Kudelski shares drop sharply amid concerns over cracked encryption system

6 February 2008

ZURICH – Kudelski SA shares dropped sharply Wednesday as the Swiss maker of encryption cards for TV set-top boxes suffered a double hit on mounting concerns about the viability of its partnerships with Germany’s Premiere AG and US-based EchoStar Corp.

German pay-TV station Premiere, a major customer of Kudelski, said hackers have circumvented the Swiss company’s security software, to the point of hurting fourth quarter sales. Premiere said earlier Wednesday it is talking with Kudelski and other vendors about a new encryption system.

Shares in Kudelski, based in Cheseaux, Switzerland, dived 16.5% to CHF16.28 during afternoon trading Wednesday.

“There’s quite a risk Kudelski will lose Premiere as a client,” Helvea analyst Thomas Hilfing said in a note to investors. He estimates this would cost Kudelski annual revenue of about CHF22 million.

Kudelski had sales of CHF756 million in 2006.

A spokesman for Kudelski said the company was fully aware of the problems at Premiere. He said Kudelski was confident it will continue to work with Premiere. The contract with the German company is set to last until 2015.

“For us it is business as usual,” said spokesman Rodolfo Cucci. “We will replace the cards in question. This is part of our contract.”

Still, analysts said that Premiere could seek a new partner and file a liability lawsuit against the Swiss company.

“Either way, it doesn’t look good,” said Mark Diethelm of the Zuercher Kantonalbank, adding that a continuation of the partnership with Premiere would still mean that Kudelski has to replace existing software at its own cost.

Retaining the contract with Premiere has worried Kudelski investors ever since Rupert Murdoch’s News Corp bought a near-15% stake in Premiere last month. News Corp is also the largest shareholder of NDS Group PLC, Kudelski’s major competitor, causing fears Premiere would switch to the British company’s security systems.

Premiere company spokesman Torsten Fricke said that the breach of Kudelski’s software could have negative effects. “But there could be positive effects as well, if viewers who don’t pay for our service right now due to piracy become subscribers after the security gap is closed,” he told Dow Jones Newswires.

Premiere said Wednesday that piracy in the fourth quarter of 2007 could adversely impact the company’s earnings guidance for 2008, which it is due to present February 14.

Concerns rose further after Goldman Sachs cut its rating for Kudelski Wednesday, to sell from neutral, and dropped its target price, citing fears that a US recession would hurt EchoStar – Kudelski’s largest customer in that region.

Goldman Sachs said a recession would hurt the US firm’s ability to attract clients for its pay-TV services, which use smartcards for decoders provided by Kudelski. The broker also estimates Kudelski has close to CHF250 million francs of revenue directly exposed to the declining dollar.