Description

Acacia Research Corp (ACTG) is a patent monetization business that has undergone a sweeping transformation without gaining much attention from the market. In 2018 the prior management team was ousted by shareholders after an activist proxy contest. Acacia is now led by two participants of the said activist group – CEO Clifford Press and Chief Investment Officer Alfred Tobia.

Since their victory, the new management has: reinstated earnings calls, reconstituted the Board with independent directors who are experts in the IP space, and brought back former IP expert Marc Booth to serve as Chief IP Officer (Booth previously served at Acacia between 2006 and 2017 as Executive VP). In addition to governance improvements, the team has worked to set up a beneficial partnership structure in which to execute a refocused strategy.

This revised strategy expands from Acacia’s historical focus on patent monetization and seeks to transform the company into an absolute return vehicle for investing in patents, royalties, acquisition opportunities and shareholder activism in smaller public companies (with a particular interest in those owning patents, royalties, and/or tech that can be monetized). In executing their new strategy, Acacia has partnered with Starboard Value, a high-profile activist fund manager with an excellent track record. This deal will see Starboard contribute capital to Acacia while also providing deal flow and expertise.

The deal with Starboard plays a big role in this thesis so let’s review what’s occurred so far. The partnership was first announced in November 2019, and starts with an initial investment of $35M from Starboard for convertible preferred stock and warrants (convertible and exercisable respectively at $3.65/share, a 50% premium to the last closing price). Starboard will also provide Acacia with access to $365M in debt financing in the form of secured notes (at a 6% interest rate and 2027 maturity date). A second round of warrants are also being purchased by Starboard for $4.6M with an exercise price of $5.25/share, but could alternatively be exercised at $3.65/share through cancellation of amounts drawn on the secured notes, adding further shareholder alignment. Current shareholders will be offered the opportunity to invest in notes and warrants with the same terms as Starboard. Starboard will gain a seat on Acacia’s board and up to two more director seats in the future to participate in investment approval and planning with Acacia.  

Starboard’s track record as an activist investor can give us a sense of the prospective return profile that may be generated by Acacia’s shareholder activism - annualized returns of 15.5% over 2002-2014, with majority of their activist campaigns being profitable for shareholders (as disclosed in a 2014 article by Fortune). Investors can get some sense for future target opportunities by reviewing Acacia’s recent and ongoing ~$12M investment in Immersion Corp (IMMR). IMMR came under pressure by multiple activist investors to improve governance and capital allocation, including the involvement of Raging Capital Management, Viex Capital Advisors and Shannon River Fund Management. IMMR has over 3,600 issued and pending patents, which likely factored heavily into Acacia’s investment thesis.

The Share Price Disconnect

ACTG’s stock recently closed at $2.44/share, a steep discount to the $3.36/share in cash & marketable securities value on its debt-free balance sheet. This bargain purchase price embeds a meaningful margin of safety for investors and seems to give little weight to upside optionality from Acacia’s refocused strategy. ACTG’s current price seems to incorporate a largely negative sentiments for Acacia possibly over fears of cash burn and negative investment returns. Usually such wide discounts to liquid assets are ascribed to seriously flawed businesses or investor concerns about the skill and/or incentives of the management team. But these factors don’t appear to pose a serious threat for Acacia given the backgrounds of the people involved and the expanded scope of Acacia’s go-forward strategy. Cash burn shouldn’t pose a large risk either – management has stated that their current operating plans spend no more than 5% of the cash balance on opex and investment due diligence between now and August 2021 or their first investment (whichever comes sooner). In an optimistic scenario, Acacia deploys capital in the near term into income generating investments including royalty streams or acquires a profitable business and offsets their taxable income with their large balance of NOLs – last reported at $242M in federal and state NOLs expiring between 2026 and 2038 and $51M in foreign tax credits.

It’s likely that part of the share price disconnect can be attributed to a lack of analyst research coverage and investor communication from management while they’ve cleaned up Acacia’s corporate governance and set up the partnership with Starboard.

There are several positive indications of insider alignment that should bolster investors’ conviction here. Alfred Tobia left his position as Portfolio Manager at Sidus Investment Management (a tech-focused investment firm that he cofounded in 2000) to be the Chief Investment Officer at Acacia as a full-time employee after the activist campaign. A large part of Press’ and Tobias’ compensation package consists of common stock grants that vest at certain price targets well above today’s price. In order to see 100% of their restricted stock vest (450k shares), Acacia’s stock needs to reach a price over ~$4/share over the next three years. This would generate a return in excess of 60% over today’s share price. Additionally, Tobia has stated on a prior earnings call that the prior management at Acacia tried to buy out the activist investors’ interest in ACTG at a 40% premium to their purchase price, an offer which the investors declined.

Risks

Aside from usual small cap equity risks, the primary risk to this thesis is that a meaningful portion of Acacia’s strategy revolves around activism and M&A, which can vary widely in outcomes. 

Catalyst

• Increased investor awareness as Management communicates new strategy to a broader investment audience
• ACTG generates attractive returns from patents, royalty streams, acquisitions and activism
• Utilization of large NOL carryforwards
• Share repurchases – insiders initiated a $10M repurchase program in August 2019 but have yet to execute any buybacks, perhaps they are waiting to finalize Starboard deal and to identify the set of investment opportunities before using cash to buy back stock, which seems prudent