|Shares Out. (in M):||49||P/E||10.0x||7.4x|
|Market Cap (in $M):||1,100||P/FCF||-||-|
|Net Debt (in $M):||-327||EBIT||73||130|
The team at our family office tries to approach investing with a balanced mindset. In contrast to larger capital allocators that often get caught in the institutional imperative, we take pride in the flexibility of our thinking and our pursuit to remain creative and open minded in our investment process.
By striving to see things from varying perspectives, we tend to fish where others might choose not to; this way, our opportunity set is kept fresh and varied.
Our flexible approach doesn’t mean we don’t rely on a solid foundation of time-tested principles – after all, we consider ourselves value investors, wanting to buy a dollar for fifty cents with a margin of safety embedded in our assumptions about the quality of a business, its valuation and possible risks. However, we are careful not to confuse discipline with dogma and strongly believe in the evolution of markets and our need to understand what changes and what stays the same.
By keeping our views of the world dynamic, we feel we can learn, adapt and seek out value in unique places. For example, our perpetual time frame is a clear advantage and luxury in this market. We are willing to make investments without catalysts and where the bulk of value comes from the tail end of a stream of cashflows.
In our allocation across asset classes, we spend a significant amount of our time evaluating other money managers that possess the track record and expertise to put our capital to work alongside theirs.
Evaluating other investors isn’t a simple task and, not unlike investing in stocks, it is as much art as it is science. Our process has helped us appreciate the variety of philosophies, styles and approaches that can ultimately lead to good risk-adjusted-returns. Whether it is timber, annuities, venture capital or frontier market stocks we tend to look for certain common elements in the teams we entrust our capital with.
The above background is a longwinded introduction to one such asset manager that we like in a very unique asset class that we think has lots of potential. I present to you Acacia Research Group (ACTG).
Acacia Research Corporation (ACTG) is an industry leader in patent licensing. In a nutshell, its business model consists of partnering with inventors and patent owners (universities, research labs, corporations, VCs…) to package a portfolio of patents that in turn get licensed to corporate users. ACTG usually will strike a revenue 50/50 revenue share agreement.
As of April 2013, ACTG has generated approximately $936 million in licensing revenue. Through its subsidiaries the company controls over 275 patent portfolios (29% CAGR), covering technologies used across a wide variety of industries (semiconductor, wireless, automotive, medical, energy, and dozens more…).
Acacia has closed 1,200+ licensing agreements covering 154 technologies and been to trial only 4 times in 10 years (something to keep in mind for discussion below).
ACTG’s TTM revenue of $250 MM is still in early stages of revenue potential for existing portfolio base – which represents ~39% CAGR over six year time-frame. In simple terms, the business is driven by portfolio growth, which leads to revenue-producing licensing programs (that hold dozens of patents and agreements), which then turn into licensing revenue.
Intellectual property (IP) is an important asset class worldwide. It is a central component of innovation, and is at the heart of our knowledge driven economy – which represents a growing piece of the total pie.
Intellectual Property: center of innovation and value creation in world economy
The ability to monetize and market IP, however, has become increasingly difficult for patent holders without a licensing partner. With a sole focus on this market Acacia has become the dominant player in the partnering / licensing model.
By scaling and expanding licensing programs of existing assets to more licensees, the company continues to generate cash that helps fund its growth in acquiring more partnership programs.
No shortage of controversy; Legal Overview
ACTG isn’t only misunderstood; like a tobacco company, it is essentially universally hated and vilified. Labeled by many a “patent troll” -- Acacia is ceaselessly attacked by politicians, the media and by corporations who view it as a cancer for innovation.
Here is a good opinion piece that provides some context on the – who is a patent troll? – question: http://b.globe.com/11BQc0v
Indirectly, Acacia has become a poster child for everything that is wrong with the legal system and – together with other so-called patent-trolls – have come to represent the increasing bureaucracy and legal risks of engaging in entrepreneurship and innovation.
The truth, however, as the op-ed piece suggests is so much more complicated than the political rhetoric would have you believe. Yes, the legal system is broken and sweeping tort reform is desperately needed. Yes, some law firms and scam artists abuse the threat of litigation to sue and extort through frivolous claims. Yes, these people indirectly tax the whole business / entrepreneurship / innovation ecosystem.
When it comes to patent infringement, in many cases firms are unaware they’ve violated someone else’s property rights, and thus are very surprised when a claim is made against them. In the process, they become a defacto victim themselves - given there was never any intent of wrongdoing. However, does that mean if someone unknowingly, yet unlawfully, makes use of your property you should just look the other way?
In our opinion, prior knowledge or not, the point is moot. The essential most basic component of our capitalistic society, and arguably the most critical aspect of the west’s prosperity, is the ownership of property and the contracts and legal rights attached to it. A robust legal system to enforce these rights, despite the bureaucracy and unwanted externalities it might create, is absolutely necessary and does more good than harm.
I didn’t go to law school, by no means am I a legal expert, and like most people, I am appalled to read about obscene hourly legal fees / legal costs incurred to enforce some pretty absurd and silly cases. But having grown up in a country where corruption is rampant and rights of all kind are arbitrarily violated, I have come to appreciate the US justice system and its contribution to the vitality and dynamism of its economy.
O.K. enough of the rant. Can the legal system be more efficient? Yes. Should the government strive to reform it? Yes. Can reform squash the rights of lawful owners to enforce their property right? Absolutely not.
Should patent trolls worry about the Shield Act, Patent Act and America Invents Act? Certainly, but if you look at the provisions being proposed closely it is pretty clear that Acacia will be largely unaffected.
Paul Ryan, the CEO, has actually said that the most recent “executive actions” by Obama are a net positive for Acacia. The truth is Acacia is tired of having its reputation tarnished and would favor reform that puts a stop to the frivolous lawsuits.
Curbing abusive tactics that target downstream mom-and-pop end users by enforcing overly broad and low-quality patents, that are arguably worthless, has to be stopped. Shakedowns and extortion through the legal system is too prevalent. It is worth noting that Acacia views itself to be in the transaction business not the litigation business. Here is an interesting quote from Ryan:
“The patent market has been extremely inefficient, and over time with any new asset class there will be a variety of business formats that rationalize the process that make the markets more efficient. Historically, the only way you can get paid for a patent, and pretty much 99% the way it is today, is you have to resort to the legal system in order to transact. You'd literally have to sue another company or they generally will not talk to you. And if you talk them inappropriately, they can countersue you. They can file a declaratory judgment against you for just offering a license. So the structure of the market place really requires a lot of enforcement. Fortunately, we're far enough down the road, we've done so many deals that we have legal arrangements with a lot of leading companies where both sides preserve their legal right and can enter into arms length of discussions without litigation. And we think we'll be moving more and more in that direction, which is great for our shareholders and great for our IP partners because it lessens the friction cost of all the lawyering, improves our margins.” - Paul Ryan, CEO of Acacia
This write-up is an extension of a power point presentation I recently worked on for a group of investors. Please reference it here: https://www.dropbox.com/s/olgdp1z5k6x0jrq/Acacia%20Research%20Presentation.pdf
The basic premise of the thesis is that ACTG is an attractive play on the growth of IP as an asset class -- by investing in a specialized IP asset management firm with the technical / engineering / legal expertise to essentially buy, sell and make a market in an large and growing, but still pretty inefficient market.
The business model is quite attractive – scalable, capital-light and high-return/margin -- and has a number of similar characteristics to that of a traditional asset manager. Essentially, growth in AUM – in the form of patent portfolios – is the key leading indicator to future revenue growth and margin expansion as scale is achieved.
Of course, the key driver to driving portfolio growth is human capital. Acacia employs 55 people in Newport, CA and about 30 of them are IP investment professionals who have the backgrounds, the industry contacts and possess the skills to shop around and underwrite a portfolio of patents in their respective verticals. These “analysts” (official position titles are usually VP’s of Engineering) provide the basis, fundamentals and thesis of say, a patent portfolio of automotive airbag / sensor technologies or virtualization software used in cloud computing, and then evaluate the potential for enforcement and commercialization with business development, licensing and legal experts at the firm’s headquarters.
In conversations we’ve had with management and a few of their VP’s it’s clear that their due-diligence and decision making process is very much focused on generating attractive risk-adjusted-returns. They aren’t looking for home runs, instead focused on singles and doubles. They use words like NPV, IRRs, time and risk-adjusted returns.... Everybody involved is pretty aligned as incentive compensation is linked to incoming deals and performance in addition to the stock-heavy compensation structure. Upper management also seems to think the stock is a bargain buying up stock in the open market (insiders own ~3%).
Their track record and approach to underwriting IP investments is quite impressive. Here is a slide from the presentation that I think is worth highlighting:
A unique feature of their business model is the variety of ways they can structure a deal with a potential IP partner. Please check out the PowerPoint for a complete overview. Here are some points that describe the basic sales-proposition to IP owners:
By partnering with legal firms on a contingency basis and structuring revenue share agreements with both small and large firms they essentially own free / or very cheap options on portfolios that can generate potentially hundreds of millions of dollars without much up-front investment. It is worth noting that because of these minority / shared interests ACTG’s balance sheet doesn’t reflect a lot of the IP they own.
More recently, however, as ACTG has gained scale the full outright purchase of entire portfolios has also proven to be a great source of profitable returns.
In addition to approaching valuation by looking at multiples on our expectations for revenues and earnings in the next few years (see presentation); we also can approach it by using a SOTP of sorts, and estimating and the potential revenues for monetized IP, un-monetized IP and new IP.
Using past performance, monetization time-frames / and trends as a guide we can get a ballpark idea of the revenue potential, GM profits and required opex and capital needed to get them there. Note: the new IP essentially is a proxy for a terminal value estimate since it is value we believe will be created through future deal-making; however to be conservative we don’t capitalize it indefinitely (offset by discounting it fewer years). Some difficulty arises in estimating the timing of the CF’s since the business model is clearly lumpy. Nevertheless we discounted the entire cashflows on a weighted basis to arrive at our PT of $38 for 2013. This is essentially a DCF looking out 4 years out taken to the present.
Thesis Overview & Summary
|Subject||RE: RE: Few times/questions|
|Entry||07/01/2013 04:10 PM|
Thrive, sorry to hijack the thread, but would you mind addressing the questions to your comment on PDI? Don't care if you read the link in my post. I just would like you to elaborate on your comments, and whether there is a lag in reporting their NAV) Thanks.
|Subject||RE: RE: RE: Few times/questions|
|Entry||07/01/2013 05:09 PM|
I replied at the PDI thread. thx
|Entry||07/01/2013 05:14 PM|
Try either of these:
|Subject||RE: RE: RE: Few times/questions|
|Entry||07/03/2013 07:55 PM|
We have basically approached it by extrapolating the historical performance of portfolios. The delta is wide in terms of what a typical portfolio will produce - as low as 500k up to $50 MM - but trends are only improving. The ppt slides linked above provides an overview of how we think about analyzing the portfolios.
It is worth highlighting that legacy, brand new and incoming portfolios all have tremendous runway; so it comes down estimating lead-times for pursuing more licensing agreements (which can take 12 - 18 to put together and then start cashflowing). As long as they keep up with what they've done in the past, which there is evidence to suggest they will, they will experience stronger growth and profitability. The best leading indicator for growth is the reported # of portfolios.
Our conviction in terms of the earnings power is also a function to analyzing particular portfolios that have clear potential...We are optimistic about the Adaptix, Nokia-Siemens, Rambus portfolios and think their pipelines in energy, medical technology and automotive are extremely strong. These are being put together as we speak and will start generating revenues for many years to come.
Finally, there is a TON of deals they could potentially bring in if they some of the 800 lbs R&D heavy corporations start buying into the benefits of partnering with Acacia. Its a win win, IMO; so the likelihood they can establish some of those relationships is huge. I am not factoring these potentially transformative deals though, but I know they are working hard on selling their model to some big names.
|Subject||a few more questions|
|Entry||07/12/2013 02:52 PM|
thrive, thanks for the interesting idea, I am doing a little more digigng after watching this company from afar for a few years. However, so far I am uncovering some issues which I'd be curious to get your take on. You note that the company has generated an average of $6M or so per patent portfolio and take them at their word that there is another $9M to go. However, when I look below the surface it seems like the vast majority of their settlements are for a few hundred thousand dollars per portfolio and there are two significant patent portfolios- the Palm smartphone patents and the Adaptix 4G patents acquired last year- that have done well over $100M in revenue apiece. The company has indicated that the Palm patents after the $50M Apple payment in the first quarter are near the end of their economic life. That seems to leave a pretty big hole to fill just to stay even in revenue, much less put up the kind of growth you are talking about.
The Adaptix transaction is particularly troubling to me, not because I think it will be a bad deal but because I actually think it masked a significant deterioration in the rest of their business in 2012. If you look back to the end of 2011, analysts had about $260M of revenue and $105M of EBITDA modeled for 2012. This is before outside analysts knew about the purchase of the Adaptix portfolio, which cost the company $150M in cash in Q1 and was immediately licensed to MSFT and Samsung for $75M for a net acquisition cost of $75M. I think the company has said they did $100M in total Adaptix licensing in 2012, and given the minimal costs (obivously the first two deals were in the bag when the deal was signed) it had to have been at least $90M of EBITDA. So without this big, one-time transaction- that required a big outlay of capital- the company would have produced only $150M of revenue and $55M of EBITDA, far short of 2011 results on revenue and initial 2012 analyst expectations on both counts.
By the logic of your analysis, since the company increased its number of patent portfolios under management in 2011, year 2012 should have been up in revenue and EBITDA outside of the Adaptix acquisition. But unless I am missing something, it wasn't- it was actually down in revenue and roughly flat in EBITDA with much higher patent acquisition costs, which I will get to later. That makes me question how we can be confident of growth in 2013 and 2014.
The really cynical among us might theorize that the company saw a miss coming in 2012 and went out to fill the hole with M&A. The company did big equity offerings in 2011 and 2012 in the low and mid $30 range despite being very profitable, I guess the optimistic read is they thought they could put capital to work effectively but the pessimistic read might be that they thought their stock was overvalued at those levels and they would rather trade their stock for cash. Or maybe that their core business of partnering with patent owners was slowing down so the only way to grow was to spend a lot of money acquiring patent portfolios on spec and try to monetize from there.
If you think about it, in this model you could create pretty much any revenue and EBITDA number you wanted in a single year provided sufficient capital. From what I can tell the company is amortizing the Adaptix patents over 10 years so roughly speaking in 2012 they bought Adaptix for $150M, recognized $100M of revenue, maybe $10M of operating costs (and it could have been much less) and $15M of amortization for total EBIT of $75M- making the transaction look fabulously profitable (for 2012 at least) even though it's obvious it will be a negative IRR deal unless they get a lot more license revenue in the future. As IDCC, VHC and UPIP would tell you that may be a lot easier said than done.
For some reason, the company got a lot more capital intensive in 2012. Even outside of the $150M paid for Adaptix, Acacia had $178M of patent acquisition costs vs. only $14M in 2011. I don't know whether any of these other acquired patents contributed materially to results, but for whatever reason the company is having to spend a lot more money to generate continued growth.
Do you have a view of whether any of the non-smartphone patent portfolios are going to be worth a lot? It would seem to get to $340M of revenue in 2014 with minimal contribution from the Palm patents and uncertain contribution from the Adaptix patents could be a big stretch given the performance in 2012. I guess that the hope is that some of the 2012 non-Adaptix patent portfolios they bought generate multiple settlements in the 10s of millions. This is certainly possible- and it's logical that it might take some time to monetize the other patents they bought in 2012- but without knowing what those were and the monetization potential it seems like a tough bet to make.
|Subject||RE: a few more questions|
|Entry||07/18/2013 06:54 PM|
Hi Special, sorry for the belated reply. I unfortunately can't provide a very thoughtful and detailed response at the moment - but I will say, you definitely touch upon some valid concerns that could indeed be red flags. On the other hand, the sell side has been frustrated in trying to model ACTG's business from day one. The Adaptix deal did seem to mask an otherwise weak year with respect to analyst expectations, and the average revenue per portfolio has actually been heading in the wrong direction, but I am not sure we can conclude much from this other than the fact that this is a lumpy business -- even on a yoy basis.
The transition into their more capital intensive, upfront advance-payment and full-purchase model, I don't think is being used to manage revenues or earnings (but I agree it is technically possible); in fact, they are pretty explicit in calls about the challenges of quarterly reporting and have expressed their frustration with the market for being penalized for essentially doing the right thing and not selling licenses for less than they are worth.
It all boils down to timing. 2012 deals should start generating peak cashflows right about now -- but that is based 100% on past performance. The $10 - $15 MM portfolio estimate is the same story. Has something changed? Has the low-hanging fruit been picked? Perhaps...but management has indicated there is less / not more competition. The target IRRs on the big deals are high - aiming for 2-3x money. I think the Adaptix will still bring in $100 MM+ in future years as there are many infringements. Management is pretty confident the new verticals and newly acquired / structured deals in the automotive / energy / med-tech all have $100 MM+ potential.
If you believe the IP market is competitive and efficient, or that it will be prohibitively more expensive to enforce, thus diluting returns - then I would say stay away. We only got comfortable with the unknowns by meeting them in person. We haven't underwritten the portfolios and today's results caught us off guard, so we will likely do our best to ignore the short term results, and see if it indeed plays out as we expect long term. Not sure this is very helpful.
|Subject||RE: RE: RE: a few more questions|
|Entry||07/19/2013 12:42 PM|
Mojo, thanks for the feedback and I actually don't think you are being unfairly critical. This is indeed a controversial idea for value investors that want a clearly defined margin of safety and a measurable estimate on the risk / reward. I think your take on our "edge" -- or lack thereof -- is also precise; we don't claim to have particular insight or skill in underwriting or valuing IP. But we have learned to evaluate money managers over the years, and believe we can distinguish the talented ones -- with a credible strategy and process -- from those that might have gotten lucky with a few trades over the years.
We are approaching Acacia in a similar manner. As with Markel, we've sat down with the VPs who do the actual underwriting of deals, and have left each of those meetings feeling very comfortable with the way they think about their respective vertical. Can this be replicated, is this a source of competitive advantage? Technically and structurally, probably not, but similarly to finding the rare hedge fund with a talented team that has highly specialized knowledge in a certain strategy or market, they seem to have a solid business plan and team to create value. I realize that saying that meeting them in person, or evaluating and making a judgement on their underwriting skills based on historical performance, might seem downright reckless to investors who want to create detailed bottom up models for every moving part of a business. And I admit this wouldn't be the first time that we've been wrong on a "manager". Perhaps we are drinking the kool aid of the IP market being large, growing and uncompetitive -- but I still like the idea because I think there is significant potential beyond the existing assets and pipeline, and their model and value proposition makes a lot of sense for IP rich owners. Like I said in the writeup, they aren't a bunch of lawyers -- like most real patent trolls -- sitting in a room, thinking about buying cheap patents andan can generate a quick ROI through legal extortion.
Having said all that, I agree the intermediate term numbers are mixed. We are not ignoring them by any means, but we will sit tight and wait to see if these new deals and their transition to their relatively new advance / purchase model pays off.
Given that we've only recently gotten involved, and are excited about the recent new hires, I want to emphasize that a big component of where we see value is in the intake they are / will generate with the new talent. Despite raising and using working capital to invest, this is still a reltively capital light business model that is deal-driven very much like a PE or IB but with embedded fees in the ownership structure. So if we are right about the IP story and the talent, even if certain vintages sour, I think we will be okay.
|Subject||Supreme Court to review patents on software|
|Entry||12/06/2013 02:31 PM|