On Friday Pendrell (NASDAQ:PCO) released its 10-Q for the second quarter. By any reasonable measure the operating performance of the company's legacy intellectual property (IP) licensing business was excellent. I expect the stock to react favorably. I also continue to see long term upside potential from Pendrell's plan to monetize its large net operating loss (NOLs) tax assets by acquiring a profitable operating business. Overall, the company remains undervalued.
In my first article on Pendrell, I conveyed my belief that there was still "significant value" left in its IP licensing business. Pendrell's Q2 results bear this belief out, as the company generated nearly $23.5 million in adjusted operating income. There was no goodwill impairment this quarter so the only adjustment I have made to the GAAP numbers is adding back in the $2.377 million amortization of intangibles. To put the operating income figure in context, Pendrell's market capitalization using its most recent basic share count is only $154 million.
In fairness, the company's results are likely to be lumpy moving forward, and it would be unrealistic to expect future quarters to consistently approach the same level of operating income. Much of Pendrell's revenue is generated in big chunks as licensing agreements are signed with companies interested in utilizing its owned IP. For example, in Q2 it signed a large memory technologies licensing agreement with Toshiba (OTCPK:TOSBF). Pendrell did produce significant operating income in the first quarter though -- so clearly Q2 is not a complete aberration.
One of the keys to Pendrell's recent positive cash flow generation has been CEO Lee Mikles' success in reducing expenses. General and administrative costs for the first half of this year came in at only 41% of what they were in the first half of last year. The termination of the company's office lease in Plano, TX at the end of June shows that these efforts are continuing.
Pendrell has made clear in filings that its "primary focus has shifted towards identifying and evaluating new business opportunities." As such, while continuing to pursue opportunities in its IP licensing business, the company is actively in the hunt for an acquisition in order to monetize its massive $2.6 billion in NOLs. While the second quarter didn't bring any exciting announcements, the 10-Q did confirm that Pendrell "evaluated several potential strategic acquisitions and partnerships during the quarter." This active sounding language gives me hope that Pendrell will avoid languishing for years without an acquisition -- a common issue for NOL shell companies. Ultimately the most important thing for shareholders is that Pendrell consummates an acquisition that will be accreditive to the per share value of the company.
Pendrell's fortress balance sheet should help immensely in closing an acquisition. Even further, the amount of cash held by the company relative to its valuation is key to the investment thesis. Pendrell has approximately $201 million in cash and current receivables. If we net this against its $20.5 million in total liabilities, the resulting net current asset value (NCAV) is $180.31 million, an amount significantly in excess of the current market capitalization of the company. Note also that this analysis gives the company no credit whatsoever for its $20.5 million in non-current receivables even though it has never suffered any material losses on its IP accounts receivable.
Pendrell shareholders approved a reverse stock split at the annual meeting held earlier this month. A reverse stock split is necessary to avoid the company being delisted from the Nasdaq due to its share price being under $1. At some point between now and the end of September the company's board of directors will decide at which ratio (between 1-for-3 and 1-for-10) the reverse split will take place. While reverse stock splits sometimes temporarily depress a company's post-split share price, ultimately Pendrell, as a well capitalized company that isn't reliant on secondary stock offerings, will not have its intrinsic value impaired by a reverse split.
Between the recent performance of its IP licensing business, its NOL-based acquisition strategy, and the strength of its balance sheet, Pendrell is an attractive investment at its current price. My conservative short term price target remains 110% of NCAV. Based on the second quarter's results this computes to $0.82 per share, or roughly 43% higher than the current $0.574 share price.
Disclosure: I am/we are long PCO.
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.
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