Aware, Inc. (AWRE)

[Terin]

AWRE DD: A Report from Feb 2, 2012. Dated, but lots of good information on the company (link to source of report at bottom of message).

Company: Aware Inc. (AWRE)
Submitted On: Feb 02, 2012 at 04:54PM Recommendation: Long Expected Timeframe: 1 Year To 2 Years Geography: North America Country: United States Situation: Event / Special Situations Price At Recommendation: $3.20 Target Price: $7.00



SUMMARY
Aware, Inc. is a Massachusetts-based company focused upon signal processing and communications technology. At $3.20, we believe the company is currently priced at a steep discount to its intrinsic value and offers significant upside to $7.33, which could generate a return of ~130%, while having negligible downside risk. This value is derived as follows:

Biometrics $1.89/share
DSL software $0.28/share
DSL royalties $.039/share
IP portfolio $1.55/share
Litigation $0.73/share
Real estate $0.28/share
Cash $2.21/share
Less debt: $0.00/share

TOTAL EQUITY VALUE $7.33/SHARE

Furthermore, there are reasonable scenarios under which Aware equity could be worth $10/share or more, producing upside of well over 200%. Of note, neither of these valuations includes over $2/share of deferred tax assets. In short, we believe Aware offers dramatic return asymmetry with pricing at a slight premium to liquidation value and upside of 2x to over 3x.

HISTORY
Aware has its origins in the late-1980s when the company began as an IP-focused firm whose revenue was primarily derived from government research grants. Aware’s research led to a steadily-increasing patent trove and efforts to commercialize the company’s technology. This strategy resulted in Aware housing several different operating businesses over the past two decades as it refined its approach to commercializing its technology.

Ultimately, through a process of business and asset dispositions, Aware settled on two core operating segments: (1) biometrics software and services and (2) DSL test and diagnostics software and hardware. These two businesses produce the bulk of annual revenue, and each has value in its own right. In addition to the value of the operating entities, Aware offers several other components of value. The first is an IP portfolio comprised of approximately 185 U.S. and foreign patents and 271 patent applications. These patents cover a wide swath of technology including audio processing, image compression, video compression and seismic data compression. Second, Aware enjoys a continued royalty stream accruing from DSL chipset sales related to a business line it sold in 2009. Thirdly, we believe, but have been unable to confirm, that the company also likely holds an interest in the outcome of a pending patent lawsuit. Aware also owns its corporate headquarters.

In sum, Aware is a technology-focused firm with seven separate components of value:
(1) Biometrics software and services business
(2) DSL test and diagnostics business
(3) DSL chipset royalty stream
(4) IP portfolio
(5) Patent litigation
(6) Real estate

As developed in this Report, these value-drivers aggregate to approximately $151mm of equity value versus a current market cap of around $66mm.

BIOMETRICS
Markets – Aware’s biometrics business has historically centered on selling software component parts to OEMs and government clients for inclusion in end-use biometric systems. The primary markets within which Aware biometrics operates are:
- Border control – immigration, passports, national ID cards
- National defense – handheld ID devices for use in the field
- Secure credentialing – personal identity verification cards
- Law enforcement – FBI systems
- Access control – building access

Strategy – from its past focus on component software sales to OEMs, Aware has more recently begun to develop a services business that consults and assists with the development and construction of biometric enrollment and analytic systems for governments and other users. This strategy has the double benefit of creating a separate, profitable revenue source while also putting Aware in the advantageous position of consulting on projects for which its software solutions serve as component parts (thus increasing the chance of Aware products being used in the systems). Further, as a result, the services side of the business serves as a leading indicator of software demand. Aware’s biometric services business targets small projects that larger industry players do not seek based on scale.

Within the biometric systems product chain, Aware sells component and application software for enrollment and server-based transaction management systems. Beyond the development of a services/consulting business, Aware has also extended the software business toward providing fully-developed applications rather than simply producing component parts for applications created by other companies. This migration led Aware to create BioSP, its server-based transaction management system, and other like products that represent more complete application solutions.

With this background in mind, Aware’s current biometrics strategy is premised upon continued growth via (a) professional services and (b) sales of more complete product offerings, both of which provide larger and more profitable market opportunities than a purely OEM-based sales model. As discussed further below, we believe the biometrics business is very profitable, a fact that has thus far been masked by the remainder of Aware’s businesses. Management views 20%-30% annual top-line growth as a reasonable goal for the segment with the possibility of landing a larger project that would drive 100% revenue growth over 2010 numbers.

Industry/Competition – the biometrics industry is in the midst of a significant growth cycle, with ~20% annualized growth expected to carry the industry sales from ~$4.5bn in 2011 to over $10bn by 2017. Primary market participants within software and hardware for enrollment stations include Lockheed Martin, Cross Match Technologies, Unisys, Science Applications International, L-1 Identity Solutions (Safran), Northrop Grumman, Hewlett-Packard Electronic Data Systems and NEC. On the transaction management side of the business, competitors include Safran, Avalon Biometrics, NEC and 3M Cogent.

As is evident, competition within biometrics is comprised of firms significantly larger than Aware. Aware’s competitive advantage in this context stems from a combination of offering higher quality software and having a lower cost structure. Beyond the obvious benefit of a high quality product, the lower cost structure enables Aware to competitively bid for government contracts and ensures it is more cost efficient for larger OEMs to buy software from Aware rather than develop it internally.

The biometrics industry has seen an uptick in consolidation as larger players have acquired smaller firms, enabling the acquirers to complement and integrate their businesses with new technologies and capabilities. In this vein, French defense contractor Safran SA recently closed the July 2011 acquisition of L-1 Identity Solutions, while in October 2010 3M acquired Cogent.

Valuation – Aware biometrics has demonstrated steady topline performance over the trailing three years and is gaining steam as the company develops the services component of its business and continues to prove itself within the government bidding process, a contracting process in which success builds upon itself.

Although Aware does not report biometrics results as a separate operating segment, we were able to back into topline numbers based upon earnings call commentary and 10-K footnotes (management generally confirmed the accuracy of our estimates). From a 2007 revenue base of $7.5mm, biometrics produced $10mm in revenue in both 2009 and 2010. Furthermore, with the development and growth of its biometrics services work the segment has produced, through 3Q11, incremental revenue of ~$2.7mm over the first three quarters of 2010. On full-year 2010 revenue base of $10mm, this represents annualized growth of well over 30%, consistent with management’s target.

Based on our analysis, we believe the biometrics business is on track for ~$13mm in 2011 revenue. While determining the margins on the biometrics business is not possible given Aware’s failure to report biometrics as an operating segment, the company’s overall blended gross margin for hardware and software sales is around 75% and management has repeatedly indicated biometrics is a highly profitable business relative to the DSL T&D business, thus suggesting gross margins over 90%.

Given the lack of margin transparency and recent precedent transactions accruing from industry consolidation, valuing the biometrics business on a multiple of revenue is a reasonable approach. The detail on recent acquisitions follows:

Jul 2011, L-1-Safran deal, 3.5x revenue
Oct 2011, Cogent-3M deal, 5.7x revenue
(See attached PDF for more complete comp chart)

With a revenue multiple of 3.0x – significantly below both recent transaction comps – Aware’s biometrics business is worth $39mm on 2011 estimated revenue of $13mm.

DSL TEST & DIAGNOSTICS
Markets – Aware’s DSL T&D business sells software and hardware products used by telephone companies in monitoring, optimizing, diagnosing and servicing their DSL infrastructures. The hardware business supplies modem modules to OEMs for inclusion in testing devices for diagnosing line-based service problems. As noted above, the Company recently announced its intention to close the DSL hardware business with shipments ceasing during summer 2012. We view this as a positive as we believe the hardware business is unprofitable at the EBIT level and represents a drain on cash.

The remaining DSL software business is the better of the two businesses, and provides telephone companies with the ability to test, diagnose and optimize DSL performance from company mainframe computers without the need for technician engagement in the field or other hardware-based solutions. This offering drives significant cost savings for telcos, which is an increasing area of focus throughout their operations given continued migration from landlines and associated deteriorating profitability.

Aware’s DSL software business also benefits from industry tailwinds deriving from increased international DSL adoption driving demand for service assurance infrastructure and testing products. DSL has 70% of the total broadband market with ~400mm customers. Further, there are more new DSL subs each month than new subs for all other broadband alternatives combined. Although some are inclined to pan the DSL technology relative to fiber, wireless and other mediums, the reality is that DSL is the most cost efficient broadband alternative and will continue to dominate the landscape for the foreseeable future. Optimizing DSL transmission will become increasingly important, which is precisely the function of Aware’s line diagnostic platform software.

Strategy – the software business represents the future of Aware’s DSL operations, and the company is working to grow this business. International telcos were at first hesitant to adopt a software-based diagnostic and optimization approach, but over the past several years product acceptance has accelerated and the growth trend is appealing. Accordingly, Aware has been aggressively targeting this business, which has significantly higher margins than the DSL hardware business the Company is abandoning. Aware has demonstrated increasing success on this front with customer wins from two different European telcos during 2H10. Further, the company is engaged in product trials with multiple other international telcos.

Industry/Competition – competitors within the DSL T&D business include Alcatel-Lucent, Spirent Communications, Tollgrade Communications, JDS Uniphase, Sunrise Corporation, Fluke Corporation, Kurth Electronic and Assia. Within the software assurance and optimization Aware’s management has highlighted Alcatel and Assia, particularly. Assia is a VC-backed firm focused solely on this niche market. Assia’s investors include industry backers Telefonica, AT&T, Swisscom Ventures and T-Ventures. Alcatel’s Network Analyzer is that company’s competing product within the software optimization market. Aware and Assia represent the only “hardware-neutral” competitors within line diagnostics and optimization.

Value – Aware’s DSL T&D business has shown strong top-line performance. From a 2008 nadir of $5.2mm in segment revenue and $1.6mm of DSL software sales, 2010 segment revenue grew to $10.6mm with $4.1mm of software sales, cumulative growth of 104% and 156%, respectively. Through 3Q11, YTD DSL software sales have increased $200k over the same year-earlier period, which implies 2011 estimated DSL software revenue of approximately $4.4mm. With the Company’s recent decision to jettison the DSL hardware business, Aware is dropping a business that is likely to produce roughly $6mm of 2011 revenue. Importantly, software revenue carries much higher margins than hardware, with the latter generating 35% to 40% gross margins, according to management. We believe the DSL hardware business was unprofitable at the EBIT level, and this business closure should have a positive cash flow benefit over time.

While divining the margins for Aware’s remaining DSL software business is not possible, with continued sales growth within the business, we believe the DSL software business clearly has value. Our conversations with industry participants indicate that each of Aware’s, Assia’s and Alcatel’s competitive software offerings have unique attributes that distinguish them from one another – one firm’s software is best suited for different telcos depending on the customer’s systems and needs. This dynamic indicates differentiated technology amongst the competition, and a likely market for Aware’s DSL business. Given the lack of margin clarity and ability to determine segment profitability, we believe it is appropriate to look to recent precedent transactions to determine an appropriate revenue multiple.

May 2011, Tollgrade-Golden Gate Capital, 1.3x revenue
Feb 2010, Digital Lightwave-Optel Capital, 6.1x revenue

Tollgrade is a very applicable comp as the company designs and markets DSL test and diagnostics software, the same business as Aware’s DSL segment. Similarly, Digital Lightwave sells fiber-optic diagnostic and optimization products to telcos. While the latter is a relevant comp, Tollgrade is the closer analogue as the company is focused on DSL rather than fiber-optic lines. Aware’s DSL business should drive 2011 revenue of approximately $4.4mm, utilizing the Tollgrade multiple results in a $5.7mm valuation of Aware’s DSL business.

DSL CHIPSET ROYALTIES
In 2009, Aware exited its DSL chipset and home networking business whose associated expenses exceeded revenues annually. To this end, the company sold all related assets (chip designs, 41 engineering employees, two patents, one patent application) for $6.75mm booking a gain of $6.2mm. The transaction represented a favorable outcome for a business that garnered $500k to $1mm in quarterly revenue against $1.7mm to $1.9mm in quarterly expenses. Further, as a data point for valuing Aware’s DSL T&D business, Lantiq paid $6.75mm for the DSL chipset business which eliminated around $3mm in annual revenue from Lantiq to Aware, an approximate 2.3x revenue multiple.

In conjunction with the sale, Aware maintained the right to licensing revenue based upon DSL chipset sales from Lantiq (the acquirer in the DSL chipset transaction) and Ikanos Communications (Aware’s other major chipset licensing customer). Over the 4 trailing calendar years, this licensing stream has averaged $2.3mm/year with relatively consistent numbers of $2.6mm/$1.8mm/$2.1mm/$2.7mm in 2007/2008/2009/2010. This revenue flow represents pure margin to Aware.

Aware’s DSL chipset annuity is a free cash flow claim on Lantiq’s and Ikanos’ sales. While Aware does not control the long-term sustainability of these businesses, there is material value in these 100% margin cash flows. As previously noted, the royalty stream has remained relatively stable over the past four years with an average annual cash flow of $2.3mm. Capitalizing a $2mm annual cash flow with a 4x multiple values the royalty at $8mm, which is conservative from a multiple perspective. From a DCF vantage, assuming a 10% discount rate and that the $2mm royalty decreases on a 10-year straight-line basis results in a $7.7mm valuation. In any event, an $8mm royalty value appears reasonable.

IP PORTFOLIO
Background – from its inception in the late-1980s, Aware has dedicated significant resources to developing a robust IP portfolio that totals 456 patents and applications. Much of this work has centered on developing and evolving technology that drives its biometrics and DSL businesses, but the portfolio also contains additional assets of value that are unrelated to its core businesses and are essentially not valued by the market. The first category of non-core IP assets relates to DSL chipsets, LAN wireless and home networking technology that is no longer applicable to Aware’s business following the Lantiq transaction which disposed of these business lines. The second category of excess IP has been described by company management as “other,” essentially a catchall for the remainder of the portfolio. Thus, Aware’s IP can be categorized as follows:
(1) Biometrics IP
(2) DSL T&D IP
(3) DSL chipsets, wireless and home networking IP
(4) Other

Portfolio Detail – determining the exact composition of an IP portfolio is not a simple or precise task. In combing a portfolio, a helpful starting point for categorization of the various patents is the International Patent Classification codes used to classify each issued patent.

As the adjacent table indicates (SEE ATTACHED PDF FOR RELEVANT TABLE), 54% of Aware’s issued patents and applications fall within IPCs H04B and H04L and with the inclusion of H04K, H03M and H04J the total increases to 74% of the portfolio. The H04B and H04L classifications relate to transmission and transmission of digital information, while HO4K, H03M and HO4J relate to secret communication; coding, decoding or code conversion; and multiplex communication, respectively. Each of these categories is associated with communications transmission and associated technologies.

Making a determination of the specific uses of a given technology by simply reading the text of a patent is not always possible. To this end, it is helpful to analyze patent classifications across companies to determine the general areas of technological applicability. The table below compares the IPCs of Aware’s patents with those of Nortel, Motorola Mobility and Interdigital, three large firms who are viewed as having extremely valuable patent portfolios involving mobile communications technology. In July 2011, a consortium of technology firms acquired Nortel’s portfolio for $4.5bn, and on the heels of the Nortel transaction, Google agreed to acquire Motorola Mobility for $12.5bn with many commentators speculating the bulk of Google’s interest was founded upon Motorola’s patents. Likewise, during this same time period, Interdigital’s stock catapulted from $40 to $70 based on reports multiple technology firms were eyeballing the company’s intellectual property for acquisition. While much of this interest and pricing action was driven by wireless technology which has not been a core Aware focus, the transactions nevertheless demonstrate the increasing importance and value of intellectual property.

As the table demonstrates (SEE ATTACHED PDF FOR REVELANT TABLE), there is tremendous crossover amongst Aware and the comparable companies’ portfolios. H04B, the largest component of Aware’s portfolio is the first, first and third largest components of Motorola’s, Interdigital’s and Nortel’s portfolios, respectively. Further, HO4L, the second largest component of Aware’s portfolio is the first, third and third largest components of Nortel’s, Motorola’s and Interdigital’s portfolios, respectively. Similarly, there is a tremendous amount of overlap amongst the remainder of the portfolios.

Portfolio Growth & Relevance – Aware’s consistent and escalating dedication to IP creation is evident from the trend in the number of patents issued annually(SEE ATTACHED PDF FOR RELEVANT TABLE). Furthermore, from the perspective of IP relevance, Aware’s citation-to-patent ratio is very compelling relative to other IP-focused firms that derive significant value from the sale and licensing of their assets.

Monetization – in September 2010, Aware management announced it was considering the spin-off of its IP licensing assets. In reaction, two members of the Stafford family (which in aggregate owns 36% of Aware and holds voting proxies for another 10%) rejoined the board of directors in January 2011, appearing to slow the spin-off process and assess the best means of monetizing Aware’s excess IP assets. We view the Staffords’ reengagement as a positive given maximizing shareholder value is likely their sole concern.

Following the Staffords joining the board, Aware’s CEO and two tenured board members resigned in spring 2011. Subsequently, in October 2011, John Stafford, Jr. was elevated to chairman of the board, and the executive chairman – Michael Tzannes – resigned from the board to focus on heading Aware’s patent monetization efforts. In our conversations with management, a debate amongst the board has become apparent concerning the best means by which to monetize the excess-IP portfolio with some favoring spin-off and others preferring alternative routes.

There are essentially 4 likely routes to IP monetization:
(1) Licensing/litigation – Aware directly pursues licenses from and/or litigates against other companies. This route raises two primary issues: (a) Aware already houses two different operating entities and adding a third would present increased complexity for investors and (b) there could potentially be legal blowback risk for Aware’s operations should it pursue litigation against other technology firms.
(2) Spin-off new entity with excess IP assets and cash – this is the route former management began to pursue in late-2010. Typically, a spin-off would offer the benefit of tax efficiency, but given Aware’s $41.8mm deferred tax asset this consideration is not as relevant. Further, there is a very real question of whether it makes economic sense to split into two separate publicly-traded entities given Aware’s market cap and lack of scale.
(3) Assign IP and retain residual interest – Aware assigns patents to other companies who then pursue licensing and/or litigation with Aware retaining an interest in the ultimate revenues. As noted above, in this structure, the assignor’s retained interest (net of associated expenses) is often around 50%.
(4) Sell the patents

In terms of monetizing the current excess IP portfolio, the preferred route is likely asset sale(s) of the patents given the significant deferred tax asset that can be used to offset gains from the transaction, a tax asset that may otherwise be squandered by the tepid profitability of the operating businesses.

Valuation – patent valuation is far from a precise science as patent beauty is truly in the eye of the beholder. Nevertheless, there are several means by which to inform a view of value.

The first valuation approach is a “by the pound” method – assessing the total value of Aware’s patent portfolio based on recent transactions involving similar IP. The above-referenced Nortel and Motorola transactions provide useful data in this analysis. Nortel was a pure-play sale of Nortel’s IP. Although Motorola involved the sale of operations and IP, the consensus view is Google assigned the vast majority of value to Motorola’s IP for defensive and offensive use in patent litigation against Microsoft and Apple. This is consistent with the fact that Motorola generated only $76mm in 2010 operating income on $11.5bn in revenues, following operating losses of $1.2bn and $2.0bn in 2009 and 2008, respectively. Nevertheless, for purposes of patent transaction comps we assume the Motorola’s operating business was worth book value of $1.8bn, reducing the patent transaction value to $10.7bn.

As the table indicates (SEE ATTACHED PDF FOR RELEVANT TABLE), Nortel’s portfolio sold for $750,000 per patent and Motorola’s for roughly $446,000 per patent. Utilizing a $500,000 per patent assumption, results in a $228mm value for Aware’s IP, over 11x the current enterprise value. Even reducing the assumption by half to $250,000 per patent, equates to $114mm in IP value, over 5x enterprise value.

One further example of strategic patent value is offered by the recent HTC-S3 Graphics deal. In July 2011, just days after the International Trade Commission found Apple had infringed two of S3 Graphics patents, HTC agreed to purchase S3 for $300mm, or $1.3mm per patent. While S3 is reevaluating the deal in light of a subsequent reversal of the ITC ruling, the events demonstrate the tactical and monetary value of well-positioned technology IP.

Finally, we note the insider purchases of Michael Tzannes, a long-time Aware employee and former Aware CEO and executive chairman (SEE ATTACHED PDF FOR REVELANT TABLE). Tzannes is also a prodigious inventor named on the majority of Aware’s patents – if anyone knows the value of the IP portfolio, it is Tzannes. For several years prior to the announcement of the IP spin-off in September 2010, Tzannes consistently owned 91,033 shares. Following the spin-off announcement, in April and May 2011, Tzannes invested $1.02mm to purchase 321,000 additional shares. Tzannes’ investment was effected through the exercise of essentially at-the-money options ($3.18 average basis) that were not scheduled to expire until October 2013; thus, the option exercises were the effective equivalent of open market purchases. In the nine months following Aware’s decision to pursue IP monetization, Tzannes – who developed and heads Aware’s IP efforts – invested cash to increase his share ownership by 4.5x. We believe this is a bullish indicator of value.

Nevertheless, for purposes of assigning value to the IP portfolio, we take a conservative approach and capitalize Aware’s R&D on trailing five-year basis. Assuming straight-line depreciation of R&D investment from 2006 to 2010 results in IP asset value of $32mm. However, utilizing a twenty-year capitalization/depreciation schedule – consistent with the time length of patents – produces an IP asset of $85mm or over $2.50/share of incremental value (additional upside of 78%). The reasonableness of using a twenty-year capitalization/depreciation schedule is highlighted by the fact that several of the patents transferred to Hybrid Audio were filed in the early 1990s, demonstrating the long-term potential value of technology patents.

PATENT LITIGATION - HYBRID AUDIO
A final, option-like Aware value driver relates to patent infringement litigation surrounding several Aware patents. In December 2010, Aware assigned four patents to Hybrid Audio, LLC. Hybrid Audio is a Texas-based entity whose management is associated with Technology, Patents & Licensing, Inc., a Pennsylvania firm focused on developing, acquiring, managing and monetizing patent assets.

Three of the four assigned patents fall under IPC code G10L, which covers audio analysis and processing. These were the only G10L patents within Aware’s portfolio. Although Aware has provided little disclosure relating to the patent transfer or Hybrid Audio, our diligence leads us to believe Aware conveyed the patents for $300,000 and retained ~50% interest in any future net proceeds from litigation or licensing. Our discussions with IP attorneys indicate patent assignors often retain a percentage of future proceeds. Further, subsequent conversations with Aware’s management confirmed – although they would not address Hybrid Audio specifically – that in patent assignments geared toward monetization by the assignee Aware would typically retain 50%+/- interest in future net proceeds.

The belief that Aware structured a deal with Hybrid Audio for the latter to pursue patent infringement claims is bolstered by the fact that simultaneous with the assignment Hybrid Audio filed federal suit in the Eastern District of Texas against HTC, Apple, Dell, Motorola Mobility, Nokia, RIM and Samsung. The claimed infringement involves one of the four assigned patents and relates to the processing of audio information under MP3 on products including iPod, iPhone 4, iPad, iTunes, XOOM and DROID.

While handicapping the value of patent litigation is difficult, the Hybrid Audio suit certainly appears to involve a colorable claim and significant potential value. Plaintiff’s counsel is McKool Smith, a national trial law firm with a patent litigation focus. McKool secured several recent victories in infringement suits against Microsoft, including a $290mm claim in favor of i4i Limited Partnership that was upheld by the U.S. Supreme Court in June 2011 (SEE ATTACHED PDF FOR RELEVANT TABLE). In short, McKool is a very successful law firm, having secured more of the 100 largest U.S. courtroom verdicts than any other firm in the country during 2008 and 2009. Importantly, McKool takes IP infringement cases on a contingency fee basis, which means the firm has significant economic risk should the lawsuit prove unsuccessful, and must therefore diligence and select its clients carefully. This suggests McKool sees merit and material value in the Hybrid Audio suit.

A second positive aspect of the case is its venue in the U.S. District Court for the Eastern District of Texas, site of the above-referenced Microsoft suit and a great venue for patent suits. The judges within the District have developed an interest in patent litigation and ensure speedy process and case resolution. Additionally, the judge assigned to the Hybrid Audio suit, Judge Leonard Davis, is experienced in IP litigation and technologically knowledgeable having worked as a computer programmer prior to law school.

An attempt to put a definitive dollar estimate on the value of the Hybrid Audio litigation would be foolish – there are simply too many variables and unknowns. However, in light of McKool’s past successes and contingency fee structure, we believe it is reasonable to assume McKool sees litigation value greater than $100MM. The firm has multiple $100MM+ IP infringement verdicts over the past several years, and given the incentives and risks inherent in contingency fee representation and the expense of IP suits, McKool’s business model is predicated upon only pursuing cases with significant value potential.

Assuming McKool sees at least $100mm in infringement value, the Hybrid Audio litigation would represent $30mm in value to Aware net of a 40% contingency fee and 50% profit share with Hybrid Audio. While any value realization from Hybrid Audio is admittedly speculative, we believe there appears to be real potential for significant value associated with the relationship, and further the suit represents purely incremental value on what is an already undervalued business. For valuation purposes, we apply a 50% discount to the valuation above to arrive at $15mm of litigation value. Without the discount, Hybrid Audio would represent an additional $0.75/share of value (additional upside 23%).

REAL ESTATE VALUE
Aware owns its 72,000 square foot headquarters in Bedford, Massachusetts. The structure was constructed in 1982 and sits on 4.03 acres of property.

Aware acquired the property in 1997 for $6.7mm, and it is currently assessed at $5.7mm. This equates to an appraised value of $79 per square foot. Given recent Bedford office comp transactions in the $85 to $150 per square foot range, the assessed value of $5.7mm / $78 per square foot passes the reasonableness test (SEE ATTACHED PDF FOR RELEVANT TABLE).

In any event, at $5.7mm, Aware’s real estate represents 28% of Aware’s enterprise value.

CONCLUSION & OTHER VALUATION CONSIDERATIONS
In sum, based on our analysis, we believe Aware currently trades at 44% of a sum of its conservatively valued parts with a newly reconfigured board and management that is working to actively catalyze value recognition through asset monetization.

Moreover, there are components of value that this analysis has not considered. We have assigned no value to Aware’s $64.5mm of federal NOLs/credits and $18.6mm of state NOLs/credits, which comprise a total DTA of $41.8mm. There is currently a valuation allowance taken against the entirety of the DTA, but this asset may represent real value of $2/share as the company considers asset sales the gains from which the DTA can offset.

Finally, the limited downside risk of an Aware investment bears noting. Taking only cash and accounts receivable and assuming $5.7mm in real estate value against total liabilities of $3.2mm results in $2.51 of per share liquidation value. Accordingly, Aware trades for only a 28% premium to liquidation value, which is all the more meaningful for a company generating positive free cash flow. This 28% downside to liquidation value contrasts with upside of 129%, a roughly 5x upside-downside ratio. Moreover, conceivable scenarios exist in which Aware’s IP and litigation value offer additional upside of $3.25/share for a potential total return of over 230%. Most importantly, a buyer of Aware is paying nothing for this IP optionality as the Company trades at only a slight premium to true liquidation value and the biometrics business has clear value. We believe the asymmetry of return is compelling.

Information, opinions or recommendations contained herein are solely for informational purposes. The information used and statements made have been obtained from sources considered reliable but ....neither guarantees nor represents its completeness or accuracy. Such information and the opinions expressed herein are subject to change without notice. As of the date hereof, .....and its affiliates own securities of Aware, Inc. For further information, see Schedule 13D filed with the SEC. .


Variant View
With Aware, I am not sure there is such a thing as a variant view as that implies there is a consensus view. This is just a small company with concentrated ownership that not too many people follow.


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