The Company: OPTi Inc (OTCPK:OPTI) is a California corporation that was founded in 1989. From inception until 1995, the company focused on core logic products for desktop PCs. Faced with increasing competition, the company’s further product development dwindled until finally being ceased in February 1999. In September 2002, the company completely sold off its product fabrication, distribution and sales to an unrelated third party. Currently the company does not develop products, nor does it manufacture or sell products. So what, you may wonder, exactly does this company do? The answer lies within OPTi’s patents.
According to its 10K, OPTi states, “[the company] believes that existing technology used in current generations of core logic chipsets may be infringing some of the patented technology that the company has developed.”. As a result, OPTi’s current business strategy revolves around pursuing licensing opportunities with other companies that are infringing on its intellectual property, or outright suing those companies unwilling to acknowledge OPTi’s ownership of such patents.
OPTi is quite small, and there is not much to this company beyond owning patents and suing other businesses that infringe on its intellectual property. According to the most recent 10K, the company only has one full time employee and two part time assistants. Expenses consist mostly of the fees incurred during the process of detecting and protecting patent infringement, such as legal fees. Shares outstanding, according to its June 30th 10Q, are 11.65 million.
The situation: Over the course of a few years, OPTi has been taking on large, multi-national corporations with much success.
- October 2004, a complaint was filed against NVIDIA for infringement of five U.S patents related to predictive snooping chipset technology. Roughly 2 years later, in August 2006, OPTi and NVIDIA entered into a license agreement for an upfront $11 million and quarterly payments of $750,000 for as long as NVIDIA uses the technology, up to a maximum of 12 payments.
- February 2007 NVIDIA stated it had stopped using the snooping technology and would be discontinuing the quarterly payments; however, in October 2007 OPTi initiated arbitration against NVIDIA due to the belief that NVIDIA breached the license terms, and was continuing to use the snooping technology. In September 2008 the court ruled in favor of OPTI, requiring NVIDIA to pay $ 3.75 million.
- December 2009, the company initiated arbitration against NVIDIA, again under the belief that pre snooping technology was being used without the company’s consent. An 8-K was issued September 2010 stating that NVIDIA is required to pay $ 2 million no later than October of 2010.
Advanced Mirco Devices (AMD)
- November 2006, the company filed a patent infringement lawsuit against AMD for infringement of three U.S patents related to predictive snooping technology. In 2010 the company announced that it had settled the lawsuit and AMD had agreed to the terms of paying five quarterly, non-refundable payments totaling $32 million for an indefinite use of the specified patents.
- July 2007 the company filed a patent infringement lawsuit against AMD and other companies for the infringement of two patents titled Compact ISA-Bus Interface. In April 2010, the OPTI settled the lawsuit by agreeing to license the patents for a one-time fee totaling $3 million.
- January 2007 the company filed a patent infringement lawsuit against Apple for infringement of three U.S patents, all of which were titled Predictive Snooping of Cache Memory for Master-Initiated Accesses. In April 2009 the court ruled in favor of OPTi and in December 2009 OPTi was awarded a total of $21.7 million. Both parties have filed for appeal, and thus this case is still in process.
In order to assess this company going forward, it’s important to understand that the investment thesis is centered on OPTi’s patents, the company’s ability to win current lawsuits, and the company’s ability to successfully pursue further cases of patent infringement. OPTi holds patents in three main areas, Pre-Snooping technology, Predictive Snooping technology, and what the company calls Compact ISA-Bus Interface.
From what I understand, computers basically perform one task at a time. Essentially the process involves getting a command, looking for information needed to carry out such command, performing an action, and then repeating. Each step takes time, and reducing the necessary steps and time needed to perform such steps makes the hardware run faster. Opti’s pre-snooping technology helps in this area by allowing a working component to get instructions before they are needed, instead of waiting for prior instructions to be completed before moving on to getting more instructions. Thus, a working component now knows what command is coming next instead of completing its first command and then figuring out what to do next. This technology makes a computer system run faster.
A central processing unit (CPU) can be thought of as the brains of many electronic devices, and works by executing a series of stored instructions. A CPU has four primary functions, fetch, decode, execute, and writeback. When performing a function the CPU often looks in the cache first; cache is a high speed and expensive piece of memory that often stores frequently accessed data. The CPU looks here first because it is faster than sending a request to the main memory. OPTi’s predictive snooping technology works in this area, by allowing compliers to anticipate data transfer in advance.
A Bus is basically the connection between different components that are plugged into it. The faster and more efficient the bus, the faster an electronic device will be able to function, given that the other plugged in components are equally fast or faster than the transfer of information through the bus. A bus has a limited number of pin connectors, and components are made to fit standard sizes. OPTi’s Compact ISA-Bus Interface patents allow individual pins on a bus to be used for multiple things; this allows available signal lines to simultaneously handle both ISA and PCI devices. To do this, OPTi’s patents allow multiplexing, which reduces the number of signal lines needed on an ISA bus from 58 to 22. The reduced number of pins needed means that the size of the chipsets can be reduced.
Given the success of OPTi’s ongoing patent infringement suits, it seems likely that the company will prevail in its current lawsuits. The company just won another suit last month against NVIDIA, and given the fact that OPTi was awarded roughly $22 million from Apple before an appeal it seems likely that OPTi will come out on top of this suit as well.
It looks as if OPTi is starting with the largest, most well capitalized companies. Once these entities have agreed to be licensees and to pay up on past infringements, I assume OPTi will go down the list of lower tier companies that may be infringing on patents. The number of cases is not clear, but I anticipate more in the future. A significant risk is whether, or when, someone comes up with better technology and companies stop using OPTi’s patents. I am not an expert in this field, but I do feel comfortable saying someone will develop better technology; it’s only a matter of time and expense.
The Investment: Because the company doesn’t do much, we can easily assess the value of the business. Looking at the June 30th 10Q, we see net assets of $32.7 million, of which 45% is held as cash and basically 100% is held in the combination of cash and accounts receivable. Net assets divided by shares outstanding equals roughly $2.8 per share. On October 3, 2010 the shares traded at $2.65. In order to bring per share valuation closer to a more realistic measure, we need to pull out the $8.7 million dividend that was payable to shareholders as of August 12, 2010; this distribution was not recorded in the most recent 10Q. With the dividend distribution taken into consideration, we have a net asset base of $24 million, which gives the company a per share price of roughly $2.06.
Now we are confronted with the pivotal question. What is the justification for purchasing this business for $2.65 per share? Before we get into the details, let us briefly recall what this company does and how shareholders profit. OPTI searches for patent infringement, then sues, and then collects either fees for damages or enters into a licensing agreement. After collecting damages or licensing revenue, the company usually distributes unneeded cash to shareholders. In fact, OPTI usually keeps around $10 million of cash to keep the patent infringement process going, and eventually pays out the remaining amount to shareholders. In the past the company has done this quite well. Thus, once the initial investment has been recouped through cash distributions shareholders will profit from any future patent cases.
Looking into the near future, we have two key issues to consider. The first is whether there are any additional near-term payments or licensing fees coming up that may affect the company’s value, which there are. The second is the whether there may be future lawsuits, which is a little more difficult to assess. As for near term revenues to be expected, the first will be an additional $2 million to be collected from NVIDIA no later than October 2010; since this issue was announced in September, it was not recorded in the 10Q. The second, and more relevant of the near term revenue issues involves Apple. The future of OPTi’s patent pursuits should largely rest on the outcome of the Apple case, and currently the outcome looks like it will be quite favorable to OPTi considering that Apple has already been required to pay up to $21.7 million. Additionally, considering that this particular case began back in 2007, I expect this situation will be resolved within one year. Determining whether future lawsuits will arise is a difficult area to assess, and the issue has been lightly discussed above. An investor will need to rely on his or her own judgment; however, it will be shown later that the risk/return profile is still good if no future cases are taken to court.
Now back to the justification of a $2.65 per share price. Adding the NVIDIA and Apple payments into the net asset equation gives us $47.7 million, or $4.09 per share. Next, we must convert this figure into cash available for distribution. Since 2005, the company has been increasing its expenses in pursuit of patent infringement suits, having moved from $1.507 million in 2005 to $7.44 million in 2010. The highest expense level since 2005 occurred in 2009 and was roughly $10 million. Subtracting out $10 million, we can anticipate that the two near term lawsuits will add roughly $13.7 million. After a tax rate of 35% we can expect about $9 million of additional cash, or 77.3 cents per share. So now, net assets plus the addition of these near term lawsuits will put the business at $2.83 per share. Keep in mind that the $10 million used for expenses is both higher than the three or five year average, and it is higher than the most recent 2010 figure. Also note that the company has in the past recorded a little interest income, around $2 million per year in 2010 and 2009, and if continued this should add a little extra to the per share figures. Based on these assumptions, the company could easily be worth more than its current trading value within a short time frame. In addition, if more patent infringement cases surface OPTi could create substantial value with little risk to shareholders.
The Risks: Essentially, there are three outcomes to this investment scenario. The first is the company wins its current lawsuits and continues to successfully sue other organizations. In this case shareholders should easily be able to recoup their investment within a year or two, while enjoying future streams of cash distributions; there seems to be very little, if any, risk involved with this outcome. The second case would be that OPTi wins its current lawsuits but is unsuccessful in any further endeavors. In this scenario there is still little risk to shareholders, because the company should have roughly $2.83 after the Apple suit pays off. The third outcome is that OPTi loses the Apple case and is not able to win any subsequent case. Considering this as the worst outcome, OPTi should be worth around $2.06 per share, which represents a loss of 59 cents or 22% of the $2.65.
Risk versus Return: Given the risk/ return characteristics of this investment, there seems to be little downside and a high potential upside. In addition, investors should know much more about OPTi’s ability to continue its patent pursuit within one year; additional patent cases and the outcome of the Apple suit should unfold within this time frame.
Disclosure: Long OPTI