Scientific-Atlanta Inc.

Ticker: (NYSE: SFA)
Phone: 770-903-4608
Web site: www.scientificatlanta.com
(2/4/2000): $95 15/16

By George Runkle (TMF Runkle)

How Did It Double?

According to Scientific-Atlanta's 1999 annual report, that year "represented a turning point" for the company. Its digital interactive products "became a commercial reality" and the cable industry invested heavily in fiber/coax network technology as never before. Cable companies have been upgrading their networks to broadband to meet consumer demand for high-speed Internet connections and more offerings in television (to include video-on-demand), and to provide local phone service.

These cable service upgrades caused the company's sales to jump 17% in the fourth quarter of 1999 compared to the same period a year before. This was after lackluster sales growth of about 5% annually for the past three years. The demand for the necessary equipment and expertise to upgrade cable systems continues to grow, since cable companies are seeing competition from local telephone companies and direct satellite television. To meet the competition, they need to provide more services to their customers.

Business Description

Scientific-Atlanta is an Atlanta, Georgia-based company that provides products and services to the cable television industry. It provides some satellite reception equipment for the "head end"; however, this isn't the strongest area of its business. The majority of its business is providing cable companies with network equipment that distributes the signals from satellite dishes to individual consumers, and allows communication from the consumer back to the cable company.

This equipment allows cable companies to provide a large networks that allow customers to connect to the Internet, order movies on demand from servers at the cable companies' head end, and receive a larger number of television channels than they ever thought possible. Additionally, local e-commerce is possible through these systems, allowing the users to order from local merchants through set-top boxes.

Scientific-Atlanta not only provides network equipment and set-top boxes, it also provides consulting services to the cable providers -- analyzing the networks and designing and implementing the necessary broadband equipment to upgrade services. The majority (90%) of Scientific-Atlanta's sales is from supplying video network equipment to cable companies.

Financial Facts

Income Statement
12-month sales: $1,397 million
12-month income: $127 million
12-month EPS: $1.58
Profit Margin: 9.1%
Market Cap: $7,536.9 million (78.561 million diluted shares)

Balance Sheet
Cash: $315 million
Current Assets: $861 million
Current Liabilities: $254 million
Long-term Debt: $0.38 million

Ratios
Price-to-earnings: 60.7
Price-to-sales: 5.4

How Could You Have Found This Double?

Looking back, one of the fundamental changes in the industry was the passage of the Telecommunications Act of 1996, which opened up competition in many areas of communication to local phone companies and cable companies. Even so, Scientific-Atlanta's stock remained stagnant for a number of years. From February 28, 1997 to December 31, 1998, the stock rose from $19 3/8 per share to only $23 3/16 per share. However, since that date in 1998, we've watched the stock rise more than 250% to its price today.

In the first generation of digital cable, the systems were broadcast only with one-way set-top boxes. Scientific-Atlanta sat out that stage in the evolution of digital cable systems and did not produce broadcast-only set-top boxes for that market. It focused instead on developing the Explorer 2000 -- a two-way set-top box -- and eventually saw sales of this box and its supporting systems mushroom.

The main indicator for potential investors was the jump in revenue that occurred in March and June of 1999 compared with the same quarters a year before. In March, revenue was up 11% and then in June it was up 17% year-over-year. Earnings per share took an even greater jump -- a 22% year-over-year increase in March and an astounding 47% year-over-year increase in June. After looking closely at why there was such a jump in revenue and earnings, one would have seen that it was driven by a long-term increase in demand from cable companies for Scientific-Atlanta's products.

This demand was being driven by several changes in the industry. According to its 1999 annual report, Scientific-Atlanta's key customers -- Time Warner (NYSE: TWX), Charter Communications (Nasdaq: CHTR), and Comcast (Nasdaq: CMCSA) -- started "upgrading and building powerful networks." A growing demand for broadband Internet access from consumers was fueling growth of Digital Subscriber Lines (DSL) provided by the local phone companies. Direct satellite television became available via small dish antennas for a cheap price, which competed with the channel lineup provided by traditional cable companies. To compete, the cable companies have had to upgrade from one-way transmission to two-way broadband with increased services to consumers.

So, three items indicated that Scientific-Atlanta was well-positioned to take advantage of the increased opportunities -- introduction of the two-way set-top box and interactive cable systems, the jump in sales and earnings, and realignments in the cable industry.

Where to From Here?

Over the next few years, sales should continue to grow to meet the strong consumer demand for broadband. Cable companies will have competition from direct satellite television and local phone companies, which will require them to provide an expanded array of services to keep subscribers. Additionally, the growth in e-commerce, e-mail, and set-top box ease-of-use will continue to spur demand for high-speed Internet access. The Cable Television Industry Association expects growth in analog-to-digital cable to go from what was 1.4 million households in 1998 to 38.6 million households in 2006, an annualized increase of 51%.

The barriers to entry in the business of supplying network gear and set-top boxes are rather high. For the foreseeable future, the industry will probably remain a "duopoly," dominated by Scientific Atlanta and General Instrument, which has been acquired by Motorola (NYSE: MOT).

Scientific-Atlanta expects to introduce its digital system into the U.K. and, shortly after that, will introduce it to Europe and the rest of the world. This will continue a broad expansion in its business. In addition, many of its new services are software based, which will see continual increases in demand as further enhancements are made to cable systems. For the foreseeable future, we can expect to see continued expansion in Scientific-Atlanta's business, which makes this company worth considering for a long-term investment.

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