Tessera Technologies, Inc (NASDAQ:TSRA) develops, licenses and manufactures technologies related to semiconductor packaging and thermal management as well as imaging and optics. TSRA has a patent portfolio including 953 issued US patents and 393 issued international patents, as well as more than 900 applications currently outstanding. While the company does purchase intellectual property, it is far from being a patent troll as it also engages in R&D, spending upwards of $60 million per year. The company has no debt, trades at a P/E ex-cash of just 7x (the company has cash of $9.40/share vs a share price in the low $17s). Furthermore, the company has strong free cash flows, with a 5-year average of $83 million per year, representing a FCF Yield (using Market Cap ex-cash) of 21.5%!
Looking at the company’s recent history, we see that Tessera's revenue and gross margins have been improving, and the company has been fairly consistent in generating high returns on equity. Treating this company as a no-growth perpetuity using stable margins and a conservative estimate of revenue (based on current revenue generated from royalty & licensing and product & service categories), I estimated TSRA’s EPV to be in the mid $20s, providing a substantial margin of safety at current prices.
While the above is based on current and historical operating performance, the company has several option-like opportunities for substantial gains (the “long-tail catalysts” I refer to in the title). The company is currently engaged in a significant number of lawsuits which it has brought in order to protect its intellectual property. These lawsuits cost the company $20 million per year (approximately equivalent to what the company spends on COGS). Tessera has had many victories in these lawsuits historically (the company says it has generated $1.2 billion on the $200 million it has spent from 2004 to 2010 on defending its patents – quite a return on investment), with the most recent being a US Court of Appeals victory affirming the company’s earlier victory at the International Trade Commission.
I should note that the effects of these lawsuits don’t really go the other way – a loss isn’t going to lead to a judgment against the company. There are a few countersuits, but they claim that the patents are invalid (which, even if true, would not lead to a judgment against the company. Also, I should note that the patents in question have been upheld time and again, leading me to believe these countersuits are poor litigation strategy than anything).
Here’s how I see this: If the company wins these lawsuits, this will generate a significant amount of cash. Great! Even better, the litigation expenses will decline. This is pure upside, as I don’t include any potential gains in my valuation. Tessera currently generates the income used in my valuation from licensing agreements from its patents. Court victories represent gain above and beyond this. If the company loses these lawsuits, the litigation expenses also decline, providing enhanced margins and improving the company’s already stellar free cash flow. Also great!
Author Disclosure: Long TSRA.