Sector Watch: Bandwidth providers

Not long ago, when you wanted to make a call, you used a cell phone or even a run-of-the-mill telephone. When you wanted to watch TV, you used a television. These days, though, almost all our daily communication and media needs can be met through the Internet.

Because of this trend, the high demand for bandwidth is upon us and continues to expand in response to the rapid deployment of bandwidth-intensive services such as Internet phone, Internet television, online gaming and streaming video.

International Data Corp. forecasts the U.S. subscriber base for Internet phone and Internet television will grow at annual rates of 64% and 131%, respectively, between 2005 and 2009. Online digital game downloads are forecast to increase to 3.3 billion by 2009 from 1.2 billion while overall broadband penetration is projected to grow from 34% to 53% of U.S. households.

Poised to prosper are Switch & Data Facilities Company, Inc. (Nasdaq: SDXC) and RRSAT Global Communications Network Ltd. (Nasdaq: RRST), two companies that provide services that address rising bandwidth demand.
 
Switch & Data Facilities provides network neutral connection and collocation services for telecoms, Internet service providers and online content providers. Initially, the various networks that made up the Internet connected at public network access points. Eventually these became owned and managed by telecoms. As traffic grew, however, these network access points became overloaded and some network service providers began connecting directly by establishing fiber optic links between facilities. These links, expensive to build and maintain, led to the formation of commercial businesses such as Switch & Data, which operates network neutral Internet exchanges and collocation facilities.

Switch & Data’s interconnection services allow customers to directly connect and exchange network traffic. Its collocation facilities provide space and power for customers’ networking and computing equipment, thus enabling the customer to avoid building and maintaining their own facilities. Because Switch & Data’s operations are network neutral (i.e. it doesn’t own or operate its own network), customers are able to connect directly with telecoms and each other. This results in lower network transit cost, improved network performance and reduced time to market. With 33 facilities across 23 markets, Switch & Data operates the largest network neutral footprint in North America. The company has facilities in 14 of the 15 largest U.S. metropolitan areas and has approximately 900 customers, including AboveNet, Inc. (OTC: ABVT), AOL, Qwest Communications International, Inc. (NYSE: Q), DirectTV Group, Inc. (NYSE: DTV), Google Inc. (Nasdaq: GOOG), Yahoo! Inc. (Nasdaq: YHOO), YouTube and many others.

In December, Switch & Data announced the creation of a new practice focusing on the entertainment content market. The company plans to provide specialized services to online gaming companies and digital media companies that will assist them in designing, developing and deploying infrastructure solutions. During the first nine months of 2007, Switch & Data’s revenues expanded 22% year-over-year to $100 million from $82 million, operating income tripled to $3.2 million from $1 million and net losses (before preferred stock accretions and dividends) declined to $3.3 million from $10 million. The company is targeting 23% growth in full-year 2007 revenues to $137 million and expects to generate positive 2007 EBITDA (earnings before interest, taxes, depreciation and amortization) of $42.5 million. Analysts estimate Switch & Data will produce 100% growth next year and 124% annual growth over the next five years. My $25 price target for Switch & Data is above the current share price of $16.06 at Tuesday’s close. Over the last 52 weeks, shares have ranged between $13.84 and $22.  

RRSAT Global provides content distribution to television and radio broadcast customers through its proprietary RRSat Global Network, which consists of satellites, terrestrial fiber optic transmission capacity and the Internet. RRSAT provides distribution services for nearly 400 television and radio channels across more than 150 countries.

Technology advances have led to rapid growth in the number of broadcasters targeting a worldwide audience. According to EuroConsult, the number of satellite TV stations has increased to more than 13,000 in 2005 from 1,000 in 1995 and the number is forecast to exceed 29,000 by 2013. Satellite TV broadcasters have found delivering content via a network infrastructure that integrates satellite-based and terrestrial fiber optic capacity is the most reliable and least expensive way to secure global distribution. Teleports, which allow for the integration of satellites with fiber optic networks, have emerged as the primary solution. Teleport providers such as RRSAT serve a $13 billion worldwide market, according to a 2005 report by the World Teleport Association.

RRSAT’s content distribution services include uplink, downlink, turnaround, encryption, encoding, storage, localization and time delay services; integrated content management such as production and playout services, and satellite news gathering services. The company transmits information to 25 orbiting satellites and receives transmissions from 48 satellites. Its transmission range covers each of the world’s major population centers. RRSAT’s satellites connect with strategically located teleports, which comprise the ground-based portion of the satellite transmission network. Its principal teleport, located in southern Israel, provides access via a single connection to satellites that transmit directly to North and South America, Asia, Europe, Africa and Australia. RRSAT delivers television and radio broadcast content for its customers to cable TV channels, dish satellite TV stations, the Direct to Home market and the public Internet.

During the first nine months of 2007, RRSAT’s revenues grew 37% year-over-year to $42.9 million from $31.2 million and net income climbed 47% year-over-year to $8.2 million, or $0.47 per share, from $5.6 million, or $0.42 per share. The company recently increased its guidance for full-year 2007 revenues to $58 million, up 35% from last year. Analysts expect RRSAT to enjoy 30% growth next year and 25% annual longer-term growth. My $27 price target for RRSAT Global Communications is above the current stock price of $18.97 at Tuesday’s close. Shares for RRST have ranged between $10.35 and $26.50 over the last 52 weeks.

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