Kudelski margins slide on cord cutting – patents rescue US results

Despite sweeping up some major patent license agreements this year, Swiss content security firm Kudelski Group saw a dramatic 80.2% drop in operating income to $6.7 million for the first half of 2017 – as a direct result of declining subscriber numbers in the traditional digital TV business.

Its aggressive pursuit of patent deals has won Kudelski and its subsidiaries the signatures of AT&T, Arris, Scripps Networks and Turner Broadcasting System in the past months, helping it grow revenues for the period by 12.5% to $552 million, while reporting a net loss of $5.7 million.

Kudelski points to the saturation of traditional pay TV offerings in developed markets, particularly Europe, as the primary factor in its poor performance – with several established pay TV operators experiencing continued erosion in their core pay TV subscriber bases.

No operators in particular have been named and shamed, but we can highlight a few Kudelski customers such as Canal+ in France which has lost 400,000 in the past year, Sky Italia which has performed poorly compared to its UK and German operations, and Liberty Global’s numbers in both its basic and enhanced video subscriber bases are shrinking.

The biggest deal for the Kudelski Group in Europe so far this year has been for Nagra at Vodafone Spain to shift its ELK (embedded link) CAS system to Nagra Connect for its IPTV, while it saw more success in Latin America with America Movil and NET Brazil increasing their roll out of next generation TV services and features powered by the Nagra OpenTV Platform and OS.

Subscriber losses in the US were far more spectacular, but Kudelksi’s successful motion of getting operators and vendors to license its OTT video distribution patent portfolio in the US has managed to offset losses.

Had the Kudelski arsenal not included some 5,400 patents, including around 800 from Open TV, its results could have proven even more embarrassing. Other major US firms licensing patents from Kudelski and its subsidiaries include Apple, Verizon, NFL Enterprises, AOL, Cisco, Netflix, Google, Hulu, Yahoo and Disney.

Swiss financial services firm UBS estimates that Kudelski has received somewhere in the region of $62 million to $83 million from its various patent payments between 2014 and 2016. At this run rate, Kudelski could be nearing $100 million from patent license payments for 2016 and 2017 combined, but clearly only offsetting losses elsewhere and not contributing to a profit rise.

The integrated Digital TV (iDTV) segment hemorrhaged $30 million in operating income from the same period last year to post $43.1 million, but with a 12.9% revenue increase to $387.3 million. Logically that means that its costs must have risen, and the only place we can think of where that may come from is purchasing DRM licenses from companies like Microsoft and Apple as more and more deals are OTT and browser based.

Similarly, Kudelski’s cybersecurity sector grew revenues, but also flopped in profit, as it continued to invest in technologies for its budding IoT portfolio. It acquired cyber and network security firm M&S Technologies in January this year and completed the integration recently to build a platform for its managed services capabilities in this area.

Its Public Access segment, which includes sectors such as parking, was the only area to post operating income growth – growing to $1.5 million from $0.2 million in the same period last year.

The company’s outlook for full year 2017 results have been reevaluated, but it remains optimistic given the figures published this week. It lowered operating income guidance to between $45 million and $65 million – meaning the group expects to make in the region of $38.3 million and $58.3 million in operating income in the second half of this year.

It managed $64.4 million in operating income for the second half of 2016, so it is certainly achievable, but even if Kudelski hits the top end of its 2017 operating income guidance, it would still be $33 million down from its 2016 results.