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Interdigital: Key Valuation Assumptions

Posted on Sunday, Feb 3rd 2008

By Vijay Nagarajan, Guest Author

As I mentioned in the prequel, the uncertainties surrounding the IP business model and also its new ASIC ventures make it impossible to come up with an accurate mathematical model for Interdigital’s valuation. Nonetheless, I have made certain simplifying assumptions to make the problem more tractable.

3G Royalties: I believe that most, if not all, 3G vendors will have to pay royalties to Interdigital. Whether it comes through licensing deals or as a result of litigations is secondary. Based on some public statements by company executives, it seems that the royalty per unit today is close to $2. As the 3G volumes grow, I do not see this number sustain. Companies are likely to negotiate lower numbers and the caps will also be reached. This will result in a smaller net dollar amount per handset unit sold. With these in mind, I estimate an average of $0.8 for every 3G handset sold in the future.

Long-term view: While the licensing fee is Interdigital’s to collect, the timing and the legal proceedings associated with it will result in variations in its revenue pattern. I have, however, discounted the exact timelines and this potential fluctuation to take a long-term stance as I evaluate its intrinsic value. This allows a direct correlation between the growth of 3G and IDCC revenues.

ASIC division: I like the position that IDCC has taken on its ASIC business. It strives to be the champion of the high-end data-centric phones. It has also sought to validate its claims through field trials. This does create value. But the true metric for any chipset company/division is the number of design wins, the number of chipsets that will be in tomorrow’s cell-phones. With no big deals in place, I am unable to attribute a market share percentage to IDCC’s ASIC solutions. However, I have assumed a modest 1% chipset market share starting 2009. This number can only go up if the solution is market-proven.

Expenses: IP Licensing is a high-margin business while ASIC manufacturing incurs a very high percentage of expenses. As the company grows, I estimate that its operating margins will be a little less than 50% early next decade and get closer to the Qualcomm margins of about 35% 10 years from now. This is assuming that IDCC will stay as a stand-alone company and slowly widen its footprint in the ASIC business while still getting royalties from various wireless standards.

Miscellaneous: Among other factors, I have taken into account continued revenue from 2G licenses world-wide. I have also assumed a reduced growth rate of about 10% moving beyond 2012 and a 0% terminal growth rate. For this analysis, I have used a discount rate of 8% and 47.45 million as the number of outstanding IDCC shares.

These assumptions and parameters form the basis of my event-based DCF analysis and valuation which I will provide in the sequel to this piece.

This segment is a part in the series : Interdigital

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I think you need to explain your assumptions especially the the 3G rate going to .8/phone .

The CEO has publicly said they are currently getting over $2.00/phone and don’t see it going below $1.50 in the next 5 years.

How do you get to .80/phone?

What information do you have that the CEO doesn’t?

I have done some Amateur analysis of the Intrinsic Value using DCF and I believe the current Intrinsic Value of this company is at least $173.00. Making this a value growth stock.
Stock price potential is $400/share plus. IMO

FD- I hold a significant position in this stock.

David Dodd Monday, February 4, 2008 at 6:03 AM PT

David,

Thanks for your note. I had left out the analytical calculations behind my estimates so as to make it lucid to all readers. Since you have asked for it, here is a rigorous description of the same.

My understanding of the CEO’s $2.00 statement was that it pertained to the royalty rate per handset sold under an IDCC license currently. A similar number can be calculated using the following information –
1. Statements from IDCC suggesting that 60% of its revenues come from 3G licensing.
2. Statements from IDCC that it draws license money from 30-35% handsets shipped today
3. Total 2008 handset shipment estimates
4. Total IDCC revenues for 2008

With this information, we get around $2.25 per handset sold under IDCC license. The difference between this and my $0.8/phone is that I have calculated the royalty rate as a function of EVERY 3G phone sold, not just those under an IDCC license. I did this for two reasons-
1. While I am sure that the 35% number will grow, I do not have any visibility yet into the growth percentage. So, it was more appropriate for me to look at the royalty per handset sold to remove variables from my model. Alternately, you can look at $0.8/phone to be $2.25/handset under IDCC license. This view suggests that I have not accounted for market share growth and is hence a conservative estimate.
2. Secondly, as the 3G volumes grow, it is likely that even if IDCC draws in the whereabouts of $2 per licensed handset, the upper bounds or caps for royalties will be reached bringing the effective number below this price.

On the basis of these two reasons, I am comfortable with my assumption on this front for the moment. You will notice that all my valuation analysis in the sequel are done for ALL handsets sold around the world. So, $0.8 is not as low as it seems in the wake of the CEO’s statements. While incorporating the 3G market share growth rate (knowing Nokia and the others will ultimately pay royalty to IDCC) and estimating the caps is possible with more data, it will make the model unwieldy without serving extra purpose.

My rationale on expenses was based on component growth rate based on historic data, besides taking into account the cost of revenue for the ASIC business. I have also used the lessons learnt from my QCOM valuation in terms of the operating margins for companies with the IP licensing model. I think if IDCC is prudent, then in the long term, it will strive to get to the kind of margins that QCOM has currently. Note that if the ASIC business is accounted for, then the margin will be a weighted average of the high-margin IP-licensing and the tough ASIC business.

I hope these details help. To get more insights into my 3G market assumptions, I will direct you to my QCOM series.

Thanks,
Vijay

Vijay Monday, February 4, 2008 at 11:03 AM PT