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What Exactly Is “Recurring” Revenue at Tessera Technologies?
Tessera Technologies revived after an activist fund took control in 2013. But the way it characterizes revenue raises questions about its prospects.


By BILL ALPERT
Updated Oct. 3, 2015 1:50 a.m. ET
Shares of Tessera Technologies were mired around 15 bucks in late 2011, when activist hedge fund Starboard Value took an interest in the floundering San Jose, Calif.–based company. Starboard fought its way onto Tessera’s board and by 2013 had installed a new chief executive who has focused on wringing cash from the company’s chip patent portfolio and sharing the proceeds with stockholders via buybacks and dividends. Judging by Tessera’s stock price, Starboard’s intervention worked. By early this year, Tessera shares topped $40 as small-cap mutual funds crowded aboard and brokerage analysts forecast a rising stream of recurring patent revenues.

One change at Tessera (ticker: TSRA) is the way it describes revenues to investors in its financial filings. Tessera is what’s known in the tech world as a “nonpracticing entity”– or, less politely, a patent troll. It claims license fees or threatens suit against manufacturers whose products allegedly use Tessera patents. In each of the years since Starboard took control in 2013, Tessera has reported 50% growth in what it terms “recurring revenue.” Bullish analysts extrapolate these revenues to argue that Tessera shares can climb from its recent $32.73 to as high as $53.


But most of the growth in this recurring revenue hasn’t come from royalties on any licensee’s continuing product sales, but from the one-time settlement of patent disputes that Tessera has structured so as to receive payments over several years. A one-time settlement–even if payment extends over several years–isn’t what most analysts would model as recurring. Investors wouldn’t normally put an earnings multiple on such settlements. If you back these finite settlements out of Tessera’s income statement, the remainder of its recurring revenue leaves the company valued at roughly twice the level of other nonpracticing entities–like InterDigital (IDCC) or Rambus (RMBS), which get more of their revenues from continuing royalties. The premium seems unmerited by Tessera’s relatively old collection of computer chip patents. Meanwhile, Starboard appears to see better activist opportunities elsewhere. It has sold most of its position. In April, it gave up its board seat. Starboard declined to comment.

STARTING IN THE 1990S, Tessera developed technologies for connecting computer chips in compact packages that let semiconductor makers like Intel pack their chips into ever-smaller electronics products. Royalties and license payments swelled after its 2003 initial public offering of shares at $13. By 2007, annual revenues were $200 million and the shares traded above $40. Then earnings began to falter as spending on research and litigation grew faster than revenues, and Tessera got into the business of making camera components. By the time Starboard mounted its proxy fight in early 2013, Tessera was losing money on declining patent revenues and had cycled through four chief executives in five years.

In a decade of running New York–based Starboard, Jeff Smith had replaced directors at dozens of companies, including several–like Unwired Planet and MIPS Technologies–where the fund saw opportunities to realize value from patent portfolios. Tessera’s incumbent managers resisted Starboard with broadsides, saying that the activists wanted to eviscerate Tessera’s R&D and turn the company into a “patent troll.” As the May 2013 proxy vote neared, however, it became clear that Starboard had the votes it needed. On the eve of the vote, Tessera surrendered and agreed to put Starboard managing member Peter Feld on its board and let Starboard name a new CEO. The pick, Thomas Lacey, still runs Tessera.

Under Lacey, Tessera has exited all manufacturing, trimmed spending, and returned over $250 million to shareholders via dividends and stock buybacks. The company has also tried to communicate the economic potential of its intellectual property by classifying its revenues in a way that Tessera’s previous management adopted when they were trying to fend off Starboard. It calls license fees and lump-sum settlements payable in less than a year, “episodic revenue.” Payments under multi-year agreements, and any royalties on licensees’ sales, it calls “recurring revenue.”

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“We tried to think about what’s useful for investors,” Tessera financial chief Robert Andersen told Barron’s. “The majority of our large contracts are fixed and multi-year. That’s something that is not always well understood by the market.”

Recurring revenues look to have snapped back since 2013 (see chart), rising from $103 million to $150 million last year. Tessera’s guidance is for at least $235 million in 2015. Episodic revenues rose from $66 million to $129 million last year, as Tessera settled patent disputes with firms like Taiwan’s Powertech Technology. This year, Tessera expects just $29 million in episodic revenues because it has few remaining lawsuits. All told, this year’s revenues of $270 million could yield about $106 million in earnings, or $1.96 a share, says Craig Hallum analyst Richard Shannon, who rates Tessera a Buy with a $53 price target.

On close inspection, however, Tessera’s distinction between episodic and recurring revenues seems contrived. In its $196 million settlement with Powertech, Tessera called the first $96 million of payments “episodic” but the rest “recurring,” because Powertech will pay in quarterly installments through 2018. Likewise, the company struck a $155 million settlement with Amkor Technology in January 2015, but calls the payments “recurring” because Amkor is paying quarterly through 2018. While Tessera’s financial reports classify the settlement payments as recurring, neither Powertech nor Amkor agreed to royalty-bearing licenses on their future product sales.

Andersen says Tessera has clearly told investors that these components of “recurring” revenues are structured legal settlements. “We’ve been very upfront with the market about what these are,” he says.

But it’s hard to see what these dispute settlements say about Tessera’s continuing earnings power. If you back out the cash value of these payments, about four bucks a share, from Tessera’s current stock price, as well as $8 of net cash, investors are paying 40 times the 50 cents a share that the company seems to earn from continuing operations–which include digital photography software for removing red-eye and other cosmetic flaws from smartphone snapshots. Let’s hope Tessera shareholders don’t end up looking red-eyed.

http://www.barrons.com/articles/what-exactly-is-recurring-revenue-at-tessera-technologies-1443851413