InterDigital Inc (IDCC)

[Arazihk]

Also interesting from another board, a post by BRational on the Motley Fool Qualcomm board at http://boards.fool.com/Message.asp?mid=18985012




Eric's post showing relative stock price performance for five selected wireless technology companies (http://boards.fool.com/Message.asp?mid=18954780 and http://boards.fool.com/Message.asp?mid=18961163 ) stimulated my interest to revisit the IDCC story and web site, which I have not been to in the past year and a half or so. I have had IDCC on my curiosity-watch list for several years, but had not followed them too closely of late.

The main hypothesis I wanted to explore is whether one should short IDCC; why would its stock price performance appear so far ahead of Qualcomm and Nokia? Are there compelling reasons behind this divergence that we should know about, that could be either positive for IDCC or negative for Qualcomm (or both), or is it an aberration that is only tolerated because of the relatively light share trading volume of IDCC (and would hence eventually bring it back to the other companies' level)? Furthermore, bringing IDCC in line might mean that Qualcomm would rise to the same relative levels, or IDCC would come down—or both.

1. First, to better place the IDCC story in perspective, it would help to recall this company as one that has claimed to be the next Qualcomm for some time, based on its alleged patent position in WCDMA. However, it had at one time a claim on CDMA, but that was resolved in an early settlement with Qualcomm. It has further many patents in TDMA and GSM, though by far its strongest suit historically had been in TDMA, for which it has been aggressively trying to collect back pay from the European handset and infrastructure makers (and also Samsung). A very recent settlement with Sony-Ericsson on TDMA and EDGE has sent hopes up, and has largely fueled the recent run-up in its stock price, though it has yet to conclude similar deals with Nokia and Samsung (see http://www.interdigital.com/press_room_current_news_detail.jsp?releaseId=391536 ). It has visibly aligned itself with the GSM community (partly because Qualcomm effectively shut it out of the CDMA 1X realm in an early settlement between the two companies—but that is not the point of this post), and boasts claims in EDGE especially, as well as in WCDMA. It has been Nokia's “secret weapon” of sorts in WCDMA, as the main source of IDCC's revenue for the past two or three years has been an R&D contract with Nokia.

2. Second, to better appreciate the percentages in Eric's post, it helps to go back to a five-year stock price chart with both IDCC and Qualcomm (I'm sure all of you know how to do this on MSN or here at the Fool's; two things are apparent: (1) Relative to its pre-bubble levels, the appreciation in Qcom's price is still about twice IDCC's; and (2) the difference in levels shown in Eric's table is mostly due to a recent divergence, that started sometime in April, coinciding with the settlement with Sony-Ericsson.

And while we're looking at charts, note that IDCC's average daily volume of traded shares is under 1 million, compared to QCOM's average daily shares traded of about 15 million; this has implications for interpreting what it takes to produce serious price moves.

3. How significant is IDCC's potential royalty stream from its IP rights? Let's examine tow things: (1) the new legal settlement, which will account for a significant fraction of revenues in the coming two years; and (2) the historical performance record for this company. About the first item, from the press release:

The licensed products exclude any product compliant with Third Generation (3G) standards. These agreements resolve a long-standing patent infringement litigation with Ericsson scheduled for trial in May 2003. Ericsson also has granted an option to InterDigital for a Reference Design License and Support Agreement for Ericsson's GSM/GPRS/UMTS platform.

The license agreements with Ericsson and Sony Ericsson establish the financial terms necessary to define the royalty obligations of Nokia Corporation (Nokia) and Samsung Electronics Co. Ltd. (Samsung) on 2G GSM/TDMA and 2.5G GSM/GPRS/TDMA products under their existing patent licensing agreements with ITC.

How much are we talking about? Still from the press release:

ITC expects to receive aggregate payments of approximately $34 million from Ericsson and Sony Ericsson related to sales of terminal and infrastructure products through December 31, 2002. For periods thereafter through 2006, Sony Ericsson will be obligated to pay ITC a royalty on each licensed product sold. In addition, Sony Ericsson will make non-refundable advance royalty payments to ITC in 2003 covering Sony Ericsson's projected sales in 2003 and 2004.
…Under terms of its agreement, Ericsson will pay ITC an annual license fee of $6 million for sales of covered infrastructure equipment for each of the years 2003 through 2006.

This is not a huge amount, but it becomes significant because of apparent implications for how much Nokia and Samsung might have to pay:

….the Company projects that Nokia's royalty obligation for 2002 could be in the range of $100 million to $120 million and Samsung's royalty obligation for 2002 could be in the range of $22 million to $27 million. Further, based on the application of the MFL provision and assumptions noted above, recent market forecasts, and the prepayment of royalties (net of related discounts) consistent with the terms of the Ericsson and Sony Ericsson agreements, the Company projects that 2003 royalty revenue from Nokia could be in the range of $80 million to $90 million, 2003 royalty revenue from Samsung could be in the range of $20 million to $24 million, and the aggregate prepayment of royalties from Nokia and Samsung for 2003 and 2004 could be in the range of $180 million to $220 million.

This is approaching more serious revenues, though I understand that it is not yet a done deal. It can also be noted that the Nokia-Samsung presumed royalty stream is decreasing year on year.

4. To get a quick overview of the company's PR about its business case, I found a recent presentation on the company's website to be useful (http://www.interdigital.com/dis.jsp?dis=9&file=IR_Pres_April_2003.pdf – you need to first click “accept” on the disclaimer). Two remarks: (1) it highlights how huge the recent settlement is for the company; and (2) the whole “future” case is rather generic—about WCDMA and its importance, with no specifics on how its own products or IP might be relevant to the spread of 3G WCDMA.

5. In comparing its business model to Qualcomm's, the only similarity is that both companies have a significant license/royalty component of their revenues (and earnings). In the case of Qualcomm's, the significance of this component has been diminishing relative to the other businesses, especially chipsets (QCT). For example, in the last quarter reporting, only 26% of revenues (but 51% of earnings) came from licensing (QTL). Qualcomm actually introduces and sells real products (chipsets) and recurring services (Omnitracs, and now Brew) in growing markets. On the other hand, IDCC derives most of its revenues from technology development contracts, e.g. to Nokia or to carriers. Its revenues from that segment do not grow as the size of the addressable market grows. Such revenue sources are volatile, and create an overdependence on a single client. Hence the excitement about the Ericsson-Sony deal in that it would mark the possibility of a relatively “stable” stream of revenue—though the preponderance of TDMA and 2.0/2.5 technologies in that deal makes it a relatively short horizon phenomenon.

How do the two companies compare in terms of economic and financial clout: No comparison, actually. From IDCC's Q4 2002 earnings report, at:

http://205.216.251.105/press_room_current_news_detail.jsp?releaseId=391309&cb=1047906311476

For the full year 2002, the Company reported revised revenue, net income and earnings per share of $87.9 million, $2.4 million, and $0.04 per share (diluted), respectively.

Qualcomm followers undoubtedly know that IDCC's total annual revenues (approx $88 million) are less than one third of the quarterly revenues of the QTL division alone (approx $266 million this past quarter). For QCOM, GAAP reported revenues for fiscal 2002 were $3.0 billion (13 percent increase) in fiscal 2002. GAAP reported earnings were $360 million or $0.44 per share in fiscal 2002.

This information is summarized below:

IDCC QCOM
Annual Revenues (in Million $) 88 3,000
Earnings (in Million $) 2.4 360
Earnings per share ($) 0.04 0.44
Price per share (Apr. 30, '03) 22.53 31.88

Of course, “valuation” is a game fraught with many subtleties, not the least of which is that the above GAAP numbers may not be the most relevant for evaluating a company's operational performance and future prospects. But when I take the above numbers together with the recent behavior of the respective share prices, and with the composition of the revenue streams and how they are likely to evolve, I conclude that either IDCC has gotten ahead of itself and of (its best case) “comparables”, or that QCOM is way below where it should be, or both. My conclusion would be that this seems like a good time to sell one and buy the other—there is even a nice gap between 14 and 17 in IDCC's recent climb (http://www.siliconinvestor.com/research/chart.gsp?s=idcc ).

BRational


PS: Disclaimer—this is only a superficial comparison of the two companies; I am not credentialed nor qualified to make investment recommendations. Do your own research, or consult professional analysts (but only if they have received a seal of approval from Lokicious).