OPTi Inc. OPT
September 20, 2006 - 10:27am EST by
bruin821
2006 2007
Price: 4.47 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 52 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Overview

 

We think OPTI is an exceptional risk/reward opportunity with little downside risk and upside potential of 100-200% over the next one to two years. The stock trades at approximately book value (65% cash and licensing receivables) with clear catalysts for short- and long-term appreciation.

 

OPTI was originally written up for VIC in January, 2002.  Matt657 did an exceptional job writing up the story, and the stock has appreciated 150% since then.  We feel that while the stock has appreciated, it is an equally attractive opportunity now, and investors should realize the same sort of return in a much shorter time period.  We refer you to his original idea for additional background on the name. 

 

At that time, the stock traded at a small premium to book value, approximately $3.00 per share.  While management’s initial plan was liquidation of the Company and a subsequent cash/stock distribution (OPTI had a concentrated share position in publicly-traded Tripath Technology), the Company has instead pursued litigation claims pursuant to its IP portfolio.  Recently, on August 4, 2006, OPTI announced a settlement and licensing agreement with nVidia Corporation (NVDA) for infringement of the Company’s patented predicting snooping of cache memory technology.  OPTI received an immediate cash payment of $11mm in exchange for granting nVidia a non-assignable, non-exclusive license to utilize the predictive snooping technology and a low pin count interface specification related to another OPTI patent.  nVidia also agreed to make quarterly royalty payments of $750K beginning February, 2007 and ending November, 2010.  The Company trades at a very small premium to cash, has no debt and has announced its intention to reach further settlement and licensing agreements.

 

Technology

 

OPTI holds several technology-related patents.  Foremost among these are U.S. Patent No. 5,710,906 (the “906 patent”), U.S. Patent No. 5,813,036 (the “036 patent”) and U.S. patent No. 6,405,291 (the “291 patent”).  All three patents relate to OPTI’s predictive snooping of cache memory for master-initiated accesses technology. 

 

By way of introduction, most electronic devices (think PCs and MP3 players) contain a central processing unit (CPU), which performs instruction, logic, and mathematical processing.  The CPU accesses information from many places.  One of those places is cache memory, a special high-speed storage mechanism.  As the CPU processes data, it looks first in the cache memory and if it finds the data there (from a previous reading of data), it does not have to do a more time-consuming reading of data from larger memory.    

 

Predictive cache snooping is a mechanism whereby a master control circuit requests information from the cache.  The “predictive” part about this process is the key; it lets the compilers plan for the data transfer.  Without a predictive snoop, the system experiences a 5-10% decline in CPU optimization (the data transfer is slower).  According to our channel checks, this technology is “pervasive.”

 

OPTI also holds compact-ISA bus interface patents.  This technology, while valuable, is less important to the story.  Our channel checks with industry indicate that this is an older bus protocol, similar to peripheral component interface (PCI ) and used sparingly today.  The compact-ISA patents address the need for multiple available signal lines to simultaneously handle ISA and PCI devices.  OPTI’s patented process utilizes “multiplexing” to service this need.  Multiplexing is a concept used in many industries that involves the transmission of signals from one place to another.  Instead of dedicating a single transmission channel to a single signal governing a single function, the channel will transmit multiple signals used for multiple purposes at different times, frequencies, wavelengths, etc.  Using multiplexing, OPTi was able to reduce the number of signal lines needed on an ISA bus from 58 to 22, and correlatively, to reduce the size of its chipsets, by reducing the number of required pins.

 

Current Balance sheet

 

($ millions)

Cash on BS as at June 30, 2006 10-Q

 

11.75

One-time licensing settlement w/ nVidia 8/4/06

 

11.00

Royalty payments from nVidia

 

9.00

Available tax credits as at June 30, 2006 10-Q

 

8.40

Available NOLs as at June 30, 2006 10-Q

 

44.69

Current liabilities as at June 30, 2006 10-Q

 

(1.39)

Long-term debt

 

0.00

 

11.64mm shares outstanding

 

 

 

 

 

 

Future Claims

 

The nVidia settlement of $20mm should be a good proxy for a baseline settlement, however there is upside in these figures.  By a very conservative estimate, if the Company signs only two additional licensing agreements, they will generate another $40mm in cash, or $3.45 per share.  The Company has no debt, $8.4mm in tax credits, $44.7mm in NOLs and two full-time employees, so virtually all monies realized will flow straight to the bottom line.

 

We believe the number of patent infringers is great.  Presented below are our “Top 10,” rank sorted by existing overlap with OPTI’s patented predictive snooping technology and with certain emphasis on “deep pockets”:

 

  1. Apple Computer (AAPL); $63.2B market cap
  2. ATI Technologies (ATYT); $5.5B market cap
  3. Advanced Micro Devices (AMD); $12.9B market cap
  4. NEC Electronics (TSE: 6723); $4.6B market cap
  5. Freescale Semiconductor (FSL); $15.1B market cap
  6. Creative Technology Ltd (CREAF); $539.8mm market cap
  7. Sun Microsystems Inc. (SUNW); 18.0B market cap
  8. STMicroelectronics NV (STM); $15.0B market cap
  9. Renesas Technology Corp (Private)
  10. National Semiconductor Corp (NSM); $8.2B market cap

 

OPTI’s predictive snooping and compact-ISA bus interface patents enable performance optimization in a multi-channel, multi-device environment.  The Company targeted nVidia’s nForce product because nForce leaned heavily on predictive snooping to execute 3D graphics for integrated chipsets.  nForce continues to be an important product for nVidia, as it offers accelerated graphics processing for multimedia applications (think X-Box, sound cards and gaming devices).

 

Our list of potential defendants to be named in subsequent intellectual property claim(s) includes integrated microprocessor and semiconductor manufacturers and other producers of media and communications processors and accelerators.  We think OPTI will enjoy its greatest success lining up accelerated graphics card manufacturers such as Apple and ATI.  Apple’s graphics accelerator for PowerBook G-Series and the mach64 Graphics Accelerator card from ATI both utilize predictive snoops in much the same way as nVidia’s nForce product.  We think that both companies are prime candidates for future settlement and licensing agreements.   There is a real chance these settlements will be significantly larger than the nVidia settlement.

 

There is also potential liability in the server market.  The most likely candidate for this pursuit is Sun Microsystems.  Sun manufacturers and markets a full line-up of graphics cards such as the X3256A Sun XVR-1000 Graphics Accelerator and the X3678A Expert3D PCI Graphics Accelerator.

 

Other potential litigants such as STMicroelectronics and Renesas manufacture a full suite of microprocessors, which utilize pre-snoop and pre-fetch technologies to a lesser, though significant, extent.

 

Management

 

OPTI’s executive officers, Bernard Marren, President and CEO, and Micahael Mazzoni, Chief Financial Officer, receive modest annual salaries of $120,000 and $84,000, respectively.  In OPTI’s recent 10-K filing for the fiscal year ended March 31, 2006, the Company announced employment and severance agreements for both officers.  Under the terms of the agreement, Marren and Mazzoni will receive compensation ranging from 1-5% of future monies returned to OPTI shareholders.  This range of compensation (essentially, a sliding scale) is tied to the amount of money that the Company is able to return to shareholders.  We like this arrangement, as it provides strong incentives for management to aggressively pursue infringement claims and dividend future settlement and licensing awards to shareholders.    

 

Comparable Licensing Companies

 

Network-1 Security Solutions, arguably the Company’s closest comparable, trades at 14.6x book value versus 1.0x book value for OPTI.  Network-1 has not recorded revenues since 2001, and its current litigation against D-Link Corporation has yet to reach the Markman phase.  We believe that OPTI trades at a huge discount to its public peers.

 

Legal Standing

 

In the recent matter with nVidia, OPTI prevailed on 13 out of 15 construction claims presented at the Markman hearing.  A Markman hearing is a proceeding required under U.S. patent law in which both litigants present their arguments as to how certain claims should be interpreted by the court.  Patent claims, found at the end of the patent document, determine the scope of patent protection. Thus, a Markman decision has profound implications on the practical and strategic considerations for litigating a patent infringement claim.  Typically, after a Markman hearing, the successful party will file a motion for summary judgment on patent infringement, which is granted with increasing frequency.  Therefore, the importance of the Markman hearing in patent litigation cases cannot be overstated.  Our legal consultants attest that OPTI’s 13 out of 15 hit rate versus nVidia was the equivalent of a “slam dunk.” 

 

Negatives

 

The biggest risk to the story, of course, is that the Company will not be successful in signing future settlement and licensing agreements and/or will not prevail in court.  We think this scenario is unlikely.  In any case, there is a strong backstop with the cash, tax credits and NOLS and, clearly, the technology is of some value.

 

The other negative is that the stock is thinly traded.  Carr Securities is most active in trading the stock and, occasionally, has buyers or sellers for the stock.

 

The shareholder base is comprised of mostly high net worth individuals who have owned the stock for a long time. They originally encouraged management to pursue these long-term licensing agreements rather than taking a distribution, so  they seem to be strong, long-term shareholders.

Catalyst

In its recent 10-K filing, OPTI stated its clear intention to purse patent infringement claims against multiple entities. With the nVidia settlement completed, we fully expect the Company to announce its next litigation target(s) within the next few weeks. Over the next year or two, we expect 8-10 companies to sign licensing agreements or face lawsuits they probably can’t win. According to our channel checks, other potential defendants have been put “on notice.” Since the claims against other defendants will be extremely similar to the successful claims against nVidia, we expect to see similar licensing deals. In most situations like this (especially with such clear Markman victories) potential defendants quickly sign licensing agreements as opposed to litigating costly and time-consuming battles they will most likely lose. With the stock trading at a small premium to cash, and multiple catalysts for significant appreciation, we find OPTI to be a very good risk/reward opportunity.
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