing with the Securities and Exchange Commission for its initial public offering makes it clear that the company has been riding the digital-music boom. In 2001 its revenue was $1.9 million. Two years later that number was 10 times bigger, and in the first nine months of this year PortalPlayer has recorded revenue of $47.8 million.

Here's one more parallel to those heady days of the late '90s: All that revenue growth hasn't translated into a dime of profit for the company.

And that's the rub. PortalPlayer has done an admirable job of getting its costs under control. It says operating costs no longer eat up 80 percent of revenue, as they did in 2001, but were down to 59 percent last year.

Yet the way the company has structured its business gives it limited latitude to eke out higher margins. It has two partners with very sticky hands getting a piece of its action. First, it farms out the manufacturing of its designs to Inventec. (Another red flag: Inventec accounts for more than 90 percent of PortalPlayer's revenue.)

As anyone who follows the technology industry knows, these manufacturers survive on razor-thin margins, so they must extract as much as possible from design partners.

Second, Steve Jobs and Apple collect a chunk. "The good news is PortalPlayer has the iPod," says Tom Taulli, co-founder of "The bad news is they have Steve Jobs to work with. He has a reputation for being a tough negotiator. Just ask Michael Eisner."

Be cautious

I'm nervous about this company's ability to make money if it hasn't already turned a profit given the off-the-charts success of digital-music players during the last two years.

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What's more, considering the success of the digital-media-player market, I imagine others will be angling for this space in the near future.

With all these concerns, do I think the company's IPO will flop? On the contrary. PortalPlayer is the biggest player in its space, with 85 percent of a very hot market, according to its prospectus. And day-traders -- another relic from an earlier era -- are back. I think momentum will make this a hot name and day-traders will jump in quickly.

But midrange investors should sit it out for a while and see if the company can turn a profit and show some contingency planning, such as a concerted effort to get into the hard-drive-based multimedia cell phones that are just now appearing in Asia.

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