Interdigital: Valuation Roadblocks

By Vijay Nagarajan, Guest Author

As I looked at the positives of QCOM acquiring IDCC, I threw a number between $35 and $45 as a possible sale price. This price was based on a mix of historic data projection, IDCC’s current stock price and the perceived value to QCOM. I revisited the topic recently to do a more thorough valuation analysis which I will present over the next few articles.

As with my QCOM valuation, I have chosen the path of an event-based discounted cash flow analysis since it allows me to superpose the company’s position in the industry’s future. Further, the lucid picture steers clear of multiples based on the peer group in the technology sector. The valuation for companies like QCOM and IDCC which thrive on intellectual property licensing cannot be fair if it is based just on peer comparison.

This being said, the valuation of IDCC has been a challenge due to a variety of factors –

• Percentage of IDCC-licensed handsets is unclear: The company claims that 30-35% of 3G handsets have IDCC licenses currently. I do not see this number as sacrosanct. So, it is difficult to linearly predict their growing customer base.
• Lumpsum fees versus per-unit royalty: IDCC reports that 60% of its revenue comes from 3G handset sales. It is unclear if lumpsum payments made for 3G licenses like in the case of LG fit into this category. I am going with the assumption that it is.
• Royalty rates are not linear as is the case with QCOM: IDCC seeks a per-unit royalty subject to a cap. This makes it difficult to map royalty as a percentage of the handset ASP. Based on the revenue share data and the 3G market share IDCC claims, the per-unit royalty is a little over $2 currently. But with larger volumes to be shipped in the years to come, this number will certainly come down.
• The legal uncertainties: Due to the volatile nature of the IP business, it is very difficult to predict when the licenses will materialize. This in turn determines the company’s market share. This also makes the company’ primary growth driver – 3G boom – more unpredictable.
• Chipset business: IDCC’s ASIC business is a new kid on the block and its success is yet proven through major customer wins. IDCC has however completed successful performance trials and has to now draw the carrier and handset vendors’ attention to its solutions to obtain design wins. These design wins will in turn give us more concrete market share data on the company.
• Secondary growth: As I have always maintained, with a flatter patent play in OFDMA, the growth rates will be stinted with just the current model. The company will have to transition its ASIC division into a staple revenue source. Any design win will not only give it a good push right now, but also serve as the platform for the company’s secondary growth beyond 2012 when the OFDMA technologies will slowly start to make inroads.
• Expenses: The current operating expenses as a percentage of the revenue are not indicative of the long-term picture. The CAGR of the operating expense is equally misguiding. IDCC is pushing a lot of money and resources into its R&D program, primarily to develop its 2G/3G ASIC. I think that while the R&D expenses, SG&A and its sales and marketing costs will grow at about 17% to expand its engineering team, its IP related fees should flatten out. I anticipate a net 15% increase in its year-on-year operating expenses.

In the sequel, I will briefly go over some of my assumptions and rationale and later take a look into my valuation.

This segment is a part in the series : Interdigital