Dolby's transition to greatness?

Firm sitting pretty with audio technology for switch to digital TV

One of the biggest upside surprises this earnings season from among companies that make up The Hollywood Reporter Showbiz 50 stock index came from Dolby Laboratories.

The stock popped 14% the day after it reported blowout fiscal first-quarter profit and revenue on Jan. 31, and analysts are betting that there are more gains to be had, especially as digital cinema, next-generation DVD and a looming digital TV transition come into focus.

The TV transition is set for February 2009, and Dolby plays a huge role with its audio technology being built into the set-top boxes that will make the digital transition possible.

Plus, Dolby owns the licensing rights to the ATSC digital tuner standard in the U.S., meaning it gets paid for just about every TV set purchased in the country.

Dolby technology already is in many DVD players -- the old kind, as well as Blu-ray Disc and HD DVD, but not many of those next-generation players are being sold yet. That's about to change, though, as more consumers assume that Blu-ray essentially has won the format war.

Then there's the Xbox 360, the PlayStation 3 and Vista Premium software. Goldman Sachs figures that 75% of Vista sales are for the Premium editions that include Dolby's technology, and Vista sales should double in its second year compared with its first.

Add it all up, and it becomes clear why Dolby stock has outperformed that of most of its clients this year, though admittedly that's not saying much.

Dolby is down 7% this year, while Blu-ray and PS3 maker Sony is down 18% this year, Vista and Xbox 360 maker Microsoft is off 20%, and the Showbiz 50 has tumbled 14%.

"We are advising investors to buy shares of Dolby," Goldman Sachs analyst Ingrid Chung said in raising her price target on shares from $53 to $60 after Dolby's "stellar" -- her word -- earnings report.

San Francisco-based Dolby reported fiscal first-quarter earnings of $47.7 million, up from $29.9 million a year ago on revenue that grew 44% to $150.2 million. On a per-share basis, the company made 42 cents, a dime better than analysts predicted.

Then, the company raised its full-year guidance, practically assuring a giddy Wall Street response.

Even Miller Tabak analyst David Joyce was impressed enough to raise his price target on the stock from $48 to $54, though not enough to alter his "hold" rating on it.

Joyce likes Dolby's prospects, but said he will revisit his company recommendation "when we emerge from the recession."

Both analysts agree, though, that Dolby made a smart move when it agreed to purchase privately held Coding Technologies, a provider of compression technologies for digital platforms, for $253 million in November.

With Coding Technologies, Chung said, "Dolby has expanded its intellectual property portfolio for the secular growth markets of mobile handsets, digital broadcast and the Internet."

Beefing up the product mix is important, she said, to "drive growth for Dolby as the standard-definition DVD adoption cycle slows and as PC unit sales growth slows."

PCs and the Internet, though, should still be major drivers, said Steve Birenberg, a money manager specializing in media investments.

"It is a great business model," he said. " Licensing is really profitable, and the faster the speed of downloads and the more people that have broadband, the more demand there will be for better sound technology in PCs and other devices."

Dolby's potential, and excellent performance as a company of late, is well known, some argue, thus leaving the stock vulnerable to a downdraft.

But, said Motley Fool senior analyst Andy Cross, long-term investors shouldn't fret. In fact, he recommends investors scoop up shares on dips.

"They're expanding the Dolby influence with their audio technology in devices from start to finish," Cross said. "The good news comes out, the stock goes up, then it falls back. That has been its pattern."

Things are generally looking up though for the audio technology powerhouse, he believes. "This story is definitely just taking off," Cross said. "There are some neat opportunities for Dolby."