Size is not everything
After it opted against a sale five years ago, InterDigital has been on a licensing roll with a series of headline deals. The question now is whether it can maintain this growth
At first glance, InterDigital is a mass of contradictions. It is a high-tech pioneer, yet its suburban Delaware HQ is far removed from the sun-dappled campuses of Silicon Valley. Its workforce of around 300 is packed with talent, but is dwarfed by the giants of the wireless world, such as Ericsson and Qualcomm. It is a licensing business which has continued to sign deals and grow revenues at a time when the monetisation of standard-essential patents (SEPs) – particularly in the wireless space – has never been tougher. Most significantly, it is a public IP company which has seen its share price skyrocket in the last five years, at a time when many non-practising entities (NPEs) have struggled on the capital markets.
Since it failed to find a buyer for its whole business just over five years ago, InterDigital has concentrated on what it does best: investing in its own R&D, producing cutting-edge wireless technologies and licensing its intellectual property to the world’s largest device makers. Apple, Huawei and Samsung are all currently licensed to the company’s portfolio and contributed a significant chunk to InterDigital’s 2016 revenues of $665.9 million.
Eager to put its cash reserves to good use, the company is now in acquisition mode and in late 2016 announced a deal for sensor motion tech business Hillcrest Labs. That transaction could be the first of several as management looks to position the business for the rollout of fifth generation (5G) wireless technology and the ongoing development of the Internet of Things (IoT). Company executives recount with undisguised pride that they were one of only a handful of tech businesses at this year’s Mobile World Congress asked to demonstrate the latest advances in 5G technology.
“The last few years demonstrated to us that there is huge value to scale in this business”
However, as with any public company ‒ and particularly one focused on patent licensing ‒ a string of successes can seem a distant memory if potential licensees refuse to sign up or litigation goes the wrong way. “You can have great revenue at the end of the year, but if you can’t tell people how you’re going to repeat that next year, you don’t get a lot of value for that,” reflects CEO Bill Merritt. For InterDigital, this is one trend it cannot afford to buck.
Deal or no deal
Look at the company’s recent history and it quickly becomes apparent that January 2012 was something of a watershed. The previous summer, InterDigital had put itself up for sale, its patent values buoyed by the auction for the former Nortel patent assets, which were ultimately sold for $4.5 billion to the Rockstar consortium.
This sale offer was less a sign that the business was struggling and more a reflection that InterDigital’s asset base might be worth far more than anyone had previously expected. Merritt points out that management had a fiduciary duty to its shareholders to explore a possible deal. In the latter half of 2011 there were a number of reportedly interested parties, including Apple (which was part of the Rockstar consortium) and Google (which had lost out on the Nortel assets, but bought Motorola Mobility in a subsequent deal) as demand for IP assets in the wireless space rose even higher.
However, a concrete offer never materialised and after six months on the market, InterDigital announced at the start of 2012 that it was no longer for sale. “The reason we didn’t sell the company is that nobody needed anything as big as our portfolio and trying to cobble together a set of buyers was really hard,” Merritt recalls. “But it did validate for us that people saw that the portfolio was big enough and strong enough to divide into multiple pieces.”
Although the sale process was unsuccessful, it did generate interest in InterDigital’s assets. In June 2012 the company sold a portfolio of 1,700 patents and related rights to Intel for $375 million.
“You would think that we came out of the process demoralised, but we didn’t,” Merritt laughs. The fact that a company such as Intel was prepared to pay hundreds of millions for just a part of its portfolio was a big boost for him and his team, and “confirmed the belief the company had in its portfolio”. That confidence can be traced back to 2009. “The decision we made was to really focus on licensing and almost double down on that business,” Merritt explains. “What we were really good at was research and we just said, ‘You know what, let’s do more of what we’re really, really good at.’”
That choice to effectively abandon any plans to become a major product-making business allowed InterDigital to invest more in its own research and patenting efforts. Between 2006 and 2010, it received an average of just over 164 US patents annually, according to data from the Intellectual Property Owners Association. Between 2011 and 2015, that figure rose to just over 200. In the last four years the size of its US portfolio has increased from just under 1,700 in 2013 to 2,300 in 2016. Its stockpile of non-US granted patents now exceeds 12,000 – hardly comparable to the Samsungs of the world, but a potent platform nonetheless.
Table 1. InterDigital’s new US patent grants
Number of new patent grants
Source: Intellectual Property Owners Association
2011-2015 average of 201 grants per year
2006-2010 average of 164.8 grants per year
“I think the last few years demonstrated to us that there is huge value to scale in this business,” Merritt points out. To him, the decision to focus on licensing led directly to the growth in InterDigital’s portfolio, which partly explains why it has continued to succeed at the same time as other licensing businesses have suffered. “A few years ago there was this fork in the road where we had a lot of companies with portfolios of a greatly different size all carrying reasonably sized valuations,” he recalls. “And what has happened is that the ones with the small portfolios have fallen off the map and the ones with the larger portfolios are doing well.”
That divide can also, in part, be explained by companies which develop their own tech (eg, Rambus and Tessera) performing above the market, while NPEs which buy their intellectual property on the secondary market (eg, Acacia and WiLAN) have struggled to convince the investment community of their growth prospects.
Source: MDB Capital Group/IAM US Patent 1000
For the last five years, InterDigital’s performance has been good enough to win over most investors. Revenues rose at a steady clip before jumping by almost $225 million last year when the company inked new licensing agreements with Huawei in September and then Apple. The performance of the company’s share price has been even more spectacular, rising from around $20 in 2012 to the mid-$80s today.
Perhaps most impressively, this has taken place amid a much tougher legal and regulatory climate for licensing in the United States. InterDigital has seen its fair share of courtroom defeats against its mobile peers and other tech operators. It has lost several times at the International Trade Commission against the likes of Nokia, ZTE, Huawei and Microsoft (which inherited the litigation when it bought Nokia’s handset business). The company has also encountered difficulties in China, where its licensing practices – like those of Qualcomm – were targeted by the National Development and Reform Commission. However, in contrast to the giant chipmaker, InterDigital settled early with the Chinese authorities in May 2014, agreeing to adjust its pricing structure in the country in order to free itself from the ongoing threat of a hefty fine.
Source: Seeking Alpha
Senior executive vice president, Future Wireless
“We talk with our prospective licensees and those that are up for renewal for months, sometimes for years, and we do it in a very fair way”
It is not uncommon for the share price of a patent licensing business to be driven by episodic events, such as district court litigation, which sees shares soar on a positive outcome only to come crashing back down once the decision had been appealed and often overturned. As chief communications officer Patrick van de Wille points out: “If you’re an episodic company, then you get episodic investors. You don’t get people who buy for three or five years; you get people who buy to capitalise on an event.”
To guard against this, InterDigital’s management has assiduously downplayed the potential impact of any lawsuits, win or lose. “We have really de-emphasised litigation,” Merritt outlines. “We may have to litigate ‒ that is the nature of the business – but we have purposely damped down expectations either way. No one case defines the company, so no one case is an extraordinary plus or an extraordinary minus.”
While many of the disputes in which InterDigital was embroiled during the smartphone litigation wars have now concluded, the company remains involved in antitrust spats with Microsoft and Asus and some residual suits in China. The Windows titan and the Taiwanese tech player have accused InterDigital of violating antitrust laws in its enforcement of 3G and 4G SEPs, including charging exorbitant licensing fees. The Asus matter is now being arbitrated, while the Microsoft case is due to go to trial in Delaware in 2018.
Of course, litigation and licensing often go hand in hand; but Larry Shay, head of InterDigital’s wireless business, stresses that the company does not turn to the courts lightly. “We’re not about filing a lawsuit first and then talking later,” he insists. “We talk with our prospective licensees and those that are up for renewal for months, sometimes for years, and we do it in a very fair way.”
Chief licensing counsel
“Us walking into meetings knowing that three of the top phone manufacturers are licensed causes anyone who meets with us to take us seriously”
That is a familiar refrain from any patent licensor; but in sealing deals with Samsung in 2014 and then with Apple and Huawei last year, InterDigital has demonstrated a pretty healthy licensing track record (it also has deals in place with HTC, Sony and Kyocera, among others). Such relationships help to instil confidence. “I think us walking into meetings knowing that three of the top phone manufacturers are licensed causes anyone who meets with us to take us seriously,” licensing head Marie MacNichol observes.
Apple, in particular, has a reputation for being a tough licensee, as demonstrated by its recent suit against Qualcomm over the chipmaker’s licensing practices. While InterDigital is now tied into a multi-year deal with Huawei, its agreement with Samsung is up for renewal at the end of 2017. MacNichol declined to comment on any possible licensing negotiations, but it is probably safe to assume that there are ongoing talks between InterDigital and the Korean tech behemoth. When the original deal was struck, Techcrunch estimated that it was worth $500 million to InterDigital. A quick renewal without litigation, therefore, would not only add to the company’s growth story, but also augur well for future licensing negotiations.
- July 2011 – announces that it is looking for a possible buyer for the company. Apple, Nokia, Google and Qualcomm are all reported to have considered bids for it.
- July 2011 – files a case at the International Trade Commission (ITC) against Nokia, Huawei and ZTE and a case against the trio in Delaware.
- January 2012 – announces that it is no longer up for sale after failing to find a buyer.
- June 2012 – sells 1,700 patents and related rights to Intel for $375 million. Share price jumps from $23 to more than $30 before settling back at $29.
- January 2013 – forms joint venture with Sony called Convida Wireless focused on research in Internet of Things (IoT) communications and other connectivity areas. The relationship is expanded in 2015 to include advanced R&D in 5G and future wireless tech.
- January 2013 – files case at the ITC against Samsung, Huawei, Nokia and ZTE and calls for import bans against all. A previous licensing deal with Samsung had expired in December 2012.
- June 2013 – in case filed in July 2011 against Nokia, Huawei and ZTE, the ITC finds no violation as InterDigital patents are either not infringed or invalid. InterDigital appeals unsuccessfully to the Court of Appeals for the Federal Circuit.
- Sepember 2013 – the National Development and Reform Commission (NDRC) launches an investigation into InterDigital’s licensing practices in China.
- December 2013 – CEO Bill Merritt reports that Chinese authorities have said they cannot guarantee the safety of InterDigital executives sent to a meeting in China.
- May 2014 – InterDigital settles with China’s NDRC and agrees to adjust its pricing structure in China.
- June 2014 – just days before a case involving both is due to reach the ITC, InterDigital announces licensing deals with Samsung Electronics which resolve all pending litigation between the two – it covers devices from January 2013 through 2017.
- August 2014 – in a case brought in January 2013, the ITC confirms its earlier ruling that ZTE, Nokia or Microsoft (which had been added as a respondent after it bought Nokia’s handset business) did not commit any violations.
- August 2015 – the ITC rules in its long-running case against Nokia (originally filed in 2007) and then Microsoft, ultimately finding no violation. Merritt claims that the impact will be muted because of the decline in Nokia’s mobile business. In the same month Microsoft files an antitrust suit against InterDigital, alleging abusive licensing practices.
- September 2016 – signs licence agreement with Huawei. The two sides settle all proceedings related to arbitration initiated in December 2013. The deal also includes a cooperation agreement regarding ongoing joint R&D.
- September 2016 – joins IoT licensing platform Avanci.
- December 2016 – signs six-year licence agreement with Apple.
- December 2016 – acquires sensor motion tech company Hillcrest Labs. Hillcrest owns more than 235 granted patents.
- May 2017 – agrees settlement with Microsoft, bringing litigation between the two companies to an end.
As is the case for many licensing businesses, InterDigital’s revenues hinge on a handful of big deals. In 2016 the company recognised $169.3 million from the Apple deal (25% of revenues) and $154.8 million from the Huawei agreement (23% of revenues). While both included big chunks of revenue from past sales, they highlight just how susceptible licensing companies can be to lumpy revenues, where record-breaking performances one year are followed by a sharp decline the next.
Merritt says that to guard against such fluctuations, the company has emphasised multi-year deals which pay out over the course of the agreement. “We have definitely made moves over the last couple of years to go with longer-term deals if we could do that and, to some extent, to give up some revenue growth from a customer for long-term revenue stability. That was really driven by the fact that every time we did a deal that was a longer-term deal, even if it didn’t meet some expectations in the market, people loved the deal. One good double after another is better than going to the plate every time and swinging for the fences,” he comments, slipping into baseball parlance to describe the company’s pragmatic approach.
Although it has three of the top four handset makers under licence, InterDigital has only around half of the market for 4G wireless technology fully licensed. However, much of the company’s current innovation efforts and future growth prospects are targeted at licensing the IoT sector and the roll-out of 5G mobile.
If – as is widely forecast – the IoT does lead to tens of billions of connected devices, any business focused on connecting those things should be well positioned to profit. Yet the proliferation of connected devices and new manufacturers also throws up a host of potential problems, including the age-old issue of how to ensure that those who use your intellectual property pay up.
InterDigital has estimated that the IoT opportunity could be worth between $75 million and $100 million to it over the next three to five years. In order to help reach that goal, it has signed up to Avanci, a licensing platform launched in September 2016 which has brought together Qualcomm, Ericsson, Sony, ZTE, KPN and InterDigital to license their relevant IoT patents in 2G, 3G and 4G to companies in a number of sectors, including smart meters and autonomous vehicles. It is the kind of collaborative approach which has been sorely lacking in the mobile sector in recent years.
Merritt divides the IoT opportunity into two parts – the connectivity and the software side – both of which open up far more licensing opportunities for the likes of InterDigital than 4G. Merritt recalls that he would discuss how licensing might work with business leaders over drinks at industry events such as the Mobile World Congress in Barcelona. “When we looked at IoT we said, ‘This is unmanageable; we can’t do this again; it’s just too much,’” he admits. “But when we got into thinking about IoT at the connection level we thought, ‘Maybe we could do this more efficiently.’”
One of those regular confidantes was Ericsson chief IP officer Kasim Alfalahi, who left his job at the Swedish telco to launch Avanci. Although the new platform is still in its infancy, it offers a glimpse of how a more collaborative approach to licensing could make the process far smoother in 5G. “I think collaboration is going to be a bigger piece of licensing going forward and I think pools or consortiums such as Avanci do have a place,” comments Shay. “But I still believe that the bilateral negotiations of large IP holders and implementers will always be around.”
However, this collaborative approach is also becoming a part of those bilateral negotiations. In the licensing deal between InterDigital and Huawei, the two companies left the door open to possible joint R&D efforts. In early 2013 InterDigital entered into a joint venture called Convida Wireless with its licensee Sony. This was set up to focus on IoT research and was then renewed and expanded in 2015 to cover 5G and future wireless opportunities.
As the Sony example shows, such bespoke agreements can lead to a deeper relationship. They can also work better in newer markets such as China, where manufacturers are less accustomed to paying for licences. “A straight-up, plain patent licence is harder to do versus a patent licence that has other things in it, such as research,” Merritt comments. “And I love to do customised deals because they are stickier.”
Still looking to buy
This matters because, as anyone in the licensing business knows, it can be a fickle industry. Investors might buy into a growth story, but if licensees take years to sign up or to renew deals, or if they start to see a marked slump in performance (as with Nokia and BlackBerry), then a business such as InterDigital can swiftly see revenues drop and overall performance suffer. It will be a key test of the company’s recent messages to the market about its long-term fortunes and the strength of its innovation if it takes a long time to reach an agreement with Samsung and has to wait for licensing revenues from the Korean company.
The fact that the business is actively looking for more acquisitions after the Hillcrest Labs deal shows that more than five years after the aborted sale process, InterDigital is in as healthy a position as it has been in years. That may make it an attractive acquisition target ‒ much like UK chipmaker ARM, which built a formidable licensing operation and was snapped up by Softbank for $32 billion last summer.
In May the company received a further boost when it announced that it had reached a settlement with Microsoft, bringing the multi-year litigation between the two sides to an end. The pair also revealed that they were looking at further discussions around a licensing agreement and possible future collaboration.
As a public company, InterDigital is theoretically always up for sale; and as licensing conditions in the United States show some slight signs of improvement and 5G looks to transform mobile, the company may well become a more appealing prospect than it was in 2011.
“If someone put the right number up there, sure, we’d be a seller – that’s my obligation to the current shareholders. But are we intending to be a buyer?” Merritt asks. “Yes, because I think that we can leverage our customer base, we can maintain our model and we can go back to the decision we made in 2009. We’re good at this and there’s no reason we shouldn’t keep doing this because the market is still there. And this market is not going anywhere other than growing, particularly as IoT becomes a big new growth driver. We’ll just do it in a bigger way.” That should be a growth story which most can subscribe to.
InterDigital has doubled down on the strength of its R&D and its patent portfolio over recent years:
- With Apple, Huawei and Samsung among its licensees, the company has royalty-bearing relationships with three of the four biggest handset makers.
- Having signed up to Avanci, InterDigital has identified IoT licensing as an opportunity worth between $75 million and $100 million over the next three to five years.
- After buying sensor business Hillcrest Labs, the company is now in acquisition mode as it looks to grow in sectors such as IoT.
- The test for the business is whether it can keep its current run going as 5G mobile technology is rolled out.