Pace breaking out of the box

By Philip Stafford

Published: October 18 2009 16:21

Consumer demand for high-definition television has been one of the few constants in the recession. But in the opinion of the head of Pace, the set-top box maker, a “supercycle” that will change the way we watch our main source of entertainment is beginning.

For Neil Gaydon, chief executive of the Yorkshire-based group, the recession is proving one overriding point: that people still see TV as offering unrivalled value for money when it comes to entertainment.

“When questioning discretionary spend, there are three things people give up last: their mobile phone, broadband and digital TV,” he says.

While retailers and restaurateurs struggle to attract customers, and the music industry battles with piracy, many pay-TV operators, such as BSkyB and Comcast, have gained subscribers.

Pace occupies an increasingly large share of that third entertainment leg. Transformed by the acquisition of Philips’ set-top box business for £68m last year, it became the world’s third-largest personal video recorder (PVR) maker and surprised analysts and investors by upgrading its earnings forecasts twice in April.

Benefiting from problems at rivals Motorola and Thomson of France, it now expects to ship more than 16m bespoke boxes around the world this year to the major pay-TV companies such as News Corp, Canal Plus and DirecTV.

It underlines a break from the early part of the decade, when Pace was largely dependent on one contract from Sky, and profit warnings were commonplace.

To underline this, Pace has restarted dividend payments after a six-year hiatus, while its shares have risen from 43p in January to 226½p on Friday, giving it a market capitalisation of £694m.

But Mr Gaydon says future products – and Pace’s plans – are built around expectations that the way we consume TV will be different.

“The supercycle is that people aren’t just buying one of these flat panels in their home; they’re buying multiple,” he says. “For example, DirecTV average 2.8 per house per subscriber and that’s a phenomenon we’re starting to see increase as well.

“New products that allow people to pause, stop, rewind any TV, watch any content recorded in one room in another room will come in. Further down the line it will probably be streamed to a smartphone.”

Pace will need to develop new products. Arun George, an analyst at Noble Securities, points out that rivals will not always be so hampered. “Next year looks comfortable, but as we go into 2011, their ability to drive top-line growth from market share will moderate,” he says.

Buoyed by its £84m cash pile, Pace is looking to expand its bespoke PVRs. A MultiDweller service, aimed at apartment blocks and hotels where old wiring prevents the installation of new services, has signed up Canal Digital Plus. It is also targeting rural areas that have poor digital reception.

Underpinning it all is the fact that only 2 per cent of the world has taken up HDTV. As analogue signals around the world are switched off in coming years, that number will grow.

Jonathan Imlah, an analyst at Altium Securities, thinks the rapid take-up and Pace’s focus is still being underestimated by the market: “At 10 times full-year 2010 earnings, it trades at a substantial discount to the wider technology sector in spite of significantly higher forecast earnings growth.”

One source of disquiet about Pace’s performance in the past year was its decision to move a key performance indicator from gross margins to return on sales. Some have suggested it indicates the company is losing margin.

Mr Gaydon defends the move. “Investors need to look at the deals we go after,” he says.

“What we’re showing is that we know how to make money in this space where others have shown they can’t or find it more difficult.”

He points out that return on sales has risen from 3.5 per cent to 6 per cent, and it is moving towards analysts’ expectations of 8 per cent.

“On a selective [contract] basis it makes sense, but I wouldn’t like to see them do it across the board,” says Mr Imlah.

Mr Gaydon sees little competition so far from internet TV as no market can yet deliver standard definition TV to the mass market over broadband, let alone content for high-definition TV.

Mr Imlah admits it may come in the future, but not the present: “So you go and buy a Samsung internet TV. What are you going to watch – YouTube?”