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Dolby Laboratories - A Static Investment?

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April 25, 2010 – Comments (6) | RELATED TICKERS: DLB , DIVX.DL , MSFT

We noticed an article the other day at The Motley Fool site titled I Wouldn't Sell This Stock if I Were You. Among other companies, the article mentioned Dolby Laboratories, Inc. (NYSE: DLB).

The reason the article caught our attention was because it confused us.

In one part of the article the best time to sell was identified, as never, a philosophy we happen to think, as the article notes, works out extremely well for the very long-term investor.

No, the part that confused us was the part near the end when the article mentioned that there may still be lots of room for the stock to run.

While we happen to agree that the stock may indeed have lots of room to run, we also believe the stock is now mature enough, with enough shares outstanding, that some serious consideration should be given to an entry price, something the article fails to mention.

Having read the article several times, we were left wondering if now was as good a time as any to take a position?

Basis
Financial information related to Dolby Laboratories, Inc. contained in this report, is based on the company's most recent SEC Form 10-K filing for fiscal year ending September 25, 2009, as filed with the Securities and Exchange Commission on November 18, 2009.

What They Do
The company develops and delivers products and technologies that are used throughout the entertainment industry to produce a more immersive and enjoyable experience. Over the years, the company has introduced innovations that have significantly improved audio entertainment, such as noise reduction for the recording and cinema industries and surround sound for cinema and home entertainment.
 
Today the company's technologies are standard in a wide range of entertainment platforms and are used in virtually all standard definition Digital Versatile Disc (DVD) player and personal computer DVD playback software, increasingly in digital televisions, set top boxes, portable media devices, and a wide array of consumer electronic products such as gaming systems and audio/video receivers. Movie theatres and broadcasters around the world also use the company's products.

Management believes the company has the opportunity to expand the adoption of its formats for both content and devices because it is expected that the transition from analog to digital broadcasting, the upgrade to high definition (HD) content, and the advancement of online and mobile content delivery are all factors that could potentially increase the company's markets.

The company generates revenue by licensing its technologies to manufacturers of consumer electronics products and media software vendors and by selling its professional products and related services to entertainment content creators, producers and distributors, with licensees in approximately 25 countries distributing the company's products, technologies, and services in 85 countries.

Competitors

The company competes with DivX, Inc. (Nasdaq: DIVX), DTS, Inc. (Nasdaq: DTSI), Microsoft Corporation (Nasdaq: MSFT), RealNetworks, Inc. (Nasdaq: RNWK), and SRS Labs, Inc. (Nasdaq: SRSL).

Short-Term Investment
If the old stock market adage the trend is your friend is really true, then short-term investors should pay attention and run from this stock like it contained the plague.

According to the trend line there have been very few times to take a short-term position in this stock over the past nine months, since the last oversold bottom the stock made with an MACD below zero, was back in September 2009.

The stock closed recently at $61.53, with first resistance at $61.71, a 1% increase from a recent close, and first support at $56.35, an 8% decline from a recent close.

Coupling the resistance and support spreads with the trend line not being anywhere close to an oversold bottom, we think a short-term trade at this time would be a very large mistake.

Long-Term (5 Year Hold) Investment
We reviewed the company's latest annual financial information and simply couldn't find many negatives aside from current pricing levels.

Ending FY09 with Current Ratio of 5.75, a Quick Ratio of 4.84, a Cash Ratio of 4.70, and a Return On Invested Capital of almost 40%, we can certainly understand the average investor becoming very excited about the company.

About the only real negative we found in the financials was that the company only turns its inventory over slightly more than twice a year, but considering that for FY09 the company generated Free Cash Flow of $2.38 per share, had $6.37 per share of cash on hand, and had Total Debt of $0.06 per share, we hardly think slow inventory turnover is a big deal.

Common Real Estate Holdings
The other negative we found, admittedly not a big deal to many, was the amount real estate the company leases from Ray Dolby, the company founder and board chairman, and/or the Ray Dolby Family Trust.

According to the company's latest Definitive Proxy Statement SEC Form DEF 14-A as filed with the Securities and Exchange Commission on February 9, 2010, the company paid rent to Mr. Dolby of $1.3 million for a single California property.

In addition, the company and entities controlled by Ray Dolby own three (3) properties in California and two (2) properties in England, with the Ray Dolby entities having majority control.

The Ray Dolby controlled entities rent their portion of the properties to the company per standard rental agreements.

For FY09, the total amount of rent paid to the Ray Dolby Trust, the Dolby Family Trust, and the Ray and Dagmar Dolby Trust for these five (5) properties was $5.4 million, in addition to the $1.3 million paid for the single California property.

The company also allows Mr. Dolby and members of his family, to use its office facilities for their personal purposes on a limited basis. In addition, members of Mr. Dolby’s family are allowed to use the company's conference and screening rooms for personal purposes up to ten times per year, the use of which the company estimated was less than $15,000 during FY09.

Also in FY09, the company paid Mr. Dolby $1,200 per month for the use by company employees, of a condominium Mr. Dolby owns in Alpine Meadows, California.

Valuations
Based on our preliminary assessment of the company, we think a Reasonable Value Estimate for the stock is in the $59-$63 range and that a reasonable entry target is in the $26-$29 range, an entry point that is not supported by our Graham number of $21, our Tangible Book Value of $9, and our Net Current Asset Value of $6.

Final Thoughts
The company has a history of being inventive and creative, of seeing what isn't there, and then creating a need for what it has seen. Certainly the ability to hear the noise behind the music has been a positive for investors.

But our concern is for investors adding to positions or taking their first positions based on comments such as those we read several days ago.

We learned a long time ago that price determines return, and while the argument can certainly be made that investors waiting for a favorable entry price are likely to miss owning the stock altogether, we believe such instances over a lifetime of investing are rare.

Accordingly, we think investors should take all the time they need to understand where the noise behind the music actually goes, before considering how to filter it out.

Wax

To download the Wax Ink Dolby Laboratories Raw Value Worksheet, please click here.

6 Comments – Post Your Own

#1) On April 25, 2010 at 11:24 AM, cashkid79 (94.23) wrote:

Rare is true, red meat is good, if the static is useless noise, filter it ... get better sound quality...

NOTE: filtering doesn't necessarily mean discarding

'Price determines return'  - very true in MOST cases

Liprie, Timothy P

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#2) On April 25, 2010 at 4:27 PM, walt373 (99.75) wrote:

Great analysis. DLB is a good company, but it doesn't look like there is a margin of safety at the current price.

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#3) On April 25, 2010 at 5:33 PM, wax (97.64) wrote:

cashkid;

I'm not sure when price does not determine return, unless you end up eating red meat with worms, in which what you return is going to be way more than what you paid.

Wax Report this comment
#4) On April 25, 2010 at 5:35 PM, wax (97.64) wrote:

Walt;

Thanx for your comments. Your take was the same as ours, a great company that to us is trading at fair value, meaning no margin of safety whatsoever.

Wax

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#5) On April 26, 2010 at 10:55 AM, cashkid79 (94.23) wrote:

Got it ... price doesn't determine return always, but always provides a reference point to measure return ...

 

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#6) On April 27, 2010 at 4:23 AM, wax (97.64) wrote:

Cashkid;

I hadn't thought about that...yes it does indeed provide a reference point from which to measure return.

Wax

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