IDCC: A Controversial Stock Not Worth The Risk

There has been a lot of talk about patent reform, litigation, and patent trolls in the media and in Washington of late. Given the endless patent wars between Apple (AAPL) and Samsung, the multi-billion dollar patent portfolio purchases from firms like Microsoft (MSFT) and Google (GOOG), and the generally increasing time and expense of getting even a single patent, it's easy to get the feeling that the patent process in this country is largely broken. While Washington politics and lobbying from special interest groups are likely to prevent patent reform for the time being, eventually it is a near certainty that the US will have to reform its patent system.

Based on this risk, I believe that $1.6B market cap IP holding company Interdigital Inc. (NASDAQ:IDCC) is too expensive at current levels, and does not adequately reward investors for taking the risk of holding its stock.

If you believe that such reform is all but inevitable in this country eventually, then it follows that patent holding companies (derisively called patent trolls in the media), should be paying out large amounts of their free cash flow to investors in the form of dividends. Much as tobacco companies pay out large amounts of cash to investors in order to help take the target off their backs, one would think IP companies would do the same thing.

Yet IDCC pays only a 1% dividend and seems to be spending the vast majority of its incoming cash on new patents. While shareholders should always be looking for a company to reinvest in its business, in this case the company seems to be banking very heavily on the continuation of the status quo - something that may not be wise given that patent litigation has not achieved much in the way of results for either Samsung or Apple, and given that Xerox (XRX) and Nokia (NOK) have both seen disappointing results when looking at the sales of patent portfolios in recent years.

IDCC is sitting on nearly $600 mm in cash as of the end of 2012, so the company is probably not a good short candidate (though it may be a good candidate for buying long term puts on). Nonetheless investors simply aren't seeing much benefit from holding the stock as the price chart below shows. Here Interdigital is in blue while the S&P 500 is in yellow.

As the chart shows clearly, over the last five years, investors in IDCC have been subject to enormous risk, volatility, and uncertainty, all for a dividend yield about half of the overall S&P's and price appreciation only slightly greater than that of the S&P. This is one case where a diversified portfolio of all stocks was certainly better than the idiosyncratic risk associated with a single stock.

While IDCC has been able to force big companies to pay up in recent years this trend may be coming to an end. Early in July (of 2013), a judge ruled that tech titans Nokia, Huawei, and ZTE had not significantly infringed on IDCC's patents in the wireless space. This appears to be in line with anecdotal reports of increased scrutiny by judges on patent infringement claims and a stricter interpretation on exactly what innovations are covered by patents.

In response to the ruling, IDCC's stock fell more than 15%. The point here is that investors in this firm are literally risking everything they invest on the rulings of a few judges. Without favorable court treatment, the majority of IDCC's "assets" have no value. So while the company is unlikely to go out of business tomorrow, it is entirely plausible that it could very well find itself out of business in a few years through no fault of its own.

On the back of this risk profile, it is little wonder that the company trades with a ttm P/E of ~6.6x. But even at these levels, investors in the stock should be looking for exit opportunities as the profits and revenues for the firm are extremely uncertain. The chart below illustrates this.

Revenues ($M)	2013	2012	2011	2010	2009	2008
1Q	47.36	69.31	78.46	116.2	70.56	56.03
2Q	--	71.87	69.87	91.15	74.93	58.71
3Q	--	434	76.46	91.92	75.49	55.06
4Q	--	87.88	76.96	95.28	76.43	58.68
Year	--	663.1	301.7	394.6	297.4	228.5
EPS	2013	2012	2011	2010	2009	2008
1Q	-0.30	0.24	0.51	1.09	-0.20	0.16
2Q	--	0.22	0.37	0.78	0.60	0.13
3Q	--	5.56	0.57	0.80	0.69	0.20
4Q	--	0.38	0.49	0.76	0.69	0.09
Year	--	6.26	1.94	3.43	1.98	0.57

Click to enlarge

As the chart shows, history truly is no guide to IDCC's future potential. The firm's revenues are consistently inconsistent. The extremely low P/E that Interdigital currently commands is largely based on a huge $5.56 payoff in Q3 of last year and this is unlikely to be repeated. The firm's revenues look about as likely to be significantly down as up y-o-y in any given quarter, and the company posted a surprising $0.30 loss in Q1 of this year. One would normally think a firm facing this level of uncertainty would use every opportunity to pay out as much cash as it can to shareholders, but instead the firm paid out only a paltry $0.30/share in 2012 down from $0.41 in 2011.

In fact a closer look at the firm's annual financials over the last ten years reveals much the same pattern.

FYE	2012	2011	2010	2009	2008	2007	2006	2005	2004	2003
Revenue	663	302	395	297	228	234	480	163	104	115
Net Income	272	89.5	154	87.3	26.2	20	225	54.7	0.16	34.5
Cash	577	678	542	410	142	177	166	27.9	15.7	20.9
Current Assets	814	769	620	702	241	371	454	176	157	152
Total Assets	1,057	997	875	906	406	535	564	300	242	205
Current Liabilities	173	173	179	253	127	157	121	50.5	49.8	40.1
LTD	200	193	10.8	8.84	1.32	2.41	1.2	1.57	1.67	1.78
Common Equity	519	472	353	170	87.7	137	848	174	235	97.5

Click to enlarge

IDCC's revenues have been all over the map over the last decade and their net income appears equally volatile. Further, while the company doesn't carry much debt (relative to its assets, EV, or $1.4B market cap), it also doesn't seem to be interested in using its ~$600 million cash pile to reward loyal investors. Instead, the company's equity value simply continues to increase which will leave stockholders with almost all of the risk should legislation threaten the company's future going forward. Analysts seem to agree which may be why 66% of them (4) rate the stock a 'hold' which in the world of optimistic sell-side analysts is the same thing as sell.

Given the legal backdrop, the volatility in the stock price and earnings, and the ineffective corporate governance that seems to be in place at Interdigital, one is hard pressed to wonder why any sane investor would want to hold the stock for the long run. While IDCC's cash pile probably makes it too risky a short sale target, it may be an attractive stock to buy long term puts on. Further investors who are currently long the stock should be looking for a way to get to the exit ASAP!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[slimhere]

IDCC closed at $38.82 the day you wrote your article, I still think it's worth twice that amount. However, everyone is entitled to their own opinion.

[Patent News]

idcc is not that risky

[The_C_dog]

There is no question that the political, legal and regulatory forces have created a degree of uncertainty over the patent landscape. While this creates a risk factor that should not be taken lightly with respect to an investment in Interdigital, in your efforts to drive home your point I think you are a bit excessive in painting a picture of doom and gloom for Interdigital.

I will pull some quotes from your article:

1. "investors in this firm are literally risking everything they invest on the rulings of a few judges."

By "risking everything" it appears that you are implying that IDCC will go to zero in the event of an ITC defeat. Not a chance. Interdigital has over $500 million in net cash and a significant existing revenue stream. Due to the current heightened legal activity, Interdigital has been running approx. $20 million a quarter in litigation expense. Litigation expense will be greatly reduced upon completion of the ITC proceedings, and their existing revenue stream will remain. The ratcheting down of legal expense, win or lose, would contribute to the bottom line. Their mountain of cash would remain a mountain of cash should they lose at the ITC.

2 "Without favorable court treatment, the majority of IDCC's "assets" have no value."

Not accurate at all. Interdigital has signed the vast majority of its license agreements without the need for litigation. And many of those license agreements were obtained subsequent to their ITC loss to Nokia in 2009. Interdigital also suffered a loss to Motorola back in the mid-90's, and subsequently went on with a successful licensing program. Fast forward to 2013, Interdigital holds more cash (a significant asset) than it has ever held in its history, and is participating in a mobile device market that dwarfs the markets of the mid-90's and 2009. It would remain one of the top holders of patents essential for the LTE standard.

3. "it is entirely plausible that it could very well find itself out of business in a few years"

Ridiculous. Interdigital is an incredibly efficient, well managed little company. Again, it's sitting on over a half billion net cash. It's primary business expenses are R&D and litigation, and they have less than 300 employees. Those expenses are easily controllable under your doomsday scenario. Even in a worst case scenario where political, legal, and regulatory forces would create an environment where a Non-Practicing Entity business model would no longer be viable, Interdigital would likely have many opportunities to partner, merge, or sell to product oriented companies who would salivate over the prospect of having the Interdigital portfolio or parts of it as a defensive patent arsenal, just as Intel did last year, purchasing IDCC patents to the tune of $375 million.

One other thing about the prospects of an ITC loss, which concerns just a few patents of Interdigital's 20,000 plus patent portfolio. People don't consider the fact that even in the event Interdigital does not prevail at the ITC, these OEM's, despite being victorious, would still like to be licensed to the Interdigital portfolio. In addition to the appeals process which would follow, the OEMs don't want to see the Interdigital portfolio splintered and sold off in pieces, creating a situation where these OEMs are going to be facing lawsuits in every direction concerning multiple patents from multiple owners. They don't want to see the portfolio going to a competitor, which would allow that competitor to increase their negotiating leverage in an eventual OEM cross-licensing deal. The Interdigital portfolio will remain a going concern for these OEMs until licensed.

It should be noted that Interdigital has three separate ITC cases. The 613 ITC investigation could be decided at any time, and comes on the heels of an Interdigital CAFC victory last August, which defined the patent claims exactly as Interdigital had argued. Your article refers to a judge's ruling against Interdigital. That was not a "ruling" at all, but an Initial Determination by the ALJ in the 800 ITC case, to which Interdigital argues that the ALJ, in pouring over thousands and thousands of documents, made a critical "glaring" claim construction error which is not consistent with how a related patent's claims were defined by the Federal Court of Appeals. This case needs to go to the full Commission for a Final Determination. I'm not suggesting that this is a slam dunk, but this ALJ initial decision is far from over. Finally, Interdigtal has a third case at the ITC, the 868 investigation, to which no decisions have yet been made. Should IDCC lose all three cases, IDCC would still have the appeals process.

4. "Further investors who are currently long the stock should be looking for a way to get to the exit ASAP!"

This is a silly comment and the excessive and urgent doom and gloom nature of this article concerning a very financially stable and efficient company suggests an underlying financial motivation for this article.

[jsds]

Notwithstanding ;your ommmission of the $1.50 special dividend last year I think you are correct with respect to warning about investing in IDCC. Some might think the patent system is broken, I think it works exactly the way large company's and their law firms desire. It's only when they find themselves in dispute with each other does the system appear broken. If a small company like Interdigital attempts to enforce their IP rights then the process is completely fair. lol
I think the system works exactly as those in power wish it to work.
It's very good for the law firms , judges and the government agencies .

[getreel]

I wouldn't call IDCC controversial.
I would just say that its management stinks.
Its pretty pathetic, when you develop patents for 4g, have them incorporated into the standards by the standards committees and declared essential, then several years later these patents get wasted by the ITC.
What is wrong with IDCC ?
Take your pick. poor management, poor patents, poor licensing strategy, poor lawyers.
Qualcomm had their major infringers for 4g signed 5 or 6 years ago.They are now using those recurring revs to develop more patents, improve earnings, and grow the company. their r&d grows yearly, while idcc is on this famous 10 year plan, to sit around, spend 200 million on legal fees instead of r&d, give early outs to engineers, and stay the same wannabe it has been .

[Mainelefty]

There is a great deal to know about patents, wireless development and IDCC's role in this over the last thirty years.

At the moment, the "broken patent system" to which you refer has placed no risk premium on refusing to take a license for a patent on reasonable terms, thus the rise in litigation to force compliance.

That is, in the long run, a dangerous and expensive path for the infringers, and IDCC receives tens of millions each year from manufacturers who voluntarily comply. The cash they keep on hand includes what they need to sustain the company through its rather long payment cycles, remain viable in enforcing its rights against infringers and reserve prepaid license sums for future operating expenses.

They have a fairly good record of success in navigating the legal process, which can take more than 10 years (their current entanglements with Nokia are almost that old) but the accruing rights are very valuable. The spike in share price in your chart was a speculative rise as the company considered whether it should sell itself two years ago.

Since their payment cycle is elongated, your focus on the rather minor dividend - 1% is common in tech companies - is misplaced.

[Karl_V]

So IDCC is not worth the risk because of Apple, Samsung, Google, Microsoft is fighting? I don't agree with that at all. IDCC is not a troll company. A patent holding company that actually invents technologies and solutions is not a troll. There may be allot of people in the stock that bought it for the wrong reasons, or people that should not be in the stock from the beginning. Allot of them probably left in the 15% drop, I guess, and that's a good thing I think. I still believe in IDCC.

But, still. Thank you for an interesting read.

[slimhere]

You did not mention that IDCC sold a bundle of patents last year and rewarded shareholders with a $1.50 special dividend on top of it's regular dividend, so it's not surprising that you failed to mention that the CEO has stated that negotiations are currently in place to close on another bundle of patents this year.

I do agree with you that Washington needs patent reform, I just don't see that happening on Obama's watch. I do not agree with you about buying puts, I would be selling out of the money puts as a cheap way to acquire more shares of IDCC, or at least collecting the premium for those sales.

[Mike the PhD]

Thank for the comment. I agree IDCC is making changes. I just think they could be doing much more for investors. They should implement a much more substantial regular divdident to start.