Description
Interdigital (IDCC) is a wireless technology patent company (similar to a Qualcomm) that is just now entering a 5-10 year sweet spot
as its patent technology is well positioned for continued 3G and 4G adoption, yet the stock is selling for less than 10x free cash flow
and only 3-4x EBITDA. I think IDCC is worth at least $60 per share, with "better case" scenarios suggesting valuation levels closer
to $80-$100 per share.
Currently, about 60% of the 3G manufacturing market has contracts in place with InterDigital and if able to resolve
outstanding issues with Nokia, which appears increasingly likely, this number would approach 90-100%. Despite
being so well positioned, IDCC is deeply undervalued due to several overhangs and/or misunderstandings, including i) pending
Nokia litigation; ii) LG renewal of 3G license; iii) strength of 4G patent portfolio; iv) capital allocation (Nortel patents). I expect
each of these to be resolved or be less of an issue in six months time at which point IDCC should sell for a significant higher
valuation level. An investment in IDCC also offers several free call options, including a possible outright win in the Nokia litigation,
a potential takeover and/or accretive acquisitions using its significant cash hoard that is currently earning less than 0.50% annually.
Basically, when you own IDCC, you own a company with a rock solid balance sheet, that is poised to benefit meaningfully with the
continued adoption of 3G and 4G smartphones. The icing on the cake lies in either the resolution of outstanding litigation with
Nokia and/or a takeout from a Qualcomm or strategic acquired.
Background
Founded in 1972 and public since 1981, IDCC develops and patents wireless technology, including 2G, 3G and 4G. Customers
include Samsung, LG, Sharp Apple, Research in Motion, HTC, Compal, and Quanta. IDCC has over 1,200 U.S. patents and
close to 6,000 non-U.S. patents with close to 10k patents pending worldwide. R&D is not surprisingly the company's largest
expense itema and has ranged from $65-$100mm over the past three years.Since 2007, cash has grown from $177mm to $564mm
with no debt. Management thinks about its cash position in three distinct buckets, as follows: 1) $100mm in cash needed for
financial strength and stability; 2) $100mm for prepayments of future operations that are intended to support normal operations;
3) $385mm for discretionary or strategic cash; acquisitions, investments or return of capital.
Three customers currently comprise 50% of sales, as follows:
Samsung 20-25%
LG 20%
Sharp 10%
IDCC is highly levered to growth of mobile devices long-term. IDCC has significant operating leverage to the rapidly growth worldwide
mobile device market. The costs of research and development are largely fixed, while royalty revenue grows with the expansion of the
mobile device market. Currently there are ~1 billion 3G subscribers. Industry experts expect that number to be 2.5 billion by 2014. Much
of the growth is expected to occur in the developing world. Indeed, experts expect the developing world to represent more than 50% of 3G
handset shipments by 2011. The growth in emerging regions is in stark contrast to the expansion of broadband internet and landline telephones.
Financial strength is excellent.
Well positioned to capitalize on LTE. LTE stands for long-term evolution and it is a standardized mobile technology focused on substantially
enhancing the over-the-air and network capabilities of current wireless infrastructure and handsets. Specifically, the LTE specification provides
for various performance categories with most initial deployments having peak down link data rates of 100 megabits per second and uplink of 50
megabits per second (this is very fast!). Importantly, LTE also supports seamless handover with older network technologies such as
GSM/EDGE, UMTS, and CDMA2000. So LTE devices will almost all be multimode. With the proliferation of smartphones and wireless laptops,
LTE is ESSENTIAL for operators going forward (many wireless operators are already having bandwidth issues). Management thinks the market
will transition to LTE devices "very rapidly." If this occurs, this would be good news for IDCC for several reasons: 1) LTE devices are higher
priced (IDCC takes a cut of the topline); 2) from a core invention standpoint LTE is in the sweet spot of IDCC's development portfolio;
3) Since LTE devices will be multimode, management believes that these devices will include more IDCC innovation than ever before --
than it has ever had before on a cellular device.
"We are entering the LTE licensing cycle with a high degree of confidence. We believe that LTE could rollout quickly, perhaps even faster than
what current market forecasts suggest. Further, we believe LTE will wet the appetite for even more data intensive mobile services, but will not
be able to fully meet the consumer's needs. Many industry analysts are still projecting a substantial gap between user demand and system
capacity even after LTE is deployed. This is also good news for us as that user demand will accelerate the need for the other -- for other technologies
to close that bandwidth gap. We are already working hard at those technologies, including spectrum optimization, cross network connectivity and
mobility, and intelligent data delivery techniques, what we call bigger pipes, more pipes, and better pipes. Needless to say, we are very excited
about the LTE opportunity and for the opportunities that lie beyond. The wireless market continues to be driven by innovation, posing very hard
problems that very few companies have the experience and talent to address. We do. As a result, in addition to being able to deliver great current
financial returns, we also believe that our future can be even brighter." Bill Merritt, CEO, July 29, 2010
FREE CALL OPTIONS
Possible win in Nokia case. A win in the pending Nokia litigation could translate into $400mm+ in incremental revenue. The Federal Circuit Court of Appeals
is expected to rule on the InterDigital case against Nokia in late 2010 or Q2 2001. A victory would send the original case back to the International Trade Commission
while a loss would result in InterDigital filing a new, slightly altered patent infringement case. Nokia currently controls 35% of the mobile device market and
is by far the largest device manufacturer. A win would give InterDigital contracts with 95% of 3G manufacturers, adding much credibility to its position in
the industry. This added credibility would mean less litigation going forward and a stronger negotiating position in licensing contracts. In addition, we can
reasonably expect a win to mean a verdict of more than $400m since IDCC's 2009 win against Samsung garnered a $400m verdict from a manufacture
that controlled only 20% of the mobile device market (versus 35% for Nokia). A win would likely increase the intrinsic value of the stock by at least 50%.
Potential Takeover Target. With an Enterprise Value of only $672m, InterDigital is a likely takeover target by other firms involved in wireless technology
research including Qualcomm, Broadcom, Intel, Infineon Technologies, Huawei, LG, Samsung, and Nokia. These firms hold large amount in cash often
for the purpose of M&A. For example, Qualcomm holds $10.0b in cash and Broadcom holds $2.0b. For LG, Samsung, and Nokia, an acquisition would
be immediately accretive since these firms either already pay royalties to InterDigital or an involved in patent litigation with the company. The challenge
of acquisition and integration would be limited as each of these firms already has large research and development arms aimed at the advances in 3G
and 4G technology.
MANAGEMENT
CEO Bill Merritt has been in charge since 2005, having served as President and General Patent Counsel from 2001-2005 and in other functions since 1996.
He has essentially led the build-out of IDCC's licensing program and its IP portfolio. Mr. Merritt holds a B.S. in Mechanical Engineering from Rensselaer
Polytechnic Institute and a J.D. degree from Temple University and holds admissions in the States of Pennsylvania and New York, the U.S. District Courts
for the Eastern and Southern Districts of New York, The U.S. Court of Appeals (11th Circuit), and the U.S. Patent & Trademark Office.
Management in general appears very solid and balanced but they own only 1.6% of the company. After reading several quarterly earnings call transcripts,
I get the sense that they are very knowledgeable about the business but also very mindful of shareholder value (and how it is created).
I feel comfortable that they will not destroy shareholder value with their cash hoard.
Catalyst
Continued solid execution, renewal with LG, resolution of the Nokia litigation, coupled with continued adoption of 3G and 4G, should allow IDCC's to appreciation materially over the next several years.