TiVo faces uncertain future in the market it pioneered

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TiVo this: TiVo's largest customer, DirecTV, likely in coming months will strike a deal to put a competing DVR on DirecTV. That's a problem, considering the satellite-TV service supplies more than half of TiVo's subscribers and over the past four quarters generated two-thirds of TiVo subscriber growth. Yet even if DirecTV does that deal, the game's not over for TiVo.

The near-term is easy to project. Rupert Murdoch's DirecTV probably will deploy Rupert Murdoch's digital video recorder.

Mr. Murdoch's News Corp. bought control of DirecTV Group in December. News Corp. helped start and owns 78% of NDS Group, a U.K.-based supplier of broadcasting technology including DVR software.

TiVo's 10-K filing makes it clear: "It is possible that DirecTV under News Corp. could seek to transition to an alternative DVR technology platform, such as that created by NDS."

defining the market

TiVo defines the market, and users love the service-yet its biggest opportunity could be slipping away. TiVo claims 40% of the overall DVR market and 80% of standalone DVR sales. But DVRs' biggest growth probably will come from cable and satellite services. TiVo prospects are dampened by uncertainty about DirecTV and a failure to sign a major cable system.

TiVo Chairman-CEO Michael Ramsay, speaking at a Deutsche Bank conference this month, tackled both issues. "You've seen strong support from DirecTV that they intend to continue with TiVo," he said, noting plans for a lower-cost DirecTV/TiVo platform. He was more cautious about cable. "I don't really want to build expectations that a cable deal for TiVo is do or die-it's really important, but it's certainly not do or die-and I don't want to set expectations that it's just around the corner."

TiVo is less dependent on DirecTV than it might first appear. DirecTV supplies about 55% of TiVo subscribers, but only 10% to 15% of revenue, said Daniel Ernst, managing director at investment firm Rodman & Renshaw, New York. That's because DirecTV pays TiVo about $1.44 a month per subscriber (and charges subscribers $4.99 for the DVR) while TiVo charges standalone customers $12.95 a month (including some additional services). TiVo is stepping up marketing to increase its sales, with a print campaign coming in August from new agency Grant, Scott & Hurley, San Francisco.

David Miller, senior VP-media analyst at Sanders Morris Harris, believes TiVo will get a cable deal at some point but speculates it would be at a cut-rate price below $1 a subscriber.

TiVo's goal over the next three or four years is 10 million subscriptions (vs. 1.6 million as of April 30) and $1 billion in revenue (vs. $141 million in the year ended Jan. 31).

Even if DirecTV went away and cable deals didn't happen, TiVo could have a future as a niche player offering innovative technology at a premium price. Think Apple Computer, which has prospered and diversified while holding just 3% of the U.S. PC market.

But TiVo needs subscriber volume, through partners or on its own, for planned broadband services and advertising offerings. Mr. Ernst estimates TiVo's current ad revenue at less than $4 million a year-the equivalent of just two Super Bowl spots. TiVo doesn't break out ad revenue, saying only that it's below 10% of revenue (that is, below $3.5 million last quarter). Mr. Ramsay is bullish: "A big chunk of TiVo's revenues in the future could well come from advertising," he said at Deutsche Bank's event.

TiVo now must get through the present. News Corp.'s June sale of a 4% TiVo stake and the resignation of DirecTV Vice Chairman Eddy Hartenstein from TiVo's board raised more questions about the relationship with the key customer. TiVo declined to make executives available for comment but cited a TiVo press release in which Mr. Hartenstein, announcing his board departure, affirmed "the strong business relationship between DirecTV and TiVo."

TiVo is a big winner for DirecTV. Bob Marsocci, DirecTV VP-communications, noted TiVo users spend more money with and are less likely to drop DirecTV. "Obviously, the DVR is a very important element" in acquiring and maintaining customers, he said.

keeping options open

Yet it's easy to see how DirecTV could start using DVRs from NDS. DirecTV, in fact, was NDS's largest customer in fiscal 2003, accounting for 41%, or $161 million, of NDS revenue, even before News Corp. bought DirecTV. That revenue came from NDS technology used by DirecTV to control broadcast signals sent to set-top boxes.

Mr. Marsocci said DirecTV is exploring all options available through News Corp. "We obviously want to take advantage of those opportunities that are presented to us," he said, including "looking at utilizing some of the interactive services that have been made popular on BSkyB," News Corp.'s flagship U.K. satellite service. NDS supplies technology for interactive shopping, interactive games and the Sky+ DVR to BSkyB, its second-largest customer.

Said analyst Mr. Ernst: "It's clear in all but black and white that [DirecTV] will roll out a second vendor of DVR technology."

NDS President-CEO Abe Peled, speaking to analysts in April, said NDS hopes to sign a DVR deal with DirecTV in the fiscal year starting July 1.

A price battle is shaping up. At the Deutsche Bank conference, Mr. Ramsay said DirecTV later this year will introduce a range of products and platforms developed with TiVo and set-top box maker Thomson "that will dramatically lower costs." In an interview, NDS Americas VP-General Manager Dov Rubin vowed: "We can definitely offer lower-cost alternatives than [TiVo] can."

DirecTV's TiVo contract runs through February 2007. If NDS secures a deal before then, DirecTV likely would offer a choice of TiVo and a DirecTV-branded DVR from NDS. Then consumers could decide whether their DVR really needs to be a TiVo.

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