Kate Bulkley, Media Analyst.

Abe Peled. CEO NDS

For Digital News. June 2003.

By Kate Bulkley

NDS is a supplier of open, end to end digital systems and solutions for the secure delivery of entertainemnt and information to TVs and IP devices. It synonymous with condiitonal access and its XTV technology has been the key to the sucess of PVRs. Abe Peled has been the MD since 1995. NDS is part-owned by News Corp. and Peled sits on the News Corp. Executive Committee. NDS CA is used by over 30 million customers and generates $11 billion in revenues.

Kate: You're most recent quarterly results show revenues up but EBITDA down and the next quarter (FY Q4) is not expected to improve drastically. Yet next year you are forecasting 30% growth. Is this an indication that we are finally coming out of the market slump?

Peled: What we have said is that our guidance for our underlying business next year taking (our customer US pay TV operator) DirecTV out, is approximately 30% revenue growth. Now I donít know if we are coming out of the slump, but some people have again money and are starting to deploy (products like set top boxes). For example (cable operator) Ayuna in Spain where we won a contract three years ago, is only now starting to deploy set top boxes in any significant number. Also, I think that we have a very strong pipeline of business that is reflective of contracts we won this year and because of the lag in implementing the projects and because of our revenue recognition policy a lot of that revenue is coming through next year. Our business pipeline is as strong as I've seen in the last several years. We have won Viasat in Scandinavia that can lead to a project of (changing out encryption smart cards) for a million customers that they already have in analogue ad digital over the next couple of years. Sky Italia is also a major project for us because they have ambitions to get to 4 million subscribers over the next three years. Sky in the UK continues to do well and so that also provides a good base for our growth. We've also won Hathaway Cable in India and of course the Foxtel project in Australia which is 1.2 million subscribers that will move to digital using our system. That has integration fees for us as well as down the line subscriber additions. So, a lot of the companies have straightened out their finances and are starting to spend again money. We are certainly starting to see a lot of additional activity.

Kate: What about DirecTV in the US? This has been a big customer in the past but you are involved in an ongoing lawsuit there and they owe you £25 millionÖ

Peled: They owe us £25 million of which only £16 million is overdue.

Kate: But your contract with DirecTV ends in August. The money owed is still outstanding. However, as fate would have it, Mr Murdoch will with any luck get the green light from the US competition authorities that will give him control of DirecTV. As NDS is a close cousin to News Corp., doesnít this mean you will get a new, perhaps better DirecTV contract?

Peled: Well, we certainly are optimists by nature. We believe that if regulatory approval is obtained by News Corp. and News Corp having said it would like to replicate the success and a lot of the technology and applications of Sky in the US, then we would hope that we would be in a good position to get that (US) business

Kate: Let's talk about fraud and smart cards. This has been a huge issue and is the basis for the legal actions brought against you by DirecTV. Also Canal Plus Technologies alleged that their encryption system was broken by NDS and then put up for all to see on the internet, allegations that you have denied. So how serious is the hacking issue to your business?

Peled: It is a serious problem. But I think in the law of unintended consequences, the Canal Plus lawsuit against us which was absolutely without merit, served, however, to bring this subject to the forefront. We never used to discuss piracy and numbers of pirates but the highly publicised lawsuit and claims that they had millions of pirated cards in Italy and Spain has served to bring this issue to the forefront. Viasat of course suffers from piracy and that was a trigger for them to say, "Hey, we have a problem" and to look for who is a supplier (Viasat was using Via Access before NDS won the contract) that can help them to deal with it. As a matter of fact in Europe, all the conditional access platforms are compromised except for those provided from NDS. Out of our 34 customers, only one has piracy and that is DirecTV and we know the reasons for that which is that they have not been diligent about maintaining the security. (Editor's note: NDS claims that DirecTV failed to replace its encryption cards in a timely manner as recommended by NDS). So, everybody was talking about piracy, investors, shareholders and board members. And perhaps as a result, there are several requests for proposals out by companies that are not happy with their conditional access (C.A.) suppliers. For instance, Noos (in France) a customer of Via Access and TV Cabo (Portugal) which is a Kudelski customer, so I think that the whole issue has come to the forefront. But I should emphasise that the number of pirated cards has been highly exaggerated in the following sense. We know that in Italy when Telepiu replaced the C.A. cards (provided by Canal Plus Technologies) recently that they didnít add 2 million subscribers but something like 200,000 to 300,000, which is a large number but it's not 2 million. So, we see piracy as a very serious issue and we treat it on all fronts, both on the technology front by having consistent technology and developing it further to stay ahead, as well as with operator security that tracks down piracy and prosecutes offenders. That's our business. If there weren't thieves, one would not need locks!

Kate: Very true. One other corporate question. I know that there is about £91 million pounds of cash on your balance sheet in cash. Difficult really and perhaps not strategically necessary for you to buy out a rival because Canal Plus Technologies has recently been purchased by Thomson and Kudelski is controlled by a family. But perhaps NDS might buy a set top box maker? Pace is certainly worth a lot less from a market capitalisation standpoint than it used to be.

Peled: I can say unequivocally that we would not buy a set top box business. What we have said (about the £91 million) is that given the uncertainties that have been around the business like the future of the DirecTV contact and the litigation (with DirecTV and until recently with Canal Plus Technologies), which is expensive, that it was important to have that cash reserve and not to pay it out as dividends or to spend it unwisely. I think that when a lot of this uncertainty is out of the way and given that the acquisition opportunities are quite small, that the board will have to reconsider the issue of the dividend. I donít think there are large acquisitions out there that we know of. That may change of course and (if it does) we do have access to capital and we continue to generate strong cash.

Kate: Strategically, NDS has moved into some related areas, for example buying the games design firm Visionik and most recently forming a joint venture with Rank Group to launch a betting channel Fancy a Flutter (which will launch on Sky in the UK). Is this a way to move your reliance away from the C.A. business?

Peled: In 1999 we decided to develop another leg of our business by focusing on interactive applications and new technologies. We think that Fancy a Flutter is really the first implementation that brings together the strength of (NDS unit) Orbis, which is a back-end transaction system, with the front end from Visionik, which makes it look really entertaining, (alongside of) NDS infrastructure in the middle. Frankly, I think the joint venture with Rank, which has the Mecca Bingo brand and has customers there already, is a way for NDS to accelerate and see if we, as a technology provider, can put this together so it works. Obviously we would like to sell something that is successful to others but we are not really thinking of becoming a major service provider. We are looking to Rank to be the customer-facing part of the venture and the service provider with the gaming license and all that. Really what we see this j.v. doing is accelerating the introduction of that (interactive gambling) technology and demonstrating the kind of capabilities we have and can develop further if it is successful. I also want to add that it is not a lot of money for NDS to do this. For Rank, with the upcoming liberalising of the gambling laws in the UK, this is a way to leverage themselves from a good position on the internet (with gambling) where the backend technology is also powered by Orbis. As a result, if you already have an account on Rank.com you can play using the same account on interactive TV.

Kate: This sounds like convergence really at work?

Peled: It is very convenient because the only cumbersome part of the application is registering your account and this is a lot easier to do -type your name, your address etc.-- on the internet. Part of the marketing strategy is to sign up members of Mecca Bingo there first.

Kate: How important are interactive applications like Fancy a Flutter to pay TV in general and to your business in particular?

Peled: I think that the important part is the entertaining aspect of it. As you know, we have always focused on things where TV is strong which is entertainment. Most of the interactive applications that we have done are to enhance the TV viewing experience except of course QVC where we have developed their shopping applications but it enhances what is a shopping experience. Even gaming is entertainment. People do it for fun even if they also want to win the bet on the football. It enhances the TV experience. We think that iTV first and foremost reduces churn. We do not think it is a coincidence that Sky's churn is the lowest in the world for a major platform at 9.3%. This is like a third of the churn of digital cable in the US and less than half of the churn rate of US satellite. But also iTV is a potential ARPU (average revenue per user) booster over time. I donít think this is all about new revenue but if it reduces churn that is a hell of a lot (of money) to the bottom line.

Kate: PVRs are now going to be pushed in a big way by Sky with its Sky Plus product. Is this the killer application for pay TV?

Peled: I believe that the future main set top box in the house will include a PVR. It is just a question of time to get the technology sufficiently affordable. The consumer satisfaction of the Sky PVR is absolutely fantastic. There is zero churn. No body who has a PVR churns.

Kate: Have they been in the market long enough to really know, I mean, Sky makes you sign a 12-month contract for its Sky Plus PVR.

Peled: People have had it long enough. It has been there for over a year. And you know there has been a lot of research and people just love it. Consumes understand what is the added value once they get it. It is hard to explain in an advertisement but once you get it they understand. So I think PVR will be on the main set top box in the household. And five years from now all households will have PVR on the main TV set at least and possibly on other TVs as well. We have developed the XTV technology for that and we get an extra royalty for that. We also think that PVR can be an excellent base for additional interactive and value-added applications. For example, the games you can do on the PVR using the hard drive to increase the memory and power are a lot more sophisticated than the games that have to be downloaded in real time. With PVR you can approach the console game in terms of the quality of the experience and the game. There is also the idea of buying content out of your PVR, like offering the most popular movies (by downloading them to the PVR so they can be purchased "on demand"). With advertising there is the idea of ad substitution based on where the set top box is, for example. So we think that PVR is a really interesting platform not only for what it does for viewing but for future applications as well.

Kate: There are other PVR technologies that compete with your X-TV technology. How is this going to shape up?

Peled: We just got two more PVR clients (editor's note: Peled would not name them). We think that with our strategy of selling added value applications to our customers that the X-TV adds value because of its integration with the C.A. and the electronic programme guide (EPG). This will allow us to compete effectively certainly in our installed base of customers, which is substantial. We have not tried to sell XTV outside of our installed base.

Kate: What about this phantom PVR technology? UK company Blue Delta has developed this along with some money from BSkyB. This technology uses a piece of software costing about £30 to turn your VCR into a PVR. Is this a threat to your XTV?

Peled: Well, I have heard about it but I think that a lot of the inconvenience associated with the VCR will remain. One of the great advantages of the PVR is the complete integration with the programme guide and the ability to manage the content easily through random access in the same interface with the EPG. And also (this phantom PVR does not solve the problem of) not having to look for the cassettes, you know "where did I put that cassette?" So look I canít tell what will happened to phantom PVR technology but we think it is a very different scenario and ultimately the cost of adding the hard disc to the set top box is constantly becoming lower. We are currently talking about £200 or less for a PVR box but two years from now it will be much less. I think that PVR costs will come down like the cost of storage and the cost of electronics, which typically come down 20% a year. So in three years it is under £90.

Kate: Freeview has had a pretty impressive early take-up what do you think the long term future for FV is?

Peled: Obviously there was a surge of demand and as digital TV becomes cheaper I think that people will gradually go for it.

Kate: So will a free digital TV package like FV become a major competitor to pay TV?

Peled: I think that DTT has an inherent limited capacity and as such it will always be a niche. If someone is willing and interested to pay for premium content they will go for satellite or cable because basically people who have been satisfied with five channels then they are taking 30 channels but I doubt if the premium content will (fit) on DTT. Of course I think the notion that it is called Freview is appalling. I see that the TV license fee in the UK has gone from £89 to over £100 so according to my calculation this is £19 extra for every person whether or not he is using the FV or not. Calculated for people who use it now, it is quite expensive for those who don't use it and it is an unfair tax. I am amused every time I hear the BBC people call it Freeview. I point out that it is not exactly "free to view" but the BBC doesn't like to hear that. The only reason why Freeview has any momentum is because there is a lot of money being put in it by the BBC to promote it and to provide additional content for it.

Kate: And now there is the DTT PVR from Pace that will make Freeview look more attractiveÖ

Peled: Well, it is a PVR with no guide. The only way you can programme it is like your old VCR with date and time. So, I think it is called a PVR but it does not really provide the convenience that one would expect from a PVR, like the ability to do a series link, so to record Friends every evening or to set the PVR to record a programme that is on tomorrow. The Pace DTT PVRs doesnít even have the VCR Plus codes. At least put those in so it is not worse than a standard VCR!

Kate: How does NDS get involved in the DTT market? Or is it the case that because there is no pay element meaning your C.A. technolgy has no place, that there is no opportunity for NDS in DTT?

Peled: I think that if somebody were to provide an EPG then there would be an opportunity because it would be a better product when there is the option to add other kinds of content. I think there needs to be a standardised EPG that goes at least 7 days out and that there needs to be a standard for programme identifiers so you can make it easier to record. This is the whole point of a PVR. This would provide an opportunity for other services including pay services or downloaded services you could pay for. I think the minimum is an EPG and the standard for programme identifiers.

Kate: Do you think that without these in place to make Freeview more widely attractive, that the plans of the government to switch off analogue by 2006 to 2010 will fall short?

Peled: I think that most people are now saying 2010, but it is a long way off. Who knows.

Kate: Do you think that the UK government should mandate integrated digital receivers in new TV sets?

Peled: I am philosophically opposed to government regulating what it is that people buy. I was born in a country where it was regulated what you should do and I think one thing that is always sure is that governments will always get (these kind of things) wrong, or it will end up costing a lot more money than it would have cost if it happened through market forces.

Kate: How about national standards or bench marking --is this a good idea?

Peled: Standards are the role of the government, like mandating a format for the EPG. But I think they only need to provide the environment in which the commercial solutions would flourish.

Kate: What about broadband TV and also DSL-delivered TV, or TV delivered over phone lines?

Peled: We are involved in what is probably the most ambitious broadband TV project which is Yahoo broadband or BB Cable in Japan. This is an ambitious project. They have up to 12 megabits (available) to the home and they already have 2 million people signed up for the broadband ISP and now they are offering ISP and video together. The pricing is such that the combination of video and broadband internet is very competitive with satellite-delivered video. This is a very unique situation because Japan does not have a strong cable business. We are watching this situation very carefully because if it doesnít work there I donít know where it could work. In the UK, where you can get half a megabit from BT but it is expensive, it is not commercially viable yet. In the US, the phone companies are having difficulties catching up with cable on the delivery of broadband.

Kate: And HDTV?

Peled: HDTV is being pushed in the US. The FCC has recommended that all sets over a certain size include an HD tuner. They have also reached an agreement on interoperability so you can get HD over cable without a converter for basic service. But it is quite slow although as the prices come down people will buy. There is a whole long story about why the US did this, but we are agnostic if it is HD or multicast.

Kate: Return paths today for satellite pay TV providers like Sky are using the phone lines. How do you see this developing? Do you think we will see mobile phones becoming more of a return path or will it be two-way satellite t echnology like that being developed by Astra and ESA (European Space Agency) and others called Satmode. What does your crystal ball say?

Peled: I think that between mobile phone return path that with GPRS and with 3G in particular becomes always on connection and ADSL always on the issue is not the bandwidth of the return path it is the always on aspect of it. So it all comes down to cost, which is cheaper? For satellite return path from what I hear this is further out ad more expensive than always-on mobile phones or Bluetooth (short range wireless) that connects to your ADSL line.

Kate: So maybe you will be able to download and application from your Vodafone mobile phone to run your TV set?

Peled: Well you could tell your phone to tell your PVR what to record. You see a promo on your phone or in the newspaper while on your way to work and you could call up your PVR and tell it to record it. I think that is certainly something that we are working on and is pretty simple to implement with the XTV technology.

Kate: So what is your outlook for the next year?

Peled: Well, we are for sure busy and busy is good.

 

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