That has to be good news for a group of small caps focused on various areas in the digital media space. For the moment, the overall market segment is dragging many small caps down, but perhaps this HD transition may serve as a catalyst to help prop them back up.

For instance, Prague-based KIT digital (Nasdaq: KITD, http://www.kitd.com), which provides internet protocol-based video asset management solutions, reported record second quarter results on Aug. 16 with revenue up 120 percent year-over-year to $23.1 million. No doubt some of that growth came through acquisitions, but it seems to show that the HD transition could be helping them as well. The stock price was dragged down last week like many small caps, from $9.49 mid-week all the way down to $8.49 mid-day Aug. 23, which could indicate an opportunity if the market rights itself sometime soon.

San Diego-based DiVX, Inc. (Nasdaq: DIVX, http://www.divxnetworks.com) also reported a strong second quarter Aug. 4, only to have its stock price weakened shortly afterward. The company, which provides video compression-decompression software and digital video technologies for digital televisions, Blu-ray players, set top boxes , recently announced it would be acquired by Novato, CA-based Sonic Solutions (Nasdaq: SNIC, http://www.sonic.com), which develops products and services to manage digital media content. Its stock is trading at about $7.67, down from its 52-week high last spring of $9.02. Sonic’s stock has been on the rebound since dropping to $7 July 20. On Aug. 23 it was trading at $7.86.

Pompano Beach, FL-based Onstream Media (Nasdaq: ONSM, http://www.onstreammedia.com) reported sequential growth of 7.2 percent over its fiscal year second quarter on Aug. 16 but relatively flat numbers compared to the same period in 2009. Onstream, an online service provider of Internet broadcasting, corporate web communications and virtual marketplace technology, recently debuted its MarketPlace 365 platform for virtual tradeshows, which President and CEO Randy Selman called a “game-changing technology” because virtual tradeshows could become a growth driver as companies want to extend existing physical shows. Subway is the first customer.

As for ViewCast, CEO Stoner reported 26 percent top line growth year-over-year and the third consecutive quarter of sequential improvement. Highlights of the second quarter included the debut of its ViewCast Media Platform (VMp) at the National Association of Broadcasters tradeshow.

* Denotes Allen & Caron client

As users shift to new modes of communicating on the open web, they are pulling these new models into the enterprise and ushering in cultural and organizational change. This report covers the underlying technological trends, the market and its drivers, and a competitive overview of the vendors.

We do not recommend stocks.  We assume you will do your own diligence.  We simply talk about companies that interest us.

There are way more nonpublic companies than public.  If you look at some of the more visible public companies, they would include Dubai- and NYC-based KIT Digital (EBB: KDGL, http://www.kit-digital.com), which includes names that are recognizable to people who have prowled around this territory: The Roo Group, Narrowstep (assets only), and others.  A triple-play competitor with a foot in each of 3 methods of dissemination, KIT Digital may also be the only player in this space that seems like it may be poised to (a) break even on cash and (b) be profitable some time soon, leaving aside acquisition write-offs, since KIT has been an active acquiror.  KDGL shares are trading at $8.75 vs a 52-week high of $15.40 (there was a reverse split that creates anomalies in pricing), on fairly low volume of 7,000 shares and a market cap of about $40 million.

Pompano Beach, FL-based Onstream Media (Nasdaq: ONSM, http://www.onstreammedia.com/)  is another “familiar” name, but seems like it may be slipsliding these days, according to their update news release dated April 22.  They apparently backed out of an announced acquisition of the remains of tech innovator, Narrowstep, allowing KIT to pick up the choice piecese, and leaving the corporate shell behind with David McCourt, who is now seeking damages for the breakup.  Then ONSM raised a fairly draconian $750,000 to $1 million in loans with the first repayment due in 2 weeks, and interest at 12%, as well as 1.5 million shares.  ONSM has also been notified that it is liable to suspension from Nasdaq.  Nonetheless, ONSM claims illustrious customers like AXA Equitable, BT, Dell, Disney, MGM, PR Newswire and even Shareholder.com (part of Nasdaq), so it is not to be discounted.  Its shares are trading at $0.26 vs a high of $1.03 on average volume of about 62,000 shares and a market cap of about $11.3 million.

There are various players in the device side of the IPTV business, including Plano, TX-based ViewCast Inc* (EBB: VCST, http://www.viewcast.com), which makes products that capture, digitize and manage content.  In spite of reporting net income for 2008 (which becomes negative with dividend payments, complicated, but not troublesome), ViewCast is selling for a discount to last year’s revenues of $17.4 million, with VCST shares at $0.34 vs a year-high of $0.54 and a market cap of $12 million.  Current ratio of almost 3:1, and cash in the bank.  Go figure.  If you wanted to see a privately held company in an allied area, you could look at Canada’s Markham, ONT-based Digital Rapids, http://www.digital-rapids.com or Australia’s Vividas (http://www.vividas.com). 

Clifton Park, NY-based On2 Technologies (NYSE Alternext: ONT, http://www.on2.com/)  is in the video compression biz too, and its shares trade very robustly at $0.36 — average volume of 500,000+ shares, for a market cap of  $62 million.  Clearly a lot of fans, even though the stock is about a third of its year-high of $1.06.  Santa Clara, CA-based MacroVision (Nasdaq: MVSN, http://www.macrovision.com/) is a much larger company in this space, market cap of $2.1 billion, stock price of $21.10 (a new 52-week high today). 

The swarm of smaller companies is impressive — and hard to find out much about.  Most of them present themselves on their websites as virtual — it is frequently hard to figure out where they are based. They include Atlanta-based Endavo (http://www.endavomedia.com);  NY-based Verticom (http://www.verticom.tv), which is the current location of former Narrowstep Pres Carolyn Wall;  Mountain View, CA-based Verismo Networks (http://www.verismonetworks.com); NY-based NextNewNetworks (http://www.nextnewnetworks.com); EQAL (http://www.eqal.com) — about which see this burbly HuffPo article: http://www.eqal.com/2009/04/30/the-future-of-entertainment-eqal/.  It would continue with NY-based BlipTV (http://www.blip.tv), which has a homepage that is worth seeing for its entertainment value.  And of course there is the seemingly UK-based Babelgum (great name, right? http://www.babelgum.com), and another familiar name, Joost (http://www.joost.com).   There are lots more of these small nonpublic companies, including the tantalizingly named ZillionTV (http://www.zilliontv.tv),  and they should start to pepper us with reverse mergers, VC investments and IPOs over the next couple of years, that is, if they survive and no one buys them first. 

The M&A and investment banking opportunities seem virtually endless, and some of the banks to watch on these deals are BMO Capital Markets, Merriman Curhan Ford, and Jefferies Inc.  But there are lots of others too.  And notice that I wrote this whole article without mentioning Hulu and YouTube (until now).  LOL.

*Allen & Caron client

CNN Money just announced that a seeemingly unending appetite by marketers for online video has led them to invest in a much larger slate of online programming including additional online news programs.  Driven by advertisers, this move is in lockstep with others including FOX and CNBC and it forshadows whispered plans by the old guard “three letter” networks as well.  Even the social networkers are getting into the act as Facebook and Twitter have both become major referrers to online video content (http://newteevee.com/2009/03/06/changing-nature-of-virality-facebook-and-twitter/)  The verdict seems to be in, despite the early doubts of baby boomers, people are turning to the web for their fix of moving pictures and it is spawning a healthy group of new industries that warrant a close look by investors. 

Wall Street analysts seem to be in agreement that media content is universally shifting from offline to online and that the shift will create a decade-long adoption curve for digital media, content creation and infrastructure.  So who will benefit from this sea change?  There are a few ways to approach the question.  Streaming media is delivered via broadband access and the growing capacity of the “pipes” that deliver the content.  The bottleneck between the content and the computer is easing as will the bottleneck between the computer and the TV ( “home theater” for you folks in the OC).  These infrastructure needs will be filled by larger companies including telecom, cable operators, etc.

For the small cap investor, the best places for participation may be the vendors creating the nuts and bolts technologies surrounding the generation and delivery of the content to the various internet protocols that are a long way from being standardized.  Those players range from startups to .com-boom survivors and they seem to be gaining steam and getting funded, even in a disastrous economy. They can loosly be categorized into a couple of segments – content management and video compression, encoding and streaming.

Content management is the manipulation and delivery of the digital content, making it available and deliverable to the end user – think on demand videos or YouTube browsing (www.youtube.com).  These companies include MacroVision (Nasdaq:MVSN) (www.macrovision.com), OnStream Media (Nasdaq:ONSM) (www.onstreammedia.com) and Kit Digital (OTCBB:KDGL, a new symbol subsequent to a reverse split effective March 9, 2009) (www.kitd.com).

Compression, encoding and streaming companies create the hardware and software that make it possible for the content to travel from the front of a camera into the digital domain and then accommodated for viewing on a number of web-based viewing platforms.  Interesting companies in this space include On2 Technologies (NYSE Alternext US: ONT) (www.on2.com), DiVX, Inc (Nasdaq:DIVX) (www.divx.com) and Vividas.

One company, ViewCast, Inc (OTCBB:VCST) (www.viewcast.com), which has a long history of steady growth, has historically played a key role in the encoding and streaming side of things, but last week announced that it was making a bold leap into content management with its purchase of Ancept, an IBM-platform company that will allow ViewCast to drive additional revenues, take another link in the value chain of streaming media and likely take a greater share of attention on Wall Street. ViewCast is an IR client of the publisher of this blog.

Regardless of your approach to playing the online video opportunity – do play it.  It has become a part of the media fabric across the globe and will soon overtake traditional television as the medium most watched.