Rambus Inc. RMBS
November 04, 2009 - 12:06pm EST by
2009 2010
Price: 16.33 EPS -$0.72 -$0.64
Shares Out. (in M): 105 P/E NA NA
Market Cap (in $M): 1,721 P/FCF NA NA
Net Debt (in $M): -256 EBIT -82 -106
TEV (in $M): 1,465 TEV/EBIT NA NA

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Rambus Inc.'s zero-coupon convertible debt (it converts into common stock at $26.84 per share relative to a current price of $16.33) is consistent with my favorite investment theme--risking pennies to make dollars.  You can pay $1.02 (really $1,020) for convertible notes that will, in a reasonable worst case scenario, repay $1.00 on February 1, 2010.  That scenario is reasonable because Rambus had cash and marketable securities of $480 million as of September 30th and no debt or significant contractual obligations due before the $137 million of notes.  You have a chance to make dollars depending on the outcome of Rambus' litigation, including a patent infringement trial that will be decided and a price-fixing trial that will begin prior to the notes' maturity.  While it would be foolish to predict a settlement or award in either case, scenarios that result in convertible note prices of $1.30 - $1.85, representing returns of 27 - 81% on a simple basis, are not unreasonable, and even higher returns are possible.

Rambus was written up in April 2008 by Icarus76, and the analysis makes good reading.  I think the convertible notes are the better alternative because of the margin of safety provided by Rambus' cash, but that safety comes at a price.

Rambus supplies intellectual property to manufacturers of semiconductors, which are used in memory devices, controllers for memory devices and systems that include controllers and memory devices.  These, in turn, are ubiquitous in consumer electronics devices such as video game consoles, computers, HDTVs and mobile phones as well as automobiles.  If you have ever admired the processing speed of the Sony PlayStation 3 Slim, you have seen the capabilities of Rambus' technology, in the form of 4 memory chips, a memory controller and a system interface.

Technology background.  The main memory of a computer, which normally includes many memory devices, stores information that is actively utilized by the microprocessor (also known as the central processing unit or CPU). Information in longer-term storage devices, such as the hard drive, is transferred into main memory and then accessed by the microprocessor. The information can be transferred using a memory controller. The controller interfaces with the main memory and the longer-term storage devices and helps transmit messages between the memory and the CPU.  The microprocessor market, which is dominated by Intel and Advanced Micro Devices, had 2008 sales of approximately $31 billion.

The main memory is typically made up of "random access memory" (RAM)-memory in which any memory location can be accessed as readily as any other.  Dynamic random access memory (DRAM) is the most prevalent type of RAM.  DRAMs are "dynamic" because their capacitors leak charge and must be periodically refreshed to keep them from losing data. Approximately $24 billion of DRAM chips were sold in 2008.

Microprocessors are differentiated largely by the speed of their data processing.  Microprocessor speeds have grown faster than memory speeds, however, causing a bottleneck-the DRAM requires the microprocessor to slow down and wait until it receives the information it needs from memory.  The widening disparity between microprocessor and DRAM speed is typically referred to as the "performance gap," and it is a threshold issue for a very large industry.

Manufacturers attempted to address the performance gap by building devices with cache memory, which is only effective when the same data is retrieved repeatedly.  They also tried creating a "wide bus" through which data passes between the microprocessor and the DRAMs, although this solution results in more complex circuit boards and higher costs.

In April 1990, Rambus filed a patent application describing, among other things, a new kind of memory-a synchronous memory with features that enhance the performance of that memory-and a new kind of memory controller that improves the data transfer rate between the DRAM and the microprocessor. This new synchronous memory technology was known as Rambus DRAM or RDRAM.  Prior to this invention, DRAMs operated asynchronously in that read and write operations were not conducted with reference to a system clock.  Rambus' synchronous memory device, unlike asynchronous DRAMs, receives an external clock signal that provides timing information for data to be transferred into or out of the device.

Industry Standards.  Because many different companies manufacture both memory and products that use memory, manufacturers and consumers benefit if all memory is interchangeable. Interchangeability requires that memory chips be designed and manufactured in accordance with industry "standard" specifications.  To achieve this goal, several leading DRAM manufacturers, including Samsung and Micron, formed an industry standard-setting organization called the Joint Electron Devices Engineering Council (JEDEC).

When interchangeability is important, participants will design and manufacture in accordance with the relevant standard, and any technology incorporated into that standard will eventually dominate.  A company that has a patent over a technology required by a standard is, therefore, in a position to earn royalties from an entire industry.  To prevent this situation from arising, standard-setting organizations are very sensitive to avoid incorporating any technology covered by patent into a standard.

Rambus joined JEDEC in February 1992, as JEDEC was attempting to develop a synchronous DRAM with two new technologies. JEDEC was aware, of course, that Rambus had been issued its April 1990 patent.  It was not aware, however, that Rambus had additional applications pending for embodiments that were not included in the initial patent.  These additional applications, when granted, gave Rambus patent rights over JEDEC's new technologies in the  synchronous DRAM standard.  In October 1995, JEDEC asked its members, including Rambus, to vote on various features to be included in a "next-generation" synchronous DRAM standard. Two of these features were covered by pending Rambus patent applications.  In June 1996, Rambus withdrew from JEDEC. However, when JEDEC established a new standard for synchronous DRAM called double data rate synchronous DRAM (DDR SDRAM) in 1999, this standard included four technologies over which Rambus had pending patent rights.  A D.C. Circuit Court later found that although Rambus had achieved monopoly power in certain markets, its conduct was not unlawful, largely because JEDEC's disclosure requirements on members' intellectual property positions suffered from "a staggering lack of defining details."

Litigation history.  The promise of RDRAM technology was confirmed in 1996 when Intel announced it had chosen Rambus to provide its "next-generation" memory technology.  Because Intel sells the vast majority of microprocessors, Intel's choice threatened to make RDRAM the de facto standard.

Furthermore, in 1999 Rambus was awarded the first of its patents covering devices utilizing SDRAM and Double Data Rate synchronous DRAM (DDR SDRAM), allowing it to seek royalties on most memory. Rambus filed the first of its significant intellectual property lawsuits in 2000, suing Hitachi for applying RDRAM technology to the SDRAM memory architecture and Hitachi's' customer, Sega.  Months later, Toshiba announced it would pay Rambus royalties on SDRAM and DDR because they relied on "patents for fundamental high-speed memory interfaces invented by Rambus."  Hitachi then announced a similar settlement with Rambus.

Rambus' ability to seek royalties on most memory presented an alarming threat to DRAM manufacturers.  In an extraordinary turn of events, beginning in 1996 and continuing for many years, the largest DRAM manufacturers, including Samsung, Micron, Infineon, Hynix and Elpida, colluded to prevent RDRAM from becoming the state-of-the-art memory chip technology and to ensure the market-wide adoption of alternative technologies.  They did this by, among other things, jointly restricting production of RDRAM, overstating RDRAM production costs and inflating the price of Rambus-designed memory to the likes of Intel.  Samsung, Hynix, Infineon and Elpida all entered criminal guilty pleas for conspiring to fix DRAM prices in violation of antitrust law.  Micron was granted leniency for cooperating fully with the Justice Department.

Two pending trials.  An analysis of all of Rambus' current litigation, totaling 13 cases, is beyond the scope of this posting.  Two cases, however, are more likely to impact the value of the convertible notes prior to their February 1st maturity.

Rambus filed a civil suit against the colluding DRAM manufacturers in October 2004 in the Superior Court of the State of California, County of San Francisco.  The trial judge ruled that certain evidence from the Department of Justice's criminal price-fixing case, in which, Samsung, Hynix and others pled guilty, will be admissible.  When we first bought the convertible notes, the trial was scheduled to begin on September 28th.  During a pre-trial hearing, however, one of Samsung's lead attorneys became gravely ill, and the judge, concerned he might have to hold the jury over the holidays, postponed the trial until January 11th.  Rambus alleged in court documents that its damages total $4.3 billion, subject to automatic trebling to almost $13 billion (note that Rambus' current market capitalization is approximately $1.7 billion).  Given the extraordinary amount of damages involved and the uncertainty of a jury trial, a settlement prior to the notes' maturity remains a distinct possibility.

In a separate matter, Rambus recently completed its hearing against NVIDIA Corporation (with a market capitalization of approximately $6.9 billion) and more than a dozen companies whose products use NVIDIA controllers.  The venue for the hearing was the International Trade Commission, before which Rambus sought an exclusionary order blocking the importation or sale of any of the defendants' products that infringe its patent rights, representing the majority of NVIDIA's products.  Importantly, in the pre-trial Markman hearing in which the scope of the patents at issue are determined, the ITC ruled overwhelmingly in favor of Rambus' interpretation of key patent terms.  In addition, on October 15th the ITC made public a pre-hearing statement in which the ITC's own staff argued in Rambus' favor.  An administrative law judge will rule on or before January 22nd.  Estimates regarding settlement in this case are highly speculative, but are as large as $1 billion.  Although five patents are at issue in the case, it only takes one violation to seek and receive an exclusionary order.


Disclosure:  I am long these convertible notes.  As a result, you should be aware that I have a conflict that could affect the objectivity of this posting.  You should not rely on anything I have written here.


January 11, 2010 antitrust trial begins

January 22, 2010 ITC ruling

Possibility the company will agree to extend the term of the convertible notes per the indenture.

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