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Cable stocks: Think inside the box
Shares of cable companies are foundering but firms that make cable equipment are thriving.
October 19, 2005: 12:48 PM EDT
By Paul R. La Monica, CNN/Money senior writer
"Hot"-lanta: Shares of Scientific-Atlanta have done well thanks to healthy demand for digital cable set-top boxes.
Dialing up growth: Arris Group, which makes modems used by cable companies for digital phone services, has been on a tear.
Dialing up growth: Arris Group, which makes modems used by cable companies for digital phone services, has been on a tear.

NEW YORK (CNN/Money) Cable companies have been lousy investments lately despite strong demand for high-speed Internet access, digital video recorders and Internet phone services.

But the reception for equipment companies, firms like Scientific-Atlanta (Research) and Arris Group (Research), has been anything but poor on Wall Street.

Shares of Scientific-Atlanta, one of the largest makers of set-top boxes for cable companies like Comcast (Research), Time Warner and Cox, are up 25 percent during the past 12 months thanks to its healthy fundamentals. (CNN/Money is owned by Time Warner (Research))

The company will report its third-quarter results on Thursday and analysts expect a 14 percent increase in sales from last year and a 19 percent jump in profits.

And shares of Arris, which makes modems and other equipment used by cable companies for their phone and data services, have more than doubled during the past year.

Arris will report its third-quarter earnings on October 27 and it recently raised its sales and earnings guidance for the quarter. Analysts are now forecasting a 56 percent increase in revenue and a six-fold surge in earnings per share.

And even though these two stocks have been relatively hot, some analysts don't think it is time to change the channel on them and other equipment companies just yet.

I want my HDTV

Business is booming since cable companies are aggressively promoting new services in an attempt to fight off competition from phone companies and satellite television firms, as well as standalone products like TiVo's (Research) digital video recorder. (TiVo, however, as begun to partner more with cable firms. For more, click here.)

To that end, another major player in the broadband equipment business, Motorola (Research), already reported strong third quarter results. Sure, Motorola gets the most attention for its cell phone business, and rightfully so given the turnaround there. But Motorola generates about 8 percent of its sales from cable equipment.

And sales in what Motorola refers to as its connected home solutions division -- the remnants of set-top box maker General Instruments, which Motorola acquired in 2000 -- increased by 28 percent in the third quarter. And operating profits surged by 48 percent.

Cable's push into Internet phone services is particularly good news for Arris, said Lawrence Harris, an analyst with Oppenheimer & Co., since Arris is the largest maker of what are known as embedded multimedia terminal adapters, modems that allow people to receive digital phone service from their cable company.

What's more, the phone companies are also likely to need products from the likes of Scientific-Atlanta, Motorola and Arris as they launch their own video and Internet phone services.

"Telecom companies are huge so no one vendor can supply them all. This is a fairly sizable opportunity," said Paul Hogan, an analyst with Fenimore Asset Management, which owns shares of Scientific-Atlanta in the FAM Value and FAM Equity-Income funds.

But perhaps the biggest positive for cable equipment companies, Harris said, is the fact that more consumers are upgrading to high-definition television sets, which require new cable boxes that are capable of receiving HD signals. That should bode well especially for Scientific-Atlanta and to a lesser extent, Motorola, over the next few months.

"HDTV sales have been strong in the fall and we expect that to continue," said Harris. "But HDTV will have more of an impact in the fourth quarter of 2005 and the first quarter of 2006 with the holidays and Super Bowl driving sales."

Stocks look attractive

Of course, there is the threat of competition. Cisco Systems (Research), the leading maker of networking gear for corporations, has made a bigger push into home entertainment lately. Earlier this year, Cisco acquired KiSS Technology, a privately held Danish tech firm that makes consumer entertainment devices such as DVD players and digital video recorders that can connect to a home network and access content from the Web.

Still, Timm Bechter, a networking equipment analyst with investment firm Waddell & Reed, which owns Cisco, said he expects Scientific-Atlanta and Motorola to fight hard to stay on top of the set-top box business. So it may be tough for Cisco, despite its heft, to make a big dent in the home market.

And despite the big moves in Scientific-Atlanta and Arris, neither stock trades at an expensive valuation either. Scientific-Atlanta is valued at about 19 times estimates for this fiscal year, which ends in June 2006, a reasonable multiple considering that analysts expect earnings to increase at a 15 percent clip a year for the next few years.

In addition, Hogan and Harris both said that the stock is even cheaper when you consider that Scientific-Atlanta has about $1.5 billion in cash on its balance sheet, the equivalent of nearly $10 a share in cash. If you subtract that from Scientific-Atlanta's stock price, shares trade at only about 13 times fiscal 2006 earnings estimates.

Arris is also fairly attractive, Harris said, trading at just 13 times 2006 earnings estimates. Analysts are projecting earnings growth of 20 percent a year, on average, for the next few years.

For more personal technology news, click here.

For more earnings coverage, click here.

Waddell & Reed's Bechter owns shares of Cisco Systems. Oppenheimer's Harris does not own shares of companies mentioned in this story and his firm has no investment banking ties to the companies.

The reporter of this story owns shares of Time Warner through his company's 401(k) plan.  Top of page

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