On April 18th, Acacia Research (ACTG) released first quarter 2013 earnings. The headlines were not pretty. Quarterly revenues fell 22% compared to the same prior year period. Non-GAAP net income was $22,710,000, or $0.47 per diluted share, compared to significantly higher $67,755,000, or $1.48, for the first quarter a year ago.
The next day, the stock plummeted, losing over a quarter of its value in a single trading session. Media journalists and bloggers quickly followed behind calling the company "way too volatile a business" and criticizing the dip in the bottom line. But this type of quarterly earnings analysis for an IP licensing company such as Acacia is flawed and certainly does not merit a sudden 27% decline in share price.
In many ways, Acacia serves as an asset manager which profits by monetizing its IP (intellectual property) for itself and its partners. Acacia analyzes, researches, and prices these patents. The company then asserts and monetizes IP. Partners can therefore focus resources and time on their core business, yet recoup sunken research and development (R&D) costs on IP development. Through Acacia they can accomplish this in low risk way, while still having a share in profits.
Acacia stands in stark contrast to the win-all-lose-all nature of high stakes IP plays, such as VirnetX (VHC) and Network-1 Security Solutions (NSSI.OB). Acacia offers a vastly more stable, diverse, and proven model. In the long run, Acacia may provide investors a less risky vehicle to ride the hot IP monetization sector.
IP is a newly emerging asset class not well understood by the investment community. The complexity and opaqueness of this space provides difficulty for analysts and investors to price portfolios, much less companies as a whole. Licensing involves private discussions with companies and quite often litigation. Each potential licensee has a complex web of issues and situations they must navigate for themselves in order to license, if at all, from Acacia. The closed nature of this business and reliance on specific circumstances with licensees make it impossible to predict when a license (revenue) will be realized. Thus the 3 month estimate guessing game can be a bit unproductive. Any comparisons to previous quarterly results need to be handled delicately within this unique sector.
On top of this challenge, the exceptional events during the first quarter of 2012 for Acacia add to the skewed (and unconstructive from an investing standpoint) year over year quarterly comparison. In the first quarter of 2012, Acacia shelled out $160 million in a large purchase of 4G wireless patents from ADAPTIX. Within a few weeks, Microsoft (MSFT) and Samsung (GM:SSNLF) licensed this IP for about $65 million. This unusually large purchase and subsequent revenue further throws off any year over year quarterly comparison.
Management recently articulated the flaws in putting much weight into these earnings in a recent conference call:
"We always remind the investors that management does not attempt to manage for smooth sequential quarterly growth in revenues and therefore quarterly results can be very uneven…Our focus is always on getting paid the right price." They further explain, "Unlike most companies, revenues not generated in the current quarter are not lost, but are generally pushed into subsequent quarters building a revenue backlog."
Thus, the shear randomness in the timing of securing these licenses diminishes the value investors should place on short term earnings. More importantly, monetization can remain on track for portfolios, with revenues simply being kicked down into the coming months instead.
Acacia's business model is quite different from most other companies trading on Wall Street and thus requires a unique approach to analysis. Investors should track longer term revenue and income metrics, the overall intake (quantity & quality) of new IP, and follow developments of key patent portfolios owned by Acacia, which are the real drivers of revenue and the company's value.
Management notes Acacia possesses several key or "marquee" patent portfolios, which it views as a potential nine figure licensing opportunities. They believe Acacia currently manages at least ten of these. Any meaningful valuation of Acacia should focus on these important portfolios.
For example, the 4G wireless ADAPTIX portfolio is one of these marquee portfolios. As noted earlier, the upfront payment for this portfolio was $160 million. Acacia has recouped two-thirds of this investment within the first year. Management projects the company could be "in the money" on this investment by the end of 2013, meaning tens of millions more are expected to be brought in from this portfolio alone.
The Access portfolio is another key investment by Acacia. Management notes there continue to be large companies in litigation with this IP. Interestingly, they also signal Acacia "…will expand [its] licensing efforts in the foreign markets…", meaning more revenue is expected here.
Although these portfolios may not have had the impact investors were hoping for in the previous quarter, it is clear that the return on investment (ROI) for these portfolios is progressing unabated and will bring in revenue in the coming quarters instead.
Management evaluates company performance on four metrics. These should provide a template for investors as well.
1. Annual growth of patent portfolios under management
2. Annual growth of new licensing programs
3. Annual growth in revenues and
4. Annual growth in net profits.
In 2012, Acacia set new records in all four metrics. For the full year, Acacia invested $328 million on a record intake of 55 new patent portfolios. The company inked licenses from 68 different programs. The quantity and quality of portfolios managed continues to steadily increase. Historically, there has been a clear correlation between patent acquisitions and later realization of revenue. So despite the sudden alarm from some in the investment community regarding the recent 3 month earnings snapshot, the long term trends remain intact.
In fact, this momentum and the massive pipeline of patent portfolios already acquired should continue ramping revenues through 2013 and beyond. The recent selloff of Acacia shares by over a quarter of their value does not align with the actual progression of the company's business. Investors should take advantage of discounts in equity due to such quarterly "misses", as the overall progression continues positively.