Patently Undervalued?

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

InterDigital (NASDAQ: IDCC) recently struck an agreement with Intel (NASDAQ: INTC) to sell 1,700 of its patents and patent applications for $375 million in cash. My first thought after reading this was, what is the remaining value of the patent portfolio? According to the company, they own about 8,800 current patents and they have about 10,000 patent applications. Given the ongoing value of these intellectual assets, it seems the market is undervaluing InterDigital at the current time. Let's see what the company might be worth, and if there is an opportunity here.

InterDigital's annual report states the company has about $616 million worth of cash and investments, and long-term debt of about $194 million. This means just doing a simple back of the envelope calculation, the company's cash above long-term debt is just over $400 million. The company's current value is about $1.23 billion. This means that roughly 32% of the company's market cap is just cash beyond long-term debt. This means the market is valuing InterDigital's patent portfolio and the company's future cash flows at just $830 million. No matter how I run the numbers, this seems low.

Looking at just a few of the company's direct competitors, we can get an idea of how InterDigital compares. For instance, Alcatel-Lucent (NYSE: ALU) operates in several different industries, but the old Bell Labs division has over 27,000 active patents worldwide. This company's market cap is about $2.5 billion. The market is saying that the future value of Alcatel-Lucent is worth twice that of InterDigital. What's interesting is while InterDigital is free cash flow positive, Alcatel-Lucent has been consistently cash flow negative. This negative cash flow would force the company to either liquidate assets, issue new shares, or issue debt to meet operating expenses. Another good example is Ericsson (NASDAQ: ERIC), which also participates in multiple industries but holds the patents to many technologies that cellular networks use on a regular basis. Ericsson is in a different league than the other two, as this company's market cap is nearly $28 billion. Ericsson also is free cash flow positive, which is something that Alcatel-Lucent can't say. While these two companies don't give us a perfect comparison, the point is that patents are worth quite a bit of money in the market not only for their current value but also their future cash flow generating capabilities. In addition, it's not as though InterDigital is sitting around waiting to be acquired.

In the most recent quarter, the company generated about $17.2 million dollars in operating cash flow, and spent just $531,000 on capital expenditures. This indicates the company benefited from over $16 million in free cash flow. If the company were to be taken over in the future, there are two concerns that investors need to be aware of. The first is, the companies choice to pay a quarterly dividend equal to roughly $4.5 million. While this is good news for current shareholders, it does have the effect of paying out some of the companies value on a quarterly basis. In addition, the company has shown its willingness to use cash on the balance sheet to repurchase shares. In fact, when the company struck a deal with Intel management they decided to double their current stock repurchase program. Under the current program, the company has already spent $75 million to repurchase 2.4 million shares. This means management believes that the share price is worth at least $31.25. With a current share value of $27.54, investors have the opportunity to buy shares at a nearly 12% discount to what management just paid. Beyond the company's balance sheet, investors should be aware that InterDigital is of course a currently operating company attempting to make money for shareholders.

Companies licensing from InterDigital are among the largest in the industry. For example, Apple, LG, Nokia, and Samsung are all counted as current licensees. In the first quarter of this year, the company generated over $68 million in license royalties. If there's one big concern about the company's future cash flows, it has to be one of the top three companies licensing patents. The largest percentage of licensee revenue comes from Samsung, Research In Motion (NASDAQ: BBRY), and HTC. My concern is with Research In Motion, which represents 17% of InterDigital's licensee revenue. This company is currently under massive pressure because of recent earnings challenges, and operating miscues. With Research In Motion expected to report net losses the next 2 years, it's possible that the companies royalty payments to InterDigital will drop as the size of their business declines. Even with all this as a backdrop, it seems InterDigital should be worth much more than it is today.

Just looking at the Intel deal as a proxy, if 1,700 patents and patent applications are worth $375 million, that's the equivalent of $220,000 per patent or application. Considering that the company has a combined 18,800 patents and patent applications, even subtracting the 1,700 that Intel is buying this still leaves over 17,000 patents and applications in the portfolio. Even assuming that each of these is worth half of what Intel paid, still means $110,000 for each one. At this price 17,100 patents and applications should be worth approximately $1.88 billion. Given that this assumes a 50% discount for the remainder of the company's patent portfolio, this should give investors a pretty good measure of safety. If the true value of this patent portfolio is closer to $1.88 billion as suggested, adding the $400 million in net cash gives a total company value of $2.28 billion. With 44.35 million shares outstanding, this would indicate a share price of just over $51. This value is 85% above the current stock price. You can imagine what the value might be if this portfolio sold for closer to what Intel was willing to pay per patent and application. For this reason, investors should give serious consideration to the value of InterDigital either as a takeover candidate, or as an ongoing enterprise. The company is cash flow positive, and has net cash on the balance sheet. With the race for patents, this takeover looks like a matter of time to me.


MHenage owns shares of Intel. The Motley Fool owns shares of Intel. Motley Fool newsletter services recommend Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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