Google (GOOG) just announced that they are buying Motorola Mobility (MMI) for $12.5 billion. They are obviously buying Motorola Mobility for their 4G IP. $12.5 billion is a hefty price to pay, but coming on the heels of the Nortel patent auction, this just goes to show the value of LTE/4G intellectual property, and starts to reveal the hidden value in Interdigital (NASDAQ:IDCC).
As we all know, Apple (AAPL)/Microsoft (MSFT)/Research in Motion (RIMM) paid $4.5 billion for the Nortel patent portfolio and Nortel's portfolio is less than 20% of the IDCC's portfolio (with a lot less essential patents on 4G). If we know that IDCC's portfolio was 5 times bigger than Nortel's (and, in addition you got the talented engineering staff of IDCC as part of an acquisition), then IDCC's 4G portfolio alone should be worth 5 times $4.5 billion. If that were the case, IDCC would have a market cap of $22.5 billion right now or about $450/share. That's one comparison valuation, but for the time being, let's just forget that.
Let's look at the current value of IDCC's LTE/4G portfolio from another angle. Based on independent estimates that have been presented at least 3 times in recent IDCC presentations and conference calls, for each .1% royalty on LTE/4G handsets, the Net Present Value is $1.2 billion (see slide 11 of 19).
No one knows for sure what rate IDCC will ultimately get on LTE/4G, but the LTE standards from ETSI have incorporated numerous IDCC essential patents. One could easily make the case that IDCC's portfolio justifies a 2.5% royalty rate on LTE/4G (QCOM has published a FRAND rate of 3.25% and many experts believe IDCC's LTE/4G patent portfolio is bigger than QCOM's). This recent report by ZTE (a Chinese manufacturer who IDCC just filed suit against at the ITC) thinks that IDCC has 24% and QCOM has only 13% of the essential LTE patents … but you will see these numbers vary all over the place depending upon who did the analysis. But, one data point is the Chinese who think IDCC is number one in LTE/4G patents by a large margin.
The chart above is only one view of the LTE/4G landscape. This article suggests IDCC has 21% of the LTE patents while Qualcomm has 19%. I have seen other articles that think QCOM leads with 21% and IDCC is second with 13%.
Just to be extremely conservative, let's just estimate that QCOM is #1 and IDCC is #2 and IDCC will have to settle for significantly less than QCOM's rate of 3.25% for LTE. Let's say IDCC licenses the industry at only 2%.
Based on the value of their LTE portfolio alone, IDCC should have a current market cap of $24 billion (NPV for each .1% is 1.2 billion) if they get a 2% royalty on LTE, yet their current market cap is only about $3.8 billion. In essence, if you just looked at the net present value of their LTE/4G IP portfolio alone, and ignored any value associated with their Wireless Convergence Technologies IP, their Machine to Machine (M2M) IP, their new digital compression technologies, their bandwidth aggregation technologies and their current 3G IP ... then IDCC should be selling right now for about $480/share ($24 billion/50 million shares). The fact that they are selling at a miniscule $76/share gives investors a unique opportunity.
Still not convinced? Okay, let’s work the future LTE revenues from another angle. In the past few months, we have seen all the major wireless providers announce their moves into LTE. It will take a few years, but soon everyone will want LTE phones to take advantage of the higher speed LTE networks. I have seen projections of 180 billion dollars per year in LTE handsets in four years. What rate will IDCC get on those phones? If QCOM is getting 3.25%, I think IDCC should pursue 3% and should get at least 2.5%.
However, if you think a 2.5% royalty is too high, then let's once again be extremely conservative and project that IDCC only gets 2% on LTE/4G. If the market size is $180 billion annually (as has been stated), that's over $3.6 billion dollars in royalties from the handset market alone. With only 50 million shares outstanding, that is $72/share in earnings (pretax) and about $45/share (post tax) (remember there are really no "COGS" for IP companies once the patents are issued). Keep in mind we are only talking about royalties from the handset market and not the Wireless Consumer Electronics market (Tablets) or the Wireless Convergence Technologies and other Network of Network technologies that I believe the carriers [AT&T (T), Verizon (VZ), etc.] will have to license in order to solve the bandwidth crunch they are already facing. Those royalties could easily add another $20-30/share annually to earnings. Also, this does not include any upside from the Machine to Machine (M2M) market where IDCC has a virtual lock due to their head start. This new M2M market is just starting to ramp and will be growing in leaps and bounds ... and the standard is based on IDCC IP.
As you know by now, I think a little out of the box. What if, instead of a buyout, IDCC is using the threat of a buyout to get the rest of the industry to license their IP at reasonable rates [i.e. Qualcomm (QCOM) type rates ... or at least 65-75% of QCOM rates]. If that happens, I think >$400/share is achievable in the short term.
What if Apple and Nokia/Microsoft signed 5-7 years licenses on 3G and 4G at rates of 1% and 2.5% respectively? Would Apple and Nokia (NOK)/Microsoft do that to keep IDCC from selling the company (or their patents) to Google? It's a helluva lot cheaper than buying them for $12-15 billion. I wonder what 1 billion in annual revenue (~$500 Million from Apple and $500 Million from Nokia/Microsoft) would do IDCC's stock price? That's an additional $13/share in annual earnings after taxes, and there would still be another 65% of the industry that would need licenses on 4G. The Apple/Nokia rate on 3G and 4G would become the minimum rate to license IDCC's IP. All the rest of the industry (including Samsung) would still need to sign licenses for IDCC's 4G IP. In addition, there are numerous other handset manufacturers that aren't even licensed now for 3G. Could this "bidding war" be a way to get the industry to finally pay competitive rates to little Interdigital? If not ... and they do decide to go ahead and sell the company ... then so be it. I'll be very surprised if it goes for < $250/share.
If IDCC only signed Apple and Nokia/Microsoft to 3G and 4G licenses, their annual earnings would immediately jump to the range of $15/share +/- $3 (assuming 1% on 3G and 2.5% on 4G). IDCC would still have another 60-65% of the market to license for 4G. As a point of reference, QCOM currently has a PE of 21, so if IDCC earned $15/share, the stock price should jump to in excess of $300.
For anyone who is skeptical, run the numbers yourselves. Take a look at slide 13 (of 19) in this presentation, and put a 1.0% royalty on 3G and a 2.5% royalty on 4G for handsets. Be conservative and start at 1.0% for 3G and gradually increase the percentage as more and more phones became multimode, IDCC would be getting a blended rate moving toward 2.5%. At some point (5-7 years down the road), the majority of phones will be both 3G and 4G capable. IDCC may elect to give licensees a special deal on multimode phones. For example, instead of charging 1.0% + 2.5% = 3.5%, they may give them a multimode deal at 3% (that's still cheaper than QCOM).
While you're looking at slide 13 ... imagine if IDCC licenses a small part of the data services market. We already know that have a lock on the M2M market and they will be getting paid on the wireless consumer electronics market (ala Acer). One of these days the analysts will start to see the true value of Interdigital ... but in the meantime ... everybody keep quiet and don't tell them.
IDCC has been working on the bandwidth crunch issue for several years. They have technologies that are on the cutting edge for solving the bandwidth crunch that carriers are already facing. If you have ever been in New York City or San Francisco and have had your calls dropped or your downloads interrupted, then you know what I am talking about. Now you know why AT&T and Verizon need to also license IDCC's IP. It's just a matter of time before we see companies like AT&T, Verizon, and Sprint signing deals with IDCC. A license with a major carrier (domestic or international) will immediately propel IDCC to > $150/share. This is the market Bill Merritt (IDCC CEO) has spoken of that is 5-7 times larger than the $180 billion dollar handset market.
I reviewed the Feb 2010 conference call recently (courtesy of Seeking Alpha) and these questions jumped out at me (highlights mine). Stop and run a calculator on Bill Merritt's comments about this 1 Trillion dollar market. Even at .2% ... it's a huge number, and most analysts have not taken this into consideration as they have valued IDCC. I have no idea what royalty rate IDCC might capture on the Carrier market (AT&T, Sprint, Verizon, etc.) ... but make no mistake, everyone will need IDCC's IP to solve the bandwidth crunch. Once one carrier (operator) signs ... they will all be forced to sign to keep up with the competition.
Tom Carpenter - Hilliard Lyons
I wanted to follow up with your comments about the bigger pipes, more pipes and better pipes. Historically 99% of the licenses have been with handset manufactures, you have got 2 M2Ms, is the bigger push going forward going to be with handset manufacturers, infrastructure or the carriers or some combination of the above, may be kind of give us some more insight into how you see that business model, specifically the revenue stream changing over the next couple of years?
Scott McQuilkin IDCC (Note I think the transcript may be incorrect and the speaker was actually Bill Merritt IDCC's CEO)
Sure, the idea is to actually create top technologies that would map across all of those markets or at least more than one of those markets right, so we get reuse of technology. Certainly that occurs with respect to the basic wireless technology, because not only does that appear in terminal units but it appears in infrastructure that is utilized by operators and it’s also now appearing in consumer electronics and other such devices. So that’s a core part of the program that will continue and have applicability across all those markets.
But we are looking at other technologies as well. An example would the compression technology. Compression technology is very important in the wireless space, because there’s a need to create the smallest packet carrying the most amount of data across that network, but compression technologies also pop up in many other devices, as you know, some of the non-wireless. So again the idea is to try to create technologies that has very significant volume flow in the market.
As far as how we would go to market with these additional technologies, that is still -- I think we have a number of opportunities there, certainly with respect to some of the technologies that can be a direct licensing strategy for example with the infrastructure side of the business. I think there are other opportunities though with respect to some software solutions like MIH and other things where the better play may be directly up to the operator, because you are providing substantial either cost reduction or operational efficiency to them, and you know a lot of times, the person who delivered value too is going to pay with the highest value back, and so we have to think about where that technology is creating the best of the highest level benefit, and so that’s being worked at the current time. The idea at the end of the day of course is to move from participation in this $150 billion market into a market that is five or seven times bigger than that. And if we can do that successfully, I think it becomes very, very significant growth story for the company.
Even though IDCC has climbed to $76/share, it is still grossly undervalued. Where else can you buy a dividend bearing stock that has the growth prospects of IDCC? In less than a year, IDCC could easily be >$400/share and all it takes is a few 4G licenses at a 2% rate (Apple, Nokia, LG) and a license with a major carrier (AT&T, Sprint, Verizon, etc.) to open the floodgates. I am not talking about a buyout price from Google or Apple, I am talking about a fair value based on earnings when they monetize their IP.
Do your own due diligence. I suggest you read the transcripts of the last eight conference calls and start playing with the royalty numbers and the possible rates and see for yourself what the upside potential is for this company. Be conservative and use 1% for 3G and 2.0 -2.5% for 4G and see what you get?
One other area that IDCC has a complete leg up on the competition is carrier aggregation. If you are interested in understanding the hidden potential of IDCC, I highly recommend you read and study these two posts by two all star posters. When you understand the significance of what this technology really means, you will start to see how undervalued IDCC really is.
Now do you see why I think IDCC would be fairly valued at ~$400? Yes, it may take a year or two to get there, but eventually it could far exceed that number (unless someone buys it now for $200 - 300). I could easily foresee a day when IDCC has earnings of over $100/share (of course long before we get there, we will have numerous stock splits along the way).
Disclosure: I am long IDCC.
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