SDL AND THE WIRED CITY

JANUARY 1974

At the Annual Meeting in November, I identified a number of areas in which SDL would be making major commitments. These areas obviously included the continued development of our successful computer services operations and their related application management services for our clients. It also included an identification of some fields of industry specialization, such as the health care field and the education market where we believe proprietary products would provide us with a steady source of income with huge growth potential. Another area that seemed certain to us we must enter is that of providing information services for home and office, utilizing broadband communication facilities. At that meeting, I identified the potential of the “Wired City” as a $20-billion-dollar-a-year industry within the next fifteen years. You may recall that the Department of Communications “Report “BRANCHING OUT” indicated that, of the major areas of development which included health, education and financial-related services, the prospects for the Wired City are that it will become one of the most important parts of the information industry. To quote the widely-respected journal on studies of the future, the October 1973 edition of “THE FUTURIST” said the following. “We are at the dawn of a new industry-information services to the home. It is an industry that some experts expect to reach revenues of $20 billion dollars per year by the end of the 1980s.” Yet it is an industry that does not now exist and is not even widely recognized.” The mere fact that, of the several areas of major corporate development, this one is the least understood, makes it all the more important that we spend a few minutes ensuring we understand just what the potential really is. Our own study of the future of linking a broadband system to a computer listed 117 possible applications and this by no means exhausts the list. To arrive at the $20-billion-dollar market figure, noted earlier, in the study conducted for the American Telephone & Telegraph Company, only about 30 such application areas were selected, as follows:

Projected Dollar Value
of the Market in 1989
Services (in millions)

1. Plays & Movies from a Video Library 2829

2. Computer-Aided School Instruction 2047

3. Cashless-Society Transactions 1810

4. Person-to-Person (paid work at home) 1713

5. Computer tutor 1414

6. Adult Evening Courses on TV 1131

7. Correspondence School 943

8. Dedicated Newspaper 849

9. Answering Services 743

10. Computer-Assisted Meetings 707

11. Household Mail & Messages 707

12. Secretarial Assistance 707

13. Shopping Transactions (Store Catalogues) 584

14. Banking Services 566

15. Grocery Price List, Information and Ordering 566

16. Special Sales Information 354

17. Consumers’ Advisory Service 354

18. Daily Calendar & Reminder about Appointments 292

19. Legal Information 285

20. Weather Bureau 228

21. Newspaper, Electronic, General 200

22. Past and Forthcoming Events 130

23. Fares & Ticket Reservations 124

24. Message Recording 106

25. Index, All Served by the Home Terminal 106

26. Library Access 95

27. Bus, Train and Air Scheduling 79

28. Access to Company Files 46

29. Restaurants 35

30. Mass mail and direct advertising mail 0

The computer plays a major role in virtually all of these.

It is interesting to note that the early estimated start date for the provision of these services seems to be about 1975 and, in fact, seven of the top ten; had this as their early likely start date, including the top three. This should not be taken to mean that in a year from now, one should expect to start receiving these kinds of services on their TV set, but it does indicate that the new industry which has now been called the Cable Information Systems industry (CIS) is poised for its big development phase.

Our own estimates of when it would be realistic to assume some revenue from these advanced applications is in the period 3-4 years from now. The projected growth past this time, however, is very impressive. I believe it is important for SDL, as Canada “s leading information company, to be in at the start of this major new growth section of the information industry.

A POINT OF VIEW

If you look at broadband communications as being merely a means of bringing in an extra TV channel, then I believe you might fall into the trap that the early computer pundits did – that of considering that the computer is nothing more than a big adding machine. I believe that, like many other areas, the Wired City has been talked about for 5-6 years but it is now about ready for implementation.

You might well ask, however, whether SDL needs to own a broadband communications company in order to develop some of the services outlined above. In our opinion and, as clearly outlined in our Five Year Plan, it is necessary for us to acquire the industry knowledge in other fields to go along with our own computer know-how. We did this when entering the health field by acquiring Shortliffe & Associates, as we really believed we needed a medical doctor if we were going to have credibility in this field. We did much the same with the Systems Research Group to gain the understanding and knowledge of the education field, and I project that expansions in this area are by no means at an end.

If we felt we needed a better foothold in a geographic area, we have also acquired expertise in that particular segment, as we did when we acquired Informatel in Quebec. All of these things we have added to our basic understanding of computers and what is needed to make them useful.

It is our intention, as stated in the Annual Report, at the Annual Meeting, and on numerous other occasions, to develop applications in the cable communication field which can be marketed to other cable companies in Canada and in the United States. To do this, we need a company somewhere where we can develop these applications in a controlled situation. We need a national demonstration point. We need the credibility that comes from having done something ourselves in the broadband field rather than just telling people what we might do.

This new industry is at about the stage the remote job entry computer was when we started SDL in 1968. There have been many experiments which have clearly demonstrated the customer acceptability of these services and I believe that now is the time to move these from concept and experiment into reality.

This can only be done if we have the people and the know-how in this field that is equivalent to that we have in the computer field.

By analogy, if SDL were to have started in the computer field without a computer, we would be nothing more than a small consulting company at this point in time.

BUT WHY OCL?

OCL is a well-respected, well-run, and very profitable cable company. This alone might make it a good vehicle for SDL. However, consider the following. It is in SDL’s geographic area, making the development and testing of applications particularly easy. Ottawa is a good area, with the fifth highest per capita income in Canada. It is a secure area for cable because of its relative isolation from American TV through any other means with few industrial areas, there is a high density per square mile, making OCL a particularly profitable cable company it has the advantage of being in the backyard of the CRTC who, undoubtedly will be most interested in the systems we will be developing

BACKGROUND ON OCL

OCL is a reasonably mature cable company with about 65,000 subscribers in total. Despite the stability of this base, there was a growth rate of about 15% in the actual number of subscribers last year and a continued growth of about 7% in the total market size. In addition, OCL has future growth potential up the Ottawa River Valley in the Pembroke/Renfrew area. The company is expected to make this year about $625,000 after tax. If we did nothing with OCL, this alone would make the company an interesting investment but this is clearly not our intent. In about another ten months, the OCL system will be wired for extended channel operation, and this opens up a whole new opportunity for profitable operation. In fact, Phase I of our development project will be built around this – i.e. charging a premium for the capability we will present by substantially broadening the range of services available in much the way Rogers Cable does in Toronto. The plans are well developed for this and we could reasonably expect additional revenue to start in 1975-76. The second part of this Phase I service will involve the development of a variety of badly-needed administrative services for cable companies. Any use of premium TV or other such services in the home will require a far more elaborate administrative system, including invoicing, accounts receivable, customer marketing aids, sales analyses, etc., than are presently available. It is our intention to use the experience of OCL, and some of our own experience in the field, to develop such packages which we believe can then be readily marketed to other cable companies in Canada. Once again, it would be reasonable to expect some revenue from these types of applications to start in our next fiscal year.

If we went no further than Phase I, I believe this alone would make the move to broadband services well worthwhile. However, during this period, we would also start experimenting with limited two-way use of the broadband network. This might involve a combination of the telephone and Cable TV to provide a Tele-Shopping Service. We might also expect during this time to start a limited In-the-Home Information Service. As some of the benefit of such systems would clearly be to other participating companies, we would expect that some of the costs of this development would be shared.

The Phase II Premium Service involving the applications noted earlier, would be developed over a period of several years and revenue would not expect to start from these major applications until the 1977-78 fiscal year. This would involve such projects as an In-the-Home educational service.

WHAT RISK IS INVOLVED?

The risk appears to be very small. We can pick and choose both the rate at which we want to add new profitable services and the amount we wish to expend to develop these. There are many examples we can take a look at in the United States and elsewhere which will give us a good feeling for the market acceptability of the many new things that are now being tried. The advantage of having our own cable system is that we can “test market ” very easily, possibly using programs or concepts developed elsewhere to ensure that what we are working on will, in fact, be a profitable operation.

Once developed, remember that the real potential is to use the credibility we have developed here in the same way we did in the computer services area to market such products and services to other cable companies.

One risk could be that this is a regulated industry. But we should remember that the regulation only involves a subsidiary which will obviously not be integrated with the rest of the SDL operations. Also, this exclusive franchise in a particular area can be considered a major advantage. If we were in open competition with other cable companies, we would have very little chance to market services we develop to others. We should also bear in mind that a number of the things we plan to develop will not in themselves likely be in the regulated area. In this area, we are making use of some of the finest technical and administrative advice we can find in Canada to ensure that risks in this area are at a minimum. I might also point out that the risks involved relative to the risks of starting SDL initially are infinitesimal.

WHAT ABOUT THE OFFER?

We declined to make the full details of the offer public, as this is only at the offer stage and, revealing all the financial details, would only invite counter offers for this very attractive company. However, as the closing date draws near, let me fill you in on same of the details. If the offer is accepted, OCL shareholders will receive 158,333 shares upon closing, and following CRTC approval and a further 139,705 shares to be issued on closing but to be released from escrow one year later.

I expect there will be very little inclination for anyone to sell shares in the present rather shaky market and many of the shares will not even be available for sale until perhaps 16-18 months from now. We should also bear in mind that the shareholders of OCL will also receive cash, which should lessen the chance that they will want to sell shares of SDL early.

The cash payment will be $1.7 million dollars on closing. For the remainder of the purchase price, SDL will issue interest-free notes. This will be made up of eleven notes of $250,000 each which will be paid quarterly commencing three months after the closing, and one note of $2,250,000 which will be payable three years after closing.

Using current interest rates, the actual discounted present value of the offer is about $10,100,000. This is about sixteen times current year “s earnings. This can be contrasted with a number of cable companies selling in the market at about thirteen times earnings, but one should remember that the price for a few trades in a weak market has no bearing on the price one would have to pay to gain control of a company. As you are well aware, if we tried to buy a company like OCL in the open market, we would quickly bid the price up to twenty times earnings or better. I might also point out that this is the maximum number of shares which would be issued because, if the average price of SDL shares at the time of closing is in excess of $15.00, the total value paid is $2,375,000 and the number of shares issued is calculated by dividing the average share price in excess of $15.00 into that amount.

Even if the maximum number of shares are issued, this still adds an after-tax earning of over $2.00 a share for those shares issued. It is further interesting to note that the eleven quarterly notes are more than financed by OCL’s own cashflow.

SUMMARY

The effect of this transaction will certainly be positive on the earnings-per-share of SDL over the years to come. We have been cautious about projecting any alteration in our own year ending June 30, 1974, because even if the deal is accepted by the OCL shareholders, it is not clear when CRTC approval will be granted. The offer is conditional on our receiving such approval by the CRTC no later than June 30, 1974, although this date can be extended at our option. If. we were fortunate enough to receive early approval by the CRTC, there might still be minimal effect on this year “s earnings, as we plan to follow our already-well-established policy of expensing development and we will have to put some development money as soon as possible into creating the administrative systems, referenced in Phase I. The effect would be, however, to help ensure that the projection, made many months ago, of about 65 cents per share after tax for this fiscal year, is realized. We have every reason to believe that this move will be looked on very positively by all levels of government who now realize the lead that Canada has in the cable communications industry and the likely export potential of products developed specifically to serve this new industry. We are excited about the potential of applications for the Wired City, and we believe this offer to OCL represents the best combination of a low downside risk with a very high upside potential.

I have talked about our proposed thrust into Wired City applications almost to the exclusion of the other things that SDL is doing. We should bear in mind that this is only one of a number of development areas for SDL and, even if we were to add the total revenue of OCL to our estimated revenue for this year and, of course, this is not possible, this would still amount to only about 18% of the combined revenues. Clearly, this will decline as a percentage of our revenue, as the other areas of service to government and industry continue to grow.

It is, however, an exciting and challenging new opportunity for profit for SDL, and I am confident that this will prove to be a sound investment of our substantial cash resources for the future.