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MIPS Technology (NASDAQ: MIPS) A good Hunting Ground for the Processor Industry

There’s a lot of money to be made for investors who would want to join the patent war bandwagon. In fact, the easiest way is to identify smaller companies with high level of patent portfolio as the next acquisition target. For instance, Nokia (NASDAQ: NOK) has massive patent on its sleeves. It recently received an initial $65 million payment from Research in Motion (NASDAQ: RIMM) for the WLAN patent settlement from a few weeks ago. While Nokia’s business has struggled for the last few years, its patent-rich portfolio will make it a good acquisition target for bigger companies planning to move into the smartphone scene.

The processor industry is not far behind from its list of potential acquisition targets. Given the strong demand for tablets and smartphones, there is a constant to need to innovate to meet the consumer demands. However, it would be easy for bigger companies with significant cash to buy smaller companies than to invest in research and development.

Having said this, a company like MIPS Technology (NASDAQ: MIPS) would fit the description discussed above. MIPS Technology provides processor architectures and cores for digital homes, networking and mobile applications. Its clients include global semiconductor companies and system original equipment manufacturers. The majority of its revenues come from licensing of embedded processor intellectual property in the form of architectures and implementations.

For the last 5 years, earnings per share have grown by 7% compared to the overall decline of the industry. Operating margins have also been higher at 18.89%, implying that the company commands pricing power over its customers. Return on equity has also been higher at 13%, versus the industry’s average return of 3%.

Its chips have a minimalist and low power design, and have been popular with other embedded devices. This is similar to some of the ARM Holdings (NASDAQ: ARMH) processors. While ARM could easily buy MIPS at its current market cap, MIPS has already agreed to sell itself to Imagination Technologies Group (OTCBB: IGNMF). Shareholders will receive about $7.94 in cash for the $100 million deal. The deal will give Imagination access to 82 patents and will now have the right to license them. In addition to that, it will receive around $14 million a quarter that MIPS generate these days. It is expected to close in the first quarter of 2013 after it receives approval from both regulators and shareholders.

Investors planning to buy the shares will have limited upside of 2%, while risking the uncertainties between now and the date of payment to shareholders. Despite this scenario, an enterprising investor could easily look for the bigger companies in the processing industry. For instance, Intel (NASDAQ: INTC) currently trades at 8 times earnings and has a dividend yield of 4.38%. The potential double-bagger is just around the corner. A good tip: an investor could slowly move down to the processor-maker ladder and find out which companies have patents that Intel is interested.