Monday, September 27, 2010

Calling Interdigital

For over a year, Interdigital (IDCC) management has rejected share repurchases in favor of hording cash for a yet-to-be-determined, possible, future acquisition.

In a conference call last year, outside shareholders practically begged for a change of course (a more balanced approach), especially in light of the company’s valuation and capital structure.

At the time, IDCC fetched $20.50 a share, a market value of some $880 million.  Cash stood at over $400 million, while debt amounted to a staggering $14 million.  Cash flow problems?  No.  The firm’s free cash flow multiple was easily in the single digits. So you can (at least in part) understand why shareholder frustration was palpable.

As a relatively small shareholder, I attempted to call attention to the issue in my article, Interdigital Intervention.  The post includes an excerpt from one of the most incredible conference calls I’ve ever witnessed. Here is a company awash in cash, yet management makes excuse after excuse for a continued stockpiling of cash. No dividends, no buybacks.  

Today, Interdigital shares trade at $28.50, with a total market value of $1.2 billion. The company still has essentially no debt and should generate in excess of $100 million in free cash flow (again) this year. Cash will no doubt reach $600 million this quarter, 50% of the company’s market cap.

Should we discuss the massive opportunity cost shareholders have endured because the company didn’t buy back shares at $20? No, that would be hindsight… and shouldn’t we be happy with our 40% capital gains in the last 11 months? Let’s not be greedy.

Can we at least agree that the company should have listened to those lone voices of (buyback) reason?

No, let's just forget that IDCC could have repurchased at least 10% of its outstanding shares for $100 million. And with only a dent in its cash balance.  They even have partial authorization already. Such an incremental step would have benefited shareholders exponentially over time.  Even factoring out the welcome capital gains in recent months, there is the issue of accretion. But let’s not stare in the rear view mirror too long. It’s just too depressing.

The main question is: Has Interdigital learned its lesson?  Given its ever increasing cash horde, solid cash flow, no debt, minuscule capital expenditures, and no good use of the cash on the horizon, can shareholders expect a change in policy?

This exchange from the Q2 conference call says it all:
Bill Nasgovitz - Heartland Funds
So we have almost $600 million in cash, is that correct?

Scott McQuilkin, CFO
Well, if you take the year and cash balance and add it in $100 million from Samsung net of the foreign withholding tax you get a pretty strong number there.
Bill Nasgovitz - Heartland Funds
So what is your aggregate yield on this money?
Scott McQuilkin, CFO
It’s what you might expect given the fact that we have got it in very liquid and very safe investments very low… on the order of 0.5%.

Bill Nasgovitz - Heartland Funds
Okay. And then what is the timing I know it's tough to figure out. But I understand that you were interested in buying additional IP, specifically I guess Nortel has been mentioned. When might that happen?

Bill Merritt, CEO
Process is on the way its hard to predict exactly when it would run out I mean we are originally thinking it should run out this year. And I think that depending upon the exact profits they apply, that’s possible to slide into next year as well.

We continue to be very interested in that opportunity and talking with some other focus about the partnering for that opportunity. So it's still very much on our radar and as we also said that we also look at that opportunity and we have look at it in comparison to other ways of deploying that cash. And we have to make sure that is superior to other use for cash, so that’s under the radar as well.

Bill Nasgovitz - Heartland Funds
So this could happen, Nortel might be 2011?

Bill Merritt, CEO
Again its hard to predict while the process is underway I will tell you it's also not moving as quickly and as we thought it would move, but we thought this is also just take off at a certain point too. I think there are still further strategies deployed by the personnel selling assets to try to maximize value here. So we will see how it goes.

Bill Nasgovitz - Heartland Funds
Okay. Well, again, speaking as a significant long-term loyal shareholder, we'd love to see the buyback reactivated even at $28, earning three bucks. Gee, just simple, that's over 10% on our money. Why not? Why not do some buyback, especially when you paid over $30 a share a year or so ago?

Bill Merritt, CEO
It’s a good question I could say the board regularly discusses that issue. And its not a question of, we believe we can create value to a stock buybacks without a question premium value it’s a question of whether there's other opportunity that can create more value. And so I appreciate your comment and I tell you that this is a topic that we roughly went out to figure on a pretty regular basis here. And let me mention before we had mentioned before we're not we have not been and we don’t expect to be people that just hoard cash. If this happens to be there is a couple of opportunities sitting out there that could be very significantly value creators and we wanted to make sure that we have sufficient liquid assets to be able to participate effectively in those processes.

Bill Nasgovitz - Heartland Funds
And those potential acquisitions would be immediately accretive to earnings for InterDigital shareholders?

Bill Merritt, CEO
As we talked about on the last call. I think the way to look at them is if you're… as a example the Nortel patent portfolio, I don’t believe today is producing significant amounts of revenue. So there really is a future opportunity but that future opportunity can be enormous.
I think Scott mentioned on the last call if you just look at it tenth of a percent royalty increase as a result of the added portfolio on a net present value basis it’s worth $900 million. So that doesn’t immediately improve your earnings in the next quarter but it could substantially increase your share holder value over time. And set out the table that that’s a question the board asked so they paid balance all this year so you are asking all the right questions.
Bill Nasgovitz - Heartland Funds
Well, I'd love to see a balanced approach, meaning an active buyback here with over a 10% earnings yield. Thank you.

I'd call that a lesson NOT learned.

When faced with the choice of an immediate 10% return (or even 20%) from a share buyback vs. 0.5% on a mountain of cash, these guys take the cash. Until, of course, that “enormous future opportunity” comes along.  Heaven help us.

These are the same people who repurchased a handful of shares in early 2009 around $30 a share. But not at $20… no way!

Instead of taking good advice (from one of their largest shareholders) to do SOME stock repurchases, IDCC’s managers make excuses.  They refuse ANY stock repurchases. So a huge, real, and current opportunity goes unrealized.  And Interdigital gradually becomes a glorified savings account.

For this, shareholders pay the company’s top 5 executives an average of $1 million a year.  Heck, I’ll happily collect & deposit royalty checks for a mere $500,000. I might even be able to manage a buyback and a dividend.  Do I get an hour for lunch?

As for a CEO?  How about Bill Nasgovitz? Interdigital is, after all, one of Heartland’s largest holdings and I’d sooner trust his/their judgment on capital allocation.

Current managers want us to believe that they are either being prudent or waiting for a big fat opportunity just around the corner.  Whatever excuse will work at the moment and get you to go away.  But like it or not, they need to hear from shareholders.  The current capital allocation approach (or lack thereof) is absurd.

If IDCC management continues to ignore its shareholders, the company’s shares could easily go back to $20. But they’d probably continue to sit on their hands.  Except for that big deal (think Nortel)... because we (the pesky shareholders) just can't live without buying some of those world-class assets!  That valuable patent portfolio that isn't generating any revenue.  Yup that's the one.  Last I'd heard, Nortel was bankrupt.

I wonder how long Mr. Nasgovitz’s will put up with this.

For now, Interdigital is "keeping its powder dry". 

Heard that one before?

These guys should be running a bank!

Disclosure: Author is long IDCC shares.

4 comments:

  1. Dividends are for companies that have stopped growing.

    Interdigital's best growth years are ahead of it.

    Bill was much more patient in the 3Q CC and he bought more shares in the 3rd qtr.

    I think that says it all.

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  2. Even growing companies can have excess capital. When cash reaches 50% of market value, it might be an indication that cash uses are few and far between. And if the question is dividends or buybacks, I'd argue for buybacks at the current stock price.

    Funny how growing companies often don't have a problem with buybacks. Except they usually do it to hide the effect of stock options.

    But its a return of capital just the same.

    ReplyDelete
  3. thanks Lonely...


    I think you Know how I feel...(in agreement, mostly)...Of course, I prefer the Dividend play at this point in time...

    Wake Up, IDCC..."Do Something"...!!!


    ..jk..

    ReplyDelete