Description

Straight Path Communications Inc. (NYSE MKT: STRP) is a severely mispriced new spin-off from IDT Corporation which has limited downside and asymmetric upside opportunity.  STRP’s unique and highly strategic assets include (i) 100% ownership of the largest U.S. portfolio of FCC licenses for 39 GHz wireless spectrum (615 39 GHz licenses) covering >90% of the country and  ideally suited for meeting the fast-growing demand for wireless backhaul capacity and (ii) 84.5% ownership of a comprehensive portfolio of fundamental patents relating to point-to-point Internet and Voice over Internet Protocol (“VoIP”) communications whose validity has survived extensive re-examination in its past litigation and licensing with Skype/eBay (now Microsoft) and others.  As the valuation scenarios below illustrate, I believe STRP shares are worth, at a bare minimum, nearly 2x their current market value on an orderly liquidation value basis and quite possibly will prove to be worth 5x+ their current market value as licensing arrangements are secured against de minimis incremental cost, creating a highly asymmetric risk/reward opportunity.  Further, I believe that STRP’s TEV is likely fully covered if not exceeded by the value of only 5-15 of its “best” 39 GHz spectrum licenses, providing a strong margin of safety.

Why the Opportunity Exists

1)     Classic Spin-off Dynamics.  STRP is a tiny ($44mm EV), somewhat esoteric spin-off to which virtually nobody is paying attention and where traditional spin-off dynamics have resulted in an artificially, and I believe only temporarily, depressed share price.  To compound this point, it is a spin-off from IDT, a company that itself is widely misunderstood with a highly entrepreneurial CEO and controlling shareholder Howard Jonas, who receives little respect from the investment community despite creating and unlocking tremendous shareholder value in recent years through organic growth, three (3) spin-offs, and regular and special dividends.  There is little doubt that the vast majority of IDT investors (including us until we dove into the spin-off in the last few weeks) severely underestimate the quality and value of STRP’s assets.

2)     CEO Nepotism.  STRP’s CEO is Davidi Jonas, the 26-year old son of IDT CEO Howard Jonas and whose primary “experience” is as a rabbi.  Most investors clearly think this is absurd.  Personally, I think it is brilliant, as Howard is clearly the one pulling all the strings behind the scenes, and both Jonases are squarely aligned to maximize value as the Jonas family owns >30% of STRP equity plus 10% of Straight Path IP Group (the entity holding the patents).

3)     Strong Emerging Demand for Small Cell Wireless Backhaul.  STRP’s spectrum is wildly mispriced because the investment community does not realize that when the spectrum was last listed for sale (2010), small cell wireless backhaul was something of which nobody had ever heard (today, it is still not a well-known technology).  At the time, IDT rejected an informal offer of $30mm for the spectrum (see p. 5 here).  With small cell wireless backhaul about to take hold in a big way and expected to grow to 3.5mm outdoor small cells by 2015, STRP's nationwide 39 GHz spectrum is ideally positioned (STRP owns roughly 1/3 of the nation's 39 GHz coverage) and I believe almost certain to be extremely valuable (see new Spectrum presentation here).  AT&T, Sprint, Verizon, T-Mobile & others are in testing for small cells, and reportedly found that "small cells bring nearly perfect coverage to problem areas" and demand is set to grow at an extremely high rate (read here and here).  In the latter article, AT&T's head of small cell says “The beauty of a lot of the small cell-type of technology is we are building out this core infrastructure within our network that gives us flexibility to target a variety of use cases."  As an added scarcity bonus for STRP holders, FiberTower's 39 GHz spectrum is effectively taken out of supply as of May, and likely to be unusable by anyone due to the bankruptcy court enjoining the FCC from transferring licenses - read the 2nd to last paragraph here.

4)     Unappreciated Intellectual Property.  Few, if any, investors have taken time to read and understand the extent of the STRP’s Internet communication and VoIP patents.  Management believes, and it seems logical from my research, that STRP has potentially among the most fundamental of IP in the Internet communication industry (point-to-point communication links), which is evident in settlements reached with Skype/eBay and several others.  The Complaint filed several days ago with the ITC can be found here, and p. 18 (p. 26 of the .pdf file) gives a detailed "non-technical" description of the patents.  In the ITC complaint, STRP asked the ITC to halt the importation and sale of the manufacturers’ infringing products in the U.S.  Examples of infringing products include smartphone handsets, tablet computers, eReaders, smart TVs, gaming consoles, Blu-ray players, and set-top boxes.  It appears from the ITC complaint that STRP is emphasizing the fact that Skype/Microsoft has licensed and extensively implemented STRP’s IP, and that the technology plays a major role in their company now (Xbox One, Skype, etc.).  While timing and net proceeds to STRP are uncertain, I value the IP very conservatively yet believe there is good home run potential, even after contingent legal fees.  By requesting a portion of his 2012 compensation in heavily discounted stock of IPCI, the former entity holding the patents, Howard Jonas has reminded investors who are paying attention of 2008, when he voluntarily took his compensation in IDT stock rather than cash, just prior to a 30-fold increase in value in roughly two years.

5)     Minimal Cash Burn.  Based on conversations with management, I conservatively estimate $1.5mm per annum of initial cash burn, before any licensing occurs.  STRP has four (4) employees, a bit of revenue from initial spectrum trials (Covad, AT&T, Verizon).  Patent litigation enforcement is being led by Kirkland & Ellis and Mintz Levin, with Hunton & Williams as local counsel, and all legal fees are on a contingency basis with law firms covering litigation costs. 

Asset Overview

Wireless Spectrum

• The management presentation regarding STRP’s spectrum holdings is a must-read to fully understand the value proposition and ideal positioning of these assets.
• See the Small Cell Forum website here for outstanding background information on small cell wireless backhaul and here for additional industry research.
• The Small Cell Forum predicts that by 2015 there will be 4.5 small cells deployed per macro cell.  In the U.S. there are over 350,000 macro cellular towers deployed, with an average of 2.5 carriers deployed per tower.  Conservatively, using the Small Cell Forum statistics management predicts there will 3.5mm small cells deployed by 2015 with a majority of these using wireless backhaul.  While the pace of rollout is debatable, it is clear from all data that rollout will be rapid.
• Background:
  • IDT acquired spectrum licenses and other assets from Winstar Bankruptcy Estate in 2001 for $60mm.
  • In 2010, IDT offered spectrum holdings for sale and rejected an informal offer of $30mm.
  • In March 2012, IDT sold four 39 GHz and four 28 GHz spectrum licenses covering certain metropolitan areas for $6.8mm.  Note that STRP’s current TEV is only $44mm and it owns 615 39 GHz licenses with nationwide coverage, including outstanding coverage in the largest U.S. metro areas.
  • Prospective value is closely tied to deployment of small cell technologies to relieve wireless network congestion, with the “best” individual licenses in the most populated areas worth many millions each.
• Key characteristics:
  • Nationwide spectrum holdings, covering 300mm residents of U.S. and Virgin Islands (>90% of the U.S.).
  • Management believes STRP owns roughly 1/3 of the 39 GHz spectrum in the U.S.
  • Over 500 MHz of spectrum in 24 of the top 25 EAs in the U.S.; over 1,350 MHz in NYC.
  • At least 2 EA licenses, or 200 MHz of spectrum, in virtually every U.S. market.
  • All spectrum in 100 MHz contiguous blocks.
  • Unlike other >3 GHz spectrum, STRP spectrum is 100% licensed for flexible use across U.S.
  • “Substantial Service” requirement met until 2020.
  • Fast-track registration with links approved by the FCC in 1-2 days.
  • Predefined coverage: area-wide licenses in both 28 GHz & 39 GHz.
  • Low interference: few license holders and uncongested use.
  • Cost effective: lower cost than fiber and other spectrum.
• Coverage Map:

• Top Metro Coverage Areas:

• Competitive Advantages of Straight Path's 39 GHz Spectrum:

Intellectual Property Group (click for link)

• Background:
  • In 1996, IDT founded Net2Phone, which helped pioneer VoIP communications.
  • In 2000, Net2Phone purchased NetSpeak, which held key patents, for $48mm.
  • In 2000, AT&T invested $1.4bn for a 32% share of Net2Phone.
  • In 2006, IDT repurchased the portion of Net2Phone’s capital stock that it did not already own for $97.1mm (TEV of $110mm per Capital IQ).
  • Settled patent infringement case with Skype/eBay in 2010 on undisclosed terms.
  • In 2012, SPIPG filed complaints in a U.S. District Court against three communications companies (Stalker Software, Inc., ooVoo, LLC, and Vivox, Inc.) for infringing a number of its key patents. SPIPG subsequently reached confidential settlements with all three defendants.
• Key characteristics:
  • SPIPG holds family of patents widely utilized in communications over the Internet.
  • Prior litigation and extensive re-examination has confirmed the validity of key patent claims.
  • Patents expire September 25, 2015 with six year lookback for damages.
• Strategy:
  • SPIPG has retained counsel to pursue enforcement on a contingency basis (up to 40% depending on timing to recovery).
  • SPIPG intends to aggressively pursue enforcement.
  • In addition to direct users of the IP, equipment manufacturers and others who derive benefit from SPIPG’s technology are potential licensees.
  • By initially establishing a solid record of favorable verdicts/settlements, SPIPG expects to facilitate subsequent licensing agreements.
  • On August 1, 2013, SPIPG filed initial lawsuits in the U.S. District Court for the Eastern District of Virginia (famous for its speed “rocket docket”) against both manufacturers (Sony, LG, Panasonic, Toshiba, Sharp, Vizio) and telecom providers (Bandwidth.com, Telesphere, Vocalocity).  Click links for the complaints.
  • I expect many additional lawsuits to be filed against highly prominent companies, which in my view are likely to include the largest smartphone, tablet, VoIP chat, VoIP hardware and wireless carrier companies.  The strategy appears to be to pursue “weaker” defendants first where quick licensing arrangements are more likely to be struck (e.g. Sony in advance of new PlayStation cycle), then pursue additional high profile defendants.
  • From my perspective, there could also potentially be synergy between the IP and spectrum divisions, as carriers could be litigation targets, and IP licenses could be a powerful “carrot” to help negotiate spectrum licenses. 

Valuation

Notes to the valuation scenarios presented below:

• At the original 39 GHz spectrum auction in 2000 (nearly 14 years ago, when cell phones were in their infancy and only used for voice), STRP’s predecessor Winstar paid $37.7mm for only 9 of the top 30 licenses (STRP owns 615 39 GHz licenses).  With the exponential increase in data and demand for small cell backhaul, it is a near certainty that this spectrum, particularly in the most densely populated cities, is worth significantly more today.  I believe that today STRP’s TEV is likely fully covered or exceeded by the value of only 5-10 of its 615 licenses (the best licenses in the most densely populated areas of the biggest cities). (a pretty good margin of safety!)
• In early 2012, IDT sold 8 spectrum licenses for $6.8mm, valuing the licenses at $850,000 per license.  My understanding is that these were on the higher end (but not the highest end) of metro areas, and only 4 of them were 39 GHz.  Spectrum valuations are often quoted in MHZ-POP [$/(MHZ * Population)].  STRP owns 61,500 MHz covering nearly 300mm people, which would yield a large valuation regardless of assumptions.  I have not valued the spectrum in this manner due to a lack of recent data, and because licenses in the most densely populated blocks are sure to command a large premium even on a MHZ-POP basis.
• Three “orderly liquidation value” (assumes spectrum is simply sold outright, rather than licensed) scenarios for the spectrum are as follows:
  • Valuing only the spectrum in the top 10 metro areas at the dated 2012 comp (assigning $0 value to all other spectrum and all IP), an extremely conservative approach as it is only assigns moderate value to 12% of STRP’s 39 GHz licenses, the Top 10 metro areas alone have a liquidation value of 1.4x STRP’s current TEV, illustrating the strong downside protection at this price.
  • Valuing the Top 10 metro areas at the last comp value, and next 15 metro areas at a 40% discount to the last comp, the Top 25 metro area spectrum has a liquidation value of 2.6x STRP’s current TEV (assigning $0 value to all other spectrum and all IP).  This methodology only assigns value to 29% of STRP’s 39 GHz spectrum licenses.
  • Valuing all spectrum licenses, on average, at only 25% of last comp (again, well before Small Cell got exciting), gets you to $130mm liquidation value just for these assets, equivalent to 3.0x STRP’s current TEV (assigning $0 value to all IP).
• To illustrate a range of potential values, I have valued the spectrum licenses both on “orderly liquidation value” and on a licensing basis (which is STRP’s stated strategy).  Despite what could be compounding conservatism, the licensing valuation leads to “home run potential” as a large, recurring free cash flow stream is created.
• The spectrum licensing scenario is based on small cell industry growth estimates in both the Information Statement and in our independent research linked in the spectrum section.
• In valuing the patents, the low end of the valuation uses the book value of Howard Jonas’ September 2012 grant, which is most certainly extremely low in order to minimize Jonas’ tax liability.  The higher end references the $110mm price IDT paid for these Net2Phone assets 7.5 years ago (Feb 2006), per Capital IQ.
• No value is assigned to the $124mm of Federal and $125mm of State NOLs.

Summary

While STRP is a somewhat non-traditional investment, I expect that these numbers end up being very conservative as small cell moves forward and the investment community begins to understand and appreciate the value of STRP’s unique assets. 

I believe downside is quite limited and would prove temporary, while upside is asymmetric in a way we rarely see, with potential returns equaling multiples of our initial investment.  Finally, given Jonas’ bullishness on Straight Path, I would not rule out his tendering for the ~70% of STRP he does not already own in an effort to take STRP private.  He could easily close such a transaction in a cash deal with no outside financing, although this would clearly not be a value maximizing outcome.

Primary Risks

• Timing delays
• Small cell industry fails to develop as expected
• Demand for 39 GHz spectrum is less than expected
• Patents invalidated despite already surviving extensive historical re-examination and heavy referencing in other patent documentation
• Jonas buyout at significant discount to fair value
• Jonas family control

Disclaimer:  The author of this idea presently has a long position in securities of this issuer and may trade in and out of these positions without notice.  The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates.  No representation or warranty is expressed or implied as to the accuracy of the data or opinions contained herein.

Catalyst

• Investor awareness and understanding of the assets and situation
• Entering spectrum licensing agreements with one or more large U.S. carriers (AT&T, Verizon, Sprint, T-Mobile, MetroPCS, US Cellular, etc.)
• Entering spectrum sale agreements
• Filing of additional patent infringement lawsuits against high-profile defendants
• Entering patent license agreements with one or more defendants, further bolstering its strength with remaining defendants
• Sale of the company to a strategic buyer
• Sale of the company to Howard Jonas in a going private transaction