InterDigital’s And Tessera’s Communication Problems

We recently saw how Qualcomm is benefiting from global growth in the use of 3G devices. Shipments of 3G-enabled phones, accounting for 38% of the market in 2009, are forecast to increase to approximately 60% of the market by 2013. Another beneficiary of the 3G boom is InterDigital, an IP licensee that holds about 50% of the 3G handset license market and annual revenue of $297.4 million. The company recently reported its second quarter results. In this post, we will look at the performance and prospects of both InterDigital (NASDAQ:IDCC) and Tessera (NASDAQ:TSRA).

InterDigital reported second quarter revenue of $91.2 million, up 22%. Net income was $35 million or $0.78 per share, up 32% from last year. The company ended the quarter with cash and short-term investments of $485.8 million. Samsung accounted for 28% and LG Electronics 16% of total revenue. InterDigital’s agreement with LG will expire at the end of the year. Q1 coverage is available here.

At the end of 2009, InterDigital’s patent portfolio consisted of 1,242 U.S. patents and 5,996 non-U.S. patents. Patent licensing royalties of $85.1 million increased 17% driven by agreements with Samsung, Pantech, and Cinterion as well as the recent renewal of a patent license agreement. InterDigital is not disclosing the licensee.

Technology solutions revenue was $6.1 million, more than double from $2.2 million last year owing to contributions from two customers added during first half of 2010, Beceem and CapiSemi, as well as growth in per-unit royalties related to licensing of the company’s SlimChip modem core. The customer base for SlimChip modem core has grown to six companies, covering 10% of the current 3G cellular ASIC market. In March 2009, InterDigital announced a repositioning plan that stopped further product development of the SlimChip modem technology and sought to monetize the product investment through technology licensing.

InterDigital is trading around $27 with market cap of about $1.2 billion. It hit a 52-week low of $18.41 on October 28 of last year. Ben Strubel of SeekingAlpha wonders if its patent portfolio is undervalued. He values it in the range of $25–$38.35.

In general, IP companies have an esoteric business model, and they are hard to understand and quantify. As such, there is only a small group of investors who know how to play this market, keeping trading volumes relatively low. InterDigital is surely hurt by this barrier and will continue be unless it gets significantly better at explaining its business and the prospects of its various lP elements. As it stands, I find the company’s investor relations poorly done. With all due respect and at the risk of being arrogant, I think I could help them position their business much better than they currently do. And to unlock the stock’s value, this positioning is crucial.

In 2007, guest author Vijay Nagarajan did a deep-dive analysis of InterDigital and valued the stock at $75 and a long-term Buy. Since then, there have been many developments that have worked against the company: the recession, the cessation of production of SlimChip modems, and the setback in InterDigital’s infringement suit against Nokia.

However, InterDigital also managed some upsides, a major one being the $400 million Samsung deal. It initiated the licensing of its long-term evolution (LTE) or 4G portfolio in 2009 and currently has 360 U.S. patents and patent applications to the European Telecommunications Standards Institute (ETSI) for LTE. Unlike for the 3G roll-out, InterDigital expects the 4G roll-out to be rapid, mainly because the networks are already congested as an increasing number of people use wireless devices.

Tessera, which licenses its miniaturization technology to various mobile device vendors and has annual revenue of $299.4 million, recently announced plans to acquire Siimpel Corporation for $15 million. Siimpel is a developer and manufacturer of MEMS-based camera solutions for mobile imaging applications and complements Tessera’s focus on the growing market for camera-based handsets.

Second quarter revenue was $74.6 million, up 17%. Net income was $15 million, or $0.30 per share compared with $11.84 million, or $0.24 per share last year. Microelectronics revenue was $55.6 million, and Imaging & Optics revenue increased 43% to $9.5 million including $3.3 million in royalties and license fees.

For the third quarter, Tessera expects revenue of $79 million to $82 million, up 20% to 24%. The company expects microelectronics revenue to be between $69 million and $72 million and Imaging & Optics to be approximately $10 million including $4.5 million in royalties and license fees. It is targeting to reach the milestone of $100 million imaging and optics revenue by 2011. Its Imaging and Optics licensees include Samsung, STMicro, and Toshiba. According to Gartner, the $1 billion image sensor market is expected to grow to more than $2.3 billion by 2013.

Most of Tessera’s revenue-generating patents will start to expire over the next couple of years. Patent no. 6,433,419, which is related to semiconductor packaging technologies that are much used in the wireless industry, expires in September 2010. Last year, the International Trade Commission (ITC) ruled that this patent was infringed by Qualcomm, STM, Motorola, Freescale, and Spansion. Motorola subsequently signed a deal with Tessera, but the duration of the deal is not known.

The stock is trading around $17 with market cap of about $850 million. It hit a 52-week low of $15.39 on July 1 on concerns of expiring patents and declining revenue. But the recent quarterly results pushed up the stock a bit. The concern about the expiring patents, however, remains, and Tessera also needs to do a much better job in explaining its strategy given that looming issue.