Tessera: Implementation Of Strategic Initiatives And Starboard's Involvement May Create Substantial Upside

| About: Tessera Technologies, (TSRA)
  • Tessera Technologies (NASDAQ:TSRA) – Currently trading at $17.80
  • Potential Upside: $6.00
  • Market Capitalization: $920M
  • Cash:$535M; Total debt: $0
  • Shares Outstanding: Approximately 51.5M
  • Dates to watch out for: 30- March -2011 (AGM date)
  • Sector: Technology; Industry: Technical & System Software
  • Main Catalyst: Starboard Value asking for half the Board seats; Business Restructuring; 2012 monetization of Imaging & Optics (I&O) R&D Management
  • Trading timeline: 2 months– 14 months

What TSRA does:

Tessera Technologies develops, invests in, licenses and delivers miniaturization technologies and products for next-generation electronic devices through semiconductor packaging technologies, such as chip-scale packaging, multi-chip packaging, and wafer-level packaging; silicon-level interconnect and three dimensional (3D) packaging, and silent air cooling technology. Tessera’s Imaging and Optics solutions provide camera functionality in consumer electronic products through technologies that include extended depth of field (EDOF), zoom and Micro Electro Mechanical Systems (MEMS) based auto focus.

The company also offers customized micro-optic lenses for semiconductor lithography, communications and other applications. The company licenses its patents and technologies worldwide, as well as deliver products based on many of these technologies. In October 2011, the company's Invensas Corporation acquired ALLVIA, Inc.'s 3D-IC packaging technology. (Source: Google Finance)

Potential catalysts:

Involvement of a well known activist:
On 03-Jan-2012, TSRA announced it has received a letter from Starboard Value and Opportunity Master Fund Ltd. In the letter Starboard stated it holds less than 1.3% of TSRA equity and intends to nominate candidates to fill half of the positions on the company's Board of Directors. According to the letter, Starboard intends to nominate Maury Austin, Peter A. Feld and Jeffery S. McCreary for election at the 2012 Annual Meeting of the Stockholders of TSRA. According to public filings, Starboard owns approximately 9.9% of MIPS Technologies (NASDAQ:MIPS), Inc., where Mr. Austin is the former CFO and Mr. McCreary is a board member.

One option might be for Starboard to push for implementation of strategic initiatives that TSRA declared in April 2011. The strategic alternatives include, among other things, the separation of TSRA's two business segments, including divestiture or spinoff. Another option is for Starboard to push for a complete sale of business, especially when mobile optics and chip packaging sector is seeing a lot of activity due to changing technology landscape. Demand for devices has created demand for efficient and smaller chips – a technology for which TSRA holds lot of patents.

Furthermore, TSRA’s “disruptive” technology for Mobil camera is supposedly gaining traction, as the firm claims to be currently negotiating contracts to monetize its R&D. The technology and patents make either of the segments or the entire company a potential candidate for sale. Most recently Starboard was able to successfully nominate its members on the board of Regis (NYSE:RGS). The fund also went activist on another two names - AOL’s and Progressive Software (NASDAQ:PRGS). Starboard was also involved with Celera which was sold to Quest Diagnostics (NYSE:DGX). Starboard’s activist record still leaves some questions unanswered, however, if the fund nominees get elected at the AGM, it will provide upside for shareholders in the medium term as the fund might push to restructure the business.

Declaration of strategic initiatives to unlock value:
On 06 April, 2011, TSRA announced several strategic initiatives for its two units and hired GCA Savvian Advisors to assist the firm in exploring alternatives for the I&O business, including a divesture or spinoff. The two units are Imaging and Optics (I&O) and Micro Electronics (ME). The I&O segment has generated operational losses over the last 11 quarters primarily due to high operating expense, half of which is comprised of R&D costs. Separating this business may provide an additional $0.65 - $0.70 to TSRA’s EPS.

Shareholders could also benefit from a possible sale of the I&O unit if the firm is able to create value by monetizing the R&D investment done over the last few years. This would further strengthen TSRA’s balance sheet and help the company better execute its acquisition strategy for its remaining ME business. As for the ME unit, the company expanded the segment with a new group which will manage approximately 280 patents beyond packaging and will be responsible for developing, acquiring and monetizing these technologies. In the recent presentation, TSRA predicts its chip packaging solutions growing to 3 billion units by 2013

Possible monetization of I&O segment R&D:
The I&O segment that includes micro-optics and wafer level technology has application in mobile cameras, computers and toys, among others—consumer areas that have undergone growth. Clients for I&O include companies such as Sony (NYSE:SNE) and Samsung (OTC:SSNLF). In a recent response to Starboard’s letter, TSRA CEO alluded to the possible monetization of I&O R&D in 2012 by delivering a “disruptive” technology to the industry. The firm stated that it “will introduce camera modules based on silicon rather than magnetic coils to move the lenses for focusing and zoom”, thereby replacing a 100 year old camera technology currently used in mobile phones.

Among the milestones stated for this segment, TSRA said that

(i) First half of 2012: We will sign our first design win for the use of our transformational MEMS optical imaging technology in a new cell phone. (ii) Second half of 2012: We will announce major steps toward high-volume manufacturing of devices using this MEMS technology.

TSRA has reported negative EPS to date. Looking at individual segment, it can be concluded that this negative EPS is completely driven by I&O segment’s cost, of which R&D constitutes more than 50%. The calculation does not take into consideration the one time goodwill impairment charge for Sep-2011. If the firm is able to monetize this R&D, it may be able to create substantial upside for shareholders in the medium term.

Potential resolution of legal issues a positive:
TSRA is engaged in a number of legal battles with its competitors or clients, mostly due to patent infringements. According to its latest 10-K, TSRA’s more than 1400 patents—U.S. and internationally, combined—expire between now and 2029. Legal costs over the past 3 years have averaged 36% of ME’s operating costs. ME currently constitutes 80% of TSRA revenues. Several upcoming “conference management meetings” may provide direction on future legal costs to the firm. Under these conference management meetings, lawyers of the parties involved come together before a judge to explore possibilities of settlement before going to trial. An amicable solution would be a positive catalyst for TSRA’s stock price.

Management appointments:
One month after the reorganization announcement, TSRA announced the appointment of Robert Young as president and CEO to replace Henry R. Nothhaft, who is leaving the firm to advocate innovation policies and patent reform in Washington. The CEO appointment augurs well for the company as the reorganization will only be helped by his background. Mr. Young has been on TSRA’s board since 1991 and had a 17-year career at IBM. He was also a managing partner at Dillon, Read & Co.'s venture capital arm and served as its head of Technology Banking. Another notable appointment was the addition of Kevin Rivette to the board in March.

Mr. Rivette is a managing partner of 3LP Advisors, an IP investment advisory firm, and is former chairman of the United States Patent and Trademark Office (USPTO) Public Patent Advisory Committee. Another notable appointment was of Anthony J. “Tony” Tether. Tether is currently CEO of The Sequia Group (TSG), a consulting firm that provides program management and strategy development services to government and industry. In 2009, he retired from his role as director of the Defense Advanced Research Projects Agency (DARPA), a position he had held since 2001.

TSRA has $536m in cash and no debt on its balance sheet. With approximately 51m shares outstanding, TSRA has net cash of $10.4 per share, or 58% of its trading value. Divesting the I&O division may add approximately USD 1.00 per share in EBIT or USD 0.65 a share, assuming a 35% tax rate. On the contrary, if the management decides against divesting while executing and monetizing I&O’s R&D, then this business, in addition to the ME segment, might create more upside for the shareholders as a combined company. TSRA traded at an average P/E of 15x, while the current P/S of 3.0x.

Its competitors traded at a median P/Ex of 20x and 2x, respectively. For investors looking at investing in the firm, TSRA may present an array of options by which they can benefit as investors. One is the potential separation of the two segments, which can be traded separately via a spin-off. This also makes them potential takeover targets since the firm has relevant technology and patents in high growth areas such as the mobile industry and chip packaging. Another is the upside presented from the combined company assuming it can amicably resolve its legal battles and executes on its strategic initiatives thereby creating opportunity for multiple expansion. TSRA traded as high as $23.20 in January, 2011.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.