The share price of Dolby is now at $49.84 with a PE of 19. There were $1022 million in current assets and $186 million total liabilities in its first quarter’s balance sheet, among which $148 million were current liabilities. What a balance sheet! Among it, cash and short-term investments were at $787 million, long-term investments were 347 million. Adding these together, it’s $1134 million in cash and investments. With 113 million shares, it’s almost $10 per share. That means the actual price for Dolby is at $39.79, low than $40. With this, the actual PE is now at 16. If you think that Dolby will grow at 16% annually in next five years, the current price seems reasonable.
To get into deeper on the valuation of Dolby, I used discounted cash flow method. With growth projection of 10% annually in next 5 years, Dolby’s intrinsic value per share is $56. Adding $10 per share from cash and investment, Dolby’s intrinsic value per share is $66. The current price of 49.84 is almost 25% discount of $66. The current price is actually predicting that Dolby will grow even slower than 5% annually in the next 10 years.
The very question is “Will the growth of Dolby be 10% annually or even slower in next 5 years?”
Dolby’s profit growth in the past 5 years was 40%. Dropping to 10% or even lower is unlikely unless there will be dramatic change in the company or the industry. Well, there was one indeed recently. Dolby’s Second-quarter earnings were anemic — sales up 3%, but profits down 3%, at just $0.72 per share. Worse, management held out little hope that things will improve any time soon, saying that it is now targeting full year revenue of $905m to $945m.
The reason behind the slowdown is the slow sales in PC market and decline in DVD market. The tablet, low cost netbook and change from DVD/Blue-Ray to broadcasting do have an impact to Dolby’s results. However, both PC and DVD/Blue-Ray will not disappear over night. Dolby already had entered in the mobile and broadcast markets as we can see in its recent quarterly reports, although the license fees from these markets are lower than the PC and DVD/Blue-Ray market. However, when the entertainment industry goes for digital and online, the market of Dolby becomes larger, not smaller, not to mention that Dolby is still the market leader in audio technologies and its well-recognized brand. The logo of Dolby is effectively the sign of high quality audio entertainment. Dolby is now taking hit at the profitability during this transition period. They had 18% increase in research and development expenses and 33% increase in sales and marketing expenses in first half of 2011 on year to year basis. Among these, headcounts increased too. The slowing of growth this year is most likely a temporary phenomenon.
Wall Street is pricing Dolby for failure now. It just doesn’t make sense!