Interdigital - Valuation
Thursday, February 7, 2008
My valuation article on Sramana Mitra's website.
“Seventy Five dollars! That cannot be,” was my own reaction when I first glanced at the result of my valuation of my analysis. The number sounded outrageous compared to the current stock price of IDCC - $20.13 after hour on Jan 30th, 2008. It was also 65% above my highest estimate of what QCOM may be willing to pay for IDCC. $75 as IDCC’s stock valuation just did not seem to add up.
So I went back to my model and looked again to see if there were any calculation or transcription errors. There were none. Seventy Five was my model output for all the assumptions and risks I have listed in my earlier articles. With the impending 3G boom and IDCC’s IP portfolio, my assumptions did not seem out of place. In fact, if the company continues to inch up the ASIC market through state-of-the-art engineering efforts like the latest SlimChip, my assumptions about its ASIC business growth may be proven too conservative. The figure below illustrates IDCC valuation as a function of ASIC market share growth percentage. I have assumed a 1% market share as a starting point. As we can see, a 0.5% percent growth each year will put IDCC at a 3% market share in 2012 yielding a valuation of $113.
Similarly, 2008 will bear more concrete information on IDCC’s royalty rates and should also provide positive correction regarding its licensee-base growth. The figure below provides a snapshot of IDCC valuation for various licensing rates per 3G handset sold in the future. The graph indicates the volatility of the share price based on the company’s licensing rates. An average licensing rate of $0.6 for each 3G phone sold will drop its valuation to $43 while a $1 rate can put the share price as high as $107.
I am not discounting a negative correction to my royalty rate assumptions as well, though I think that is less likely. My only other worry is its expense management. I will be closely watching how IDCC spends its revenue in terms of R&D efforts and how it manages personnel growth. I anticipate relatively more money going into development than in research. The company should however strive to balance it with maintaining its IP position. It should also spend commensurate with the design wins it is able to get in the years to come. From my semiconductor industry experience, I can tell that it will be a different ball-game keeping its operations tight to even sustain 50% gross margins from its ASIC business. IDCC is still young on this front and is bound to make a few mistakes before quickly learning the ropes to compete with bigger veterans. The figure below gives a quick overview of how its valuation can fluctuate with operating expenses CAGR. A 20% CAGR will pull the valuation down to $32.7. With all other factors remaining the same, if IDCC is prudent with its spending and keeps the expense growth to 10%, then the price could go up to $105.
So, while I can plug in parameters in my model to pull the valuation down, I am comfortable with a $75 valuation for IDCC. I also think that the valuation can go further up with a high probability. I will therefore sign off with my verdict: LONG TERM BUY.
2 comments:
I think there are at least 3 reasons I can see-
1. Licensing Vs settlements: Wall Street likes consistency and predictability (if there is such a thing when it comes to stock). While IDCC has sufficient IP to demand money from the cellular world, it has predominantly come from legal settlements and not from licensing deals. The uncertainties associated with the legal proceedings are certainly a negative. On the other hand, if it starts to see a steady flow of revenue through pre-inked licenses, things would be a lot different. This will also boost the confidence that the Street has on the company's future.
2. Industry perceptions: The Street's perception will be governed to a certain extent on what the industry's perception of IDCC is. The truth of the matter is that IDCC has so far been seen as an IP shark waiting for the products to come out before sending them a legal notice. Given the past, they see IDCC as more to do with the legal team than the engineers and scientists who continually churn out those patents. So, many leading players in the industry perhaps have a vested interest in making sure that IDCC is low-profile.
3. Need for out-of-the-box thinking: While I mean no disrespect, I do think that there is a tendency to go with the 'masses' in terms of predictions. Most analysts, in my opinion, tend to play it safe and you don't see too much variation in either their perception and/or target prices. This reduces their risks and liability. Also, most analysts are removed from industry events and happenings and tend to employ conventional processses with historic and peer data to value companies. This is likely to yield a poorer 'guess-timate' of any company's value.
My analysis and valuation draws heavily from my close involvment with the 3GPP and other mobile standards. I have also interacted with friends from various companies and so have a sense of the relative IP positions and the geo-political alignment of the industry. Hence my perceptions tend to be a little more educated from an industry perspective. Also, I tend not to look at other reports to have a pre-conceived notion of what its value should be.
In summary, my thesis is that if IDCC has to work the system, it needs to -
1. get licenses with top handset vendors to reduce legal risks.
2. work towards changing industry perception. (I think it is already working towards this through, for example, its chip business and standards participation)
These should push its stock price closer to its 'true' value.
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I agree with your valuation. Why doesn't wall street give this stock any respect? I have owned this company for years and they have a great story and better a great balance sheet.