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This board should be a friendly, quiet place to share in-depth analysis of Gilder-related stocks. I would like to get some discussion started, so I'll begin by writing up my findings about one particular Gilder company, chosen at random for no particular reason.

It would be great to hear what your opinions about TERN or their competitors are. I would also be delighted if others reading the Fool posted any findings about other Gilder companies here.

Terayon (TERN)

Today let's look at Terayon: a 1.3B marketcap company that's been a Gilder pick since the end of 1998. Its stock has risen about 70% this year. Has this been justified by achievements in the company? I say, not yet. At the end of 1998 when Gilder added the company to his list, the company was selected for the DOCSIS standards track and was in a perfect position to change its business model and benefit from Gilder's boosting. But in September the company's proposal was bumped off the DOCSIS 1.2 track. In this one development, the company's strategy to quickly gain a dominating lead was put in jeopardy. (At least, as far as I can discern.)

Before investing, I will be watching for signs that the company can get back on the DOCSIS track, or for signs that it is succeeding in a different growth strategy.

Let me explain.


When I began researching Terayon I was pretty unfamiliar with cable modem technology, so I started by reading a primer:

Also, I was unfamiliar with the company itself, so I read the management's discussion in their latest 10-Q. This is always a good exercise:

My findings are summarized below.


Terayon has a nice little business as the only cable modem maker selling cable modems that use S-CDMA, a form of Qualcomm's CDMA. CDMA is a favorite Gilder technology that allows multiple transmitters to share the a wide stretch of spectrum by sending large amounts of redundant information (the "code" in Code Division Multiple Access) at high bit rates and at low power. The code redundancy that allows multiple senders to be discerned from each other also makes CDMA highly tolerant of noise.

As Gilder observes (and cable operators seem to agree), Terayon's modems are better at handling noise than other modems (which all use forms of TDMA - "time" division multiple access). Withstanding noise is very important for upstream (customer to cable co) transmissions, which happen in the noisy low-frequency band below 50 MHz. However, it is not particularly advantageous in the downstream direction in the clean high-frequency bands above 50 MHz. Terayon's current pure-S-CMDA modems are slower for downstream links than standard TDMA modems.

Terayon has not gained any market share dominance yet. It mainly wins contracts where cable operators need to avoid expensive physical upgrades:

As cable companies move into the telephony-over-cable business, where upstream transmissions are expected to become as crowded as downstream transmissions, squeezing efficient bandwidth out of the noisy lower frequencies (upstream) will be important. Terayon hopes to eventually benefit from this trend.

However, there is a more immediate trend which is a wild card for Terayon. Cable companies are advocating a move away from diverse proprietary modems towards uniform open standards. In the U.S., the open standard is DOCSIS. S-CDMA technology is not yet part of DOCSIS, so Terayon is not currently benefiting from the migration to DOCSIS.

DOCSIS is controlled by CableLabs, a consortium of cable operators:

Terayon wants to add its S-CDMA technology into the next DOCSIS standard, DOCSIS 1.2. This would transform its currently interesting "feature" into a required "standard". Terayon's expertise in CDMA would give it a time-to-market advantage over all other DOCSIS modem competitors in the next-generation DOCSIS modem market. It would also give Terayon the possibility of new revenue from licensing technology or selling components to other modem makers.

Terayon's play to get S-CDMA added to DOCSIS is an attempt to promote S-CDMA from a "futuristic idea" to a "standard requirement". This is the classic Gilder reflexivity: the company can benefit in real business growth through the spread of technology religion.

But in the open standards game, your design needs to be accepted by a committee. This is a whole different can of worms than just building a product. Here is where Terayon's risk comes in. In September, the DOCSIS 1.2 standard (which was to be published this year) was derailed, and CableLabs stopped making commitments about timeframes in which S-CDMA would be added to a DOCSIS standard. Here is a brief history.


Originally IEEE 802.14 was formed to create an international cable modem standard. However, the process was taking too long for US cable companies' needs, so a number of them joined together to create their own standards group and began work on a US standard called DOCSIS. The company directly responsible for DOCSIS is CableLabs.

DOCSIS 1.0 defined TDM (QAM and QPSK) schemes that achieved about 27 to 36Mbs downstream and 0.5 to 10 Mbs upstream. DOCSIS 1.0 modems are beginning to be widely deployed today.

DOCSIS 1.1 added QoS (Quality of Service) layers on top, but did nothing to improve upstream bitrates. QoS protocols provide guarantees of the kind you need to run a telephone call without interference or a video stream without degradation: they let you allocate a fixed amount of bandwidth and prevent others from bumping into your allocated stream. (Gilder thinks that QoS protocols are not very important compared to innovations that give you higher bandwidth.) DOCSIS 1.1 is currently the latest published and implemented standard.

DOCSIS 1.2 proposed adding improved physical layer technology to improve upstream bandwidth. This work on the standard was started in 97, and the project was terminated in September 1999.

When Gilder added Terayon to his list at the end of 98, things were looking good for the company. After a few false starts, the DOCSIS 1.2 commitee had evaluated four competing "advanced PHY" technologies to improve upstream performance and picked two: FA-TDMA as specified by Broadcom, and S-CDMA as specified by Terayon. (They beat out Ultricom's VCMT and ADC Telecom's OFDM. Ultracom was the main loser.)

The goal in naming two techniques (rather than one) to the standard was to "get the best of both techniques" into the standard. I think this was a big mistake: the DOCSIS group should have just made a decision in 1998 and they should have picked one winner. Instead, they chose two winners and left the details to the IEEE 802.14 working group.

Here is a white paper on Terayon's innitial CDMA tests:

After working for nine months, IEEE 802.14 finally put out their advanced PHY proposal. But then there was a problem: the proposal left some technologies optional and left some technical problems unresolved. There were too many holes and the whole process had already taken too long. So CableLabs threw out DOCSIS 1.2 and gave up on IEEE 802.14.

They decided to move FA-TDMA features into DOCSIS 1.1, a victory for Broadcom. They promised that S-CDMA would be reconsidered at some future unspecified date as "DOCSIS advanced PHY", if Terayon could furnish a working prototype that addressed CableLabs' technical objections. It was bad news for Terayon.

Terayon had been preparing to be the first on the market with a DOCSIS 1.2 modem. With the elimination of DOCSIS 1.2, the best they could do is offer a DOCSIS 1.1 modem "with S-CDMA features added". This was a much weaker position.

(By the way, did I mention that Cisco owns a significant portion of Terayon? If you own Cisco, you own Terayon.)

I have interpreted the September decision as all bad for Terayon, but perhaps it's not as bad as it looks. If somebody reading this knows anything about this, it would be great if you could post any information.

One interesting development this November was that the CTO of CableLabs joined Terayon. I don't know what this means, but it's probably a positive sign for Terayon.


So, things are not looking as rosy for Terayon as we might have hoped at the beginning of 1999. I won't be investing today.

What could change the story? I will be looking for one of a few possible positive developments.

(1) Terayon quickly gets back on track and satisfies CableLabs with a prototype of DOCSIS advanced PHY. If they can do this, I think this would put Terayon in a comparable position as Broadcom: Terayon would get a commanding role in the market, and would deserve a significantly higher valuation. (Broadcom is currently worth about $23B to Terayon's $1.3B)

I have hopes that they will be able to do (1), but I was very disappointed in their September blunder, so I am witholding a prediction.

(2) Customer demand for S-CDMA proves overwhelming despite the lack of DOCSIS standardization. This would happen, for example, if Gilder succeeded in convincing the whole industry of the need for S-CDMA. I don't think this is happening yet, but if it happened it might be even better for Terayon than DOCSIS, because it would be more difficult for competitors to follow in their tracks.

(3) Broadcom expresses an interest in purchasing Terayon. I think this would lead to quick inclusion of S-CDMA in DOCSIS, and would further increase Broadcom's lead in the cable modem component business.

Let me know what you think,

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