Friday, October 30, 2009

Interdigitial Intervention

I've participated in hundreds of conference calls over the years, but nothing prepared me for Interdigital's Q3 earnings call.

First, some background. Interdigital (IDCC) is a technology company that primarily licenses patents to cellular phone designers. A recent (losing) legal fight with Nokia has garnered lots of press and investors have become singularly focused on the outcome. As recently as August, Interdigital traded in the low 30's. With nearly 44 million shares outstanding, Interdigital had a market cap of $1.3 billion.

Thanks to the negative Nokia news, that figure now stands at $880 million. I'm not going to go line by line through the company's earnings release. Suffice it to say, that Interdigital is profitable. It's receiving large cash payments under an agreement with Samsung. And royalties continue to flow from the likes of LG, Sharp, and Research in Motion.

The real attraction of Interdigital is the balance sheet. Total debt is almost nonexistant at $14 million (plus or minus). This is offset by $429 million in CASH, 49% of the "new" market capitalization.

That's not all. Accounts receivable stands at $204 million, reflecting $200 million due from Samsung soon. Within months, the cash holdings of Interdigital should total more than $600 million. Assuming the market cap doesn't change, that represent over 70% of Interdigital's total "value".

These are the kinds of numbers that management teams usually like to highlight in conference calls, but analysts are too busy with the decimal points in their models to worry about irrelevant mountains of cash.

Indeed, it is an open secret that Interdigital is absurdly valued. Sadly, everyone knows the correct course of action, except company management. The earnings transcript (compiled by my new friends at Seeking Alpha) should be required reading. Or listen to a replay of the call. It's hilarious, or would be, if it wasn't so sad.

Interdigital was represented by: Bill Merritt - President and CEO and Scott McQuilkin - (apparently Wharton trained) CFO. Our heroes in this tale of woe are: Jonathon Skeels of Davenport, Tom Carpenter of Hilliard Lyons, Thomas Davey of Sidoti and Bill Nasgovitz of Heartland Advisors.

The first hint of trouble was Scott McQuilkin's presentation. He mentioned a 37% increase in revenue and $221 million in free cash flow for the quarter. The massive cash balances were mentioned with the caveat that "we intend to maintain a strong balance sheet to provide liquidity, flexibility and the opportunity to selectively pursue prudent investments that are fully aligned with out technology and business strategy."

Translation: Don't expect to see any of this cash.

To make matters worse, McQuilkin continues to mention a $100 million repurchase authorization from March that has been used to the tune of $25 million! Oh, but he neglects to mention that NO stock was repurchased in the quarter.

Translation: We only buy back shares when its HIGH. (Note to self: Buy blood pressure monitor)

The Q&A fun started when Jonathon Skeels asked about "plans for the cash balance and... a breakdown... of your priorities".

The response from CEO Merritt was typical. He said that Interdigital will "invest the cash based on what generates the most shareholder value". To summarize the rest of his answer: Cash is good. We may do some acquisitions. We'll look at all opportunities. We're not in a hurry. We're patient. And then there was this profile in ignorance.
One final thing I would say is, that (this) is probably not very unique, it is quiet common for technology companies including our peers to keep pretty significant cash balances on hand for just that purpose. Rambus is an example has close to $500 million of cash on their balance sheet, Tessera, I think it’s about $360 million. So I think that is probably very consistent with many other folks, that we would consider peers.
Should I be the one who points out that Rambus has a $1.7 billion market value and over $100 million in debt? Tessera's cash represents 25% of its market capitalization. Are these really comparable or just an attempt at an excuse?

Any BS to justify holding on to all this money.

It took some time for this foolishness to sink in. The analysts went on asking about royalty rates, Nokia, etc. until Tom Carpenter couldn't contain himself. He said:
As of this morning before the market opened, you guys had an $800 million market cap. Obviously we both know what the cash numbers are, so that means Wall Street was valuing the patents and your future cash flows generated by those patents at less than $400 million.

You guys think that your patents are worth a great deal more than that, especially considering from the numbers people are talking about what the Nortel LTE patents were worth? Are there any things you guys want to do to address that discrepancy whether it's got on the road more often, buy back stock, both the firm and senior management, or any other initiatives you guys are exploring?

The answer from Bill Merritt is too long to quote, but (in my opinion) he didn't answer the question, but merely acknowledged "disparities" and reiterated all the reinvestment opportunities that exist.

Undeterred, Mr. Carpenter tried again.

You guys also have $200 million slated to come in from Samsung next year, and Scott is going to have the problem most CFOs can only dream of, possibly too much cash on the balance sheet. Do you see a dividend withdrawal in the next year? Because you've been very guarded with the share buybacks this year. I don't know if you're going to step up the pace of that or because you just have so much cash that you guys are going to consider a modest dividend to encourage long-term ownership of the stock.

Bill Merritt's response:

As Scott said before, one, we always have all the options on the table, and all the options are considered with a single objective of delivering the highest value back to shareholders. So I've actually never heard Scott say he could have too much cash.
Are you kidding me? He went on to say (at length) that they needed to hold on to the money. R&D, etc.

Translation: Dividend? Hell no.

Tom Carpenter was done and the analysts got back to minutia for a time until Thomas Davey nailed CFO McQuilkin down on the share repurchase issue before again going back to his model.

Saving the best for last... along comes Bill Nasgovtiz of Heartland Advisors. A firm that (not coincidentally) owns a large chunk of IDCC shares.

He started slowly...

"In terms of cash, what are we [YES, WE] earning on OUR cash?"

The emphasis in the quote is MINE.

Scott McQuilkin (probably sensing trouble) responded:

Well, it's a very low rate. I mean, it's somewhere between 0.5% and 1%, and the reason for that is because we keep it in very safe, very liquid, very short-term types of investments.

Basically, we had next to no losses over the last couple of years, so that's the good news. The bad news is yeah, the rates are low for right now.
(TLVI: Wharton?)

Nasgovitz continued:

Okay. I appreciate that. Well, Bill, getting back to your previous statement, trying to achieve the highest value to shareholders. Just a couple comments. With the stock trading at essentially -- well, below $20 a share, and estimates I've got a 250 estimate. Maybe you're going to do it for the year. We'll see. But if so, that's an 8 PE, about a third of what QUALCOMM is selling at. But an earnings yield of 12.5%, I'm a bit puzzled by why you don't think that that's a very extremely attractive return for shareholders.
Bill Merritt
I think that if you look at the investment opportunities, and you're right though. You have to compare what you can achieve in terms of shareholder return in a buyback versus what you can achieve in a shareholder return through investment in the business. And as Scott and I both mentioned, we see some very significant opportunities out there to make some investments that we think would create greater value than share repurchase. And obviously in looking at that you have to think about the risk of execution on those strategies and compare that against the buyback of stock which some people would say, well, isn't that less risky? Well, it can be or can't be because obviously you have to think about what the stock is -- you think is worth versus what you're buying it at. And so I would -- I tell you, Bill, it's a very active dialogue within the Company.
Bill Nasgovitz
Well, I would hope so, Bill. Because the Company in the past has had a history of diversifying outside of its main business and not really making any money for shareholders, losing a ton. So to me a low-risk, very prudent approach would perhaps to do -- step up the buyback activity substantially here. Hell, you're going to have well over half a billion dollars in cash or 600 million bucks. If you spent $200 million yesterday and today you could have bought back a quarter of the Company. A quarter of the Company for $200 million for a business which today is being valued at $400 million net of cash that has thrown off over a billion and a half in royalty revenues. Is that right, $400 million for a billion and a half of previous royalties? And you're talking about a pretty optimistic future here.
Bill Merritt
(TLVI: What? No more long answers, Bill?)

Bill Nasgovitz
Or am I wrong? Or are we just BS'ing here?
Bill Merritt
Yeah. I mean, I believe we do have a very strong future.
Bill Nasgovitz
Well, holy shit, 12.5% seems to make a pretty good sense versus 0.5% or 1%, so I really urge the Board to consider, if you like the stock at $30 or $35, my god, at $19 or $20 a share it would seem to make sense.
(TLVI: The man is being driven to cuss!)

Bill Merritt
Scott, do you want --?

Bill Nasgovitz
And a dividend to shareholders might cause other people who invest also for dividends to take a look at this thing. My god, you're selling for $400 million net of cash. Am I wrong? Is my math wrong or what?
Bill Merritt
No, I think your math is probably right, and as I can -- as I said, it's a very active dialogue within the Company and I think that we have a lot of good opportunities to drive value here and --
Bill Nasgovitz
Do you expect earnings to be up? Do you expect earnings to be up next year?
Bill Merritt
We don't tend to give earnings guidance, and we never have. But certainly with respect to the business, we see a lot of opportunities to drive value.
Bill Nasgovitz
Okay. Well, I wish you well on that, but certainly give this I think a low-risk approach some serious discussion, and in my view there is a sense of urgency to take advantage of these disappointments with Nokia when the stock is selling for a ridiculous price at a fraction of your peers. The shareholders would certainly appreciate more value being recognized. The intrinsic worth of this Company is I think we would all agree substantially higher than $19 a share.
Bill Merritt
I appreciate your comments, Bill.
Needless to say, the call ended soon after this exchange.

God Bless, Bill Nasgovitz and Heartland.

Sorry for the length, I just could not edit any more. By the end of this dialogue I was standing on my desk clapping. Dead Poets Society-style.

Fellow investors, these managers work for us!!??! Where is the board of directors?

We need more analysts and shareholders to publicly call out management when they are so blatantly ignorant (or stupid) (or dishonest).

Bill Nasgovitz's math is wrong in the sense that he didn't adjust his multiple for all the excess cash. A buyback would return FAR more than 12.5% to IDCC shareholders. That Merritt and McQuiklin don't know (or care) is scary.

This management team has to go. It's time for an intervention.

Disclosure: Author owns shares of Interdigital.

1 comment:

  1. The valuation of this company is quite interesting. This certainly could be an interesting way to invest in the growth of the internet mobile computer as I like to say.