SRS Labs Upgraded to Buy

Highlights include SRS Labs, Inc. (SRSL - Snapshot Report) and Sony Corp. (SNE - Analyst Report).

Upgrading SRSL to a Buy with One Huge Caution

SRS Labs, Inc. (SRSL - Snapshot Report) develops and licenses audio technologies to OEMs in the home entertainment, portable media device, personal telecom, computing, automotive and broadcasting markets.

December quarter results were significantly better than consensus estimates. Management continues to expect 25% growth in 2009, driven by incremental revenue from new licensees. We are upgrading SRSL shares to BUY given its very strong growth prospects in the recession-hit year. However, we caution investors regarding the very small customer base, noting that the company generated 42% of revenue from Samsung alone in fiscal 2008.

The Home Entertainment segment is expected to grow strongly

The home entertainment business comprises TVs, set top boxes and speaker box systems. The bulk of revenue currently comes from advanced flat-panel televisions, such as LCD, plasma and projection TV displays. This market is expected to grow very strongly over the next few years.

SRSL has a strong position in flat panel TVs. Its technology is used in a third of the largest flat-panel TV models, and nine of the top 10 flat-panel TV manufacturers use SRS technology in various products. Samsung and LG are currently the two largest customers in this market. According to research firm DisplaySearch, Samsung Electronics and Sony (SNE - Analyst Report) were the top two flat-panel TV brands in all four quarters of 2008. The market shares of the top five in the last quarter were Samsung Electronics 20.4%, Sony 14.1%, Vizio 12.3%, LGE 8.1% and Toshiba 7.9%.

SRSL has licensing agreements with all the top five TV OEMs except Sony. This is a big positive for the company, given that more than half the flat-panel TV sales are made by the top five manufacturers. While the loss at Sony is a dampener, current findings indicate that Sony’s competing technology is an infringement of SRSL technology. This situation is expected to generate incremental revenue for SRSL.

The PC strategy should generate significant growth in 2009

The PC has emerged as a multimedia device, containing downloaded music and movies along with recorded television programming. SRS provides technology solutions that create a home theater experience on a laptop. Notebooks are expected to be the drivers in the computing market, so the company’s play in this market holds promise.

The 2009 scenario looks particularly encouraging, with the company making up for sluggishness at existing customers by signing up new licensees. Particularly, management announced HP, Ben-Q, and NEC. Management elucidated that products were already on the shelf, although significant ramp-up would be in 2009.

Sejuti Banerjea contributed to this post.