Ceva: License Fees vs. Royalty Fees

| About: CEVA, Inc. (CEVA)

The following is from the Reuters piece on Ceva from May 17 ("Ceva sees 5 cent royalty fee floor").

While the licensing pipeline is the best it has been in the past four years, Wertheizer [Ceva's CEO] said at the Reuters Summit in Paris he does not anticipate much growth in licensing due to industry consolidation.

"An IP company has to grow with royalties," he said, noting royalties could in the long term account for 80 percent of revenue.

"The company will be at that time very profitable, generating cash like crazy."

If I can assume that Reuters reported this correctly then I'd say that Wertheizer's comments are somewhat odd on several levels.

First, whether or not it's reasonable to suppose that royalties will be 80% of revenue long-term, it's perplexing that Wertheizer would declare as much for the simple reason that it sounds defeatist. Given that license deals, measured by license fees, drive future royalties it is close to being an admission that Ceva is not a long-term growth story. Perhaps Wertheizer should get points for candour, but this looks like candour of a sort that is apt to damage Ceva's standing in the eyes of investors and perhaps even harm Ceva's business.

Now it would be one thing if Wertheizer were indicating only that royalty fees might touch 80% of revenues at some single point in the future, but that is not what he is saying. He is saying that they could get to 80% of revenues and stay there long-term.

Second, one might wonder why royalty fees would so dramatically eclipse license fees long-term given what Ceva itself is saying about its new product initiatives. Is Ceva anticipating that the MM3000 video IP will not be a success? What about other initiatives? Might one argue that part of Ceva's reason for being in business is to drive the creation of new IP offerings (and license fees) to such a degree that royalty fees could never get even close to 80% of revenues? (In Q2 2010 royalty fees stood just shy of 49% of revenues.)

Finally, it's worth asking if Ceva's business could even be sustainable with royalty fees at 80% of revenues long-term. Of course contracts can be negotiated as two parties see fit. Royalty fees could rise to 80% of revenues long-term if Ceva were moving toward licensing deals that called for higher royalty fees in return for lower licensing fees. But Ceva has not given any indication that they are doing that. One constant in the semi IP business is relentless technological advancement. If the IP licensing deal, and the license fee that goes with it, is the comet and the stream of royalty fees that follow is the comet's tail . . . well . . . that tail is simply not likely to be all that long. A few years, but not a decade.

There is no reason to doubt that Ceva's royalty income will rise dramatically over the next few years. It may at some point reach 80% of revenues. But that is very different from the idea of Ceva prospering long-term with the royalty stream being replenished by a level of new licensing deals/fees that would be, as a fraction of total sales, far below what the company has experienced throughout its history. Ceva needs to explain to investors how this could work as a long-term growth model, or even be mathematically possible.

Disclosure: Long CEVA

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