VideoCipher Scrambles (and Descrambles) to Success

VideoCipher is sitting on top of the world these days, much like the communications satellites on which its technology depends.

A division of General Instrument Corp. with a virtual monopoly on satellite cable-TV scrambling and descrambling technology, VideoCipher equipment has been selected by Home Box Office, Showtime, Cable News Network and 19 other major cable-TV programmers to foil backyard satellite dish owners who until early 1986 were able to tune in cable programming without paying for it.

As more cable programmers scramble their signals, VideoCipher II descrambler boxes--costing $150 or more--have become essential to many of the nation’s estimated 2 million home satellite dish owners. Dish owners who want to receive the major cable program services sooner or later will have to buy VideoCipher decoder boxes, which are activated after the dish owner pays a monthly fee to the cable programmers.

After a slow start last year, VideoCipher sales have gone into orbit. The company has shipped 300,000 descramblers during the past 18 months, reaching a record 42,000 units shipped in June alone. San Diego-based VideoCipher is expanding plants in Puerto Rico and Juarez, Mexico, to double current manufacturing capacity by December to 100,000 boxes per month. (The descrambler also will soon be manufactured in North Carolina under license by Channel Master, a unit of Avnet Inc.)

VideoCipher sales could reach $200 million this year and $300 million in 1988 if the current growth rate holds, according to J. Lawrence Dunham, general manager and executive vice president.

Also good news for VideoCipher is that the home satellite dish market, which collapsed last year after cable programmers began to scramble, has revived. That’s important since VideoCipher wants to do more than sell descramblers to existing dish owners. In fact, the company’s combined descrambler-receivers, which sell for up to $500, are geared for new backyard dish customers and now account for about 25% of unit sales, a percentage the company says should increase to 50% during the next year.

The division’s growth has played an important role, analysts say, in the run-up of General Instrument’s stock price, which closed Monday at $38.375 in New York Stock Exchange trading. It had been trading as low as $16 late last year.

In the fiscal year ended Feb. 27, General Instrument posted revenue of $788 million and a net loss of $80 million, due in large part to writedowns and losses from discontinued operations.

VideoCipher’s upbeat prospects contrast sharply with the uncertainty that it and others in the direct broadcast satellite market faced last year, uncertainty that helped persuade the division’s former parent, M/A-Com of Burlington, Mass., to sell VideoCipher to General Instrument for $220 million cash in September, 1986.

The beginning of satellite-TV signal scrambling in early 1986 by Home Box Office, Showtime and others caused widespread confusion among backyard dish owners and those considering buying the equipment. Rumors that dish owners would be shut off entirely from programming or that they would have to buy a decoder box for each program service caused “severe disarray,” Dunham said.

As a result, the market for VideoCipher’s descramblers did not develop as quickly as anticipated by M/A-Com, which had invested millions in decoder-box inventory and added plant capacity. The disappointment plus M/A-Com’s desire to restructure itself along strictly defense-related business lines weighed heavily in M/A-Com’s sale of VideoCipher to General Instrument, a New York-based cable TV equipment company.

Late last year, a potentially disastrous problem arose with the profusion of illegally doctored VideoCipher descrambler boxes capable of receiving programs without the programmers’ authorization. “Pirates” sell the doctored boxes for up to $1,000 over the descrambler list price through mail order or under the counter at satellite equipment stores.

Although VideoCipher says it has fixed the “software error” in the descrambler boxes that made the breach possible and that all boxes shipped since February are uncrackable, the breach tarnished VideoCipher’s image with the programmers and caused a “real crisis for the company,” Dunham said.

VideoCipher has managed to turn off 12,000 of the offending boxes through electronic detection methods, but Dunham estimates that there may be as many as 30,000 pirate boxes still in operation. VideoCipher has also succeeded in obtaining injunctions and fines against some pirate distributors.

The takeoff in the descrambler market earlier this year has pushed such problems to the background, at least for the moment. Jay D. Samstag, an analyst with Duff & Phelps of Chicago, said a “critical mass” of backyard dish owners are coming around to the idea that buying descramblers is a good way of “protecting their fairly sizable investments.”

Of the many factors responsible for the improvement in descrambler sales, Dunham singled out the increasing availability of cable-program packages available to home dish owners. The packages, which are marketed by cable satellite equipment manufacturers and by programmers including Showtime, have made home dish owners “comfortable that they can buy programming at a reasonable cost,” said Aristide Vitolo, senior technology analyst with Cyrus J. Lawrence Inc. in New York.

“Before, (home dish owners) had to pay multiple sources and had no real picture as to what the pricing would be,” Vitolo said. “And the programmers are coming around to the idea that (the packages) are a good way to expand their conventional subscriber base.”

Showtime, for example, offers a package of 14 cable channels for as little as $20 per month to home dish owners. The programs are often cheaper to dish owners than through conventional cable companies because they don’t include the cost of laying and maintaining cable.

When HBO selected VideoCipher in 1983 from 11 other competitors to supply scrambling equipment, it saw program “encryption,” or scrambling, strictly as a means of shutting down the backyard dish owners. Now, the company recognizes the technology as the linchpin to a huge growth market.

All the major cable programmers that now scramble their signals have adopted the VideoCipher technology. Competitors may eventually surface, but for now the company has the field to itself.

Edward Horowitz, HBO’s senior vice president, said he is encouraged that 10,000 of the 25,000 families now buying home dishes every month are signing up for cable satellite packages. That’s a considerable market even for a giant such as HBO which, paired with sister company Cinemax (both are owned by Time Inc.), boasts 19 million subscribers.