From IV
Barclay's July 1st Note on Nortel Patent Auction
InterDigital, Inc. (IDCC, 30-Jun-2011, USD 40.85), 1-Overweight/2-Neutral
Nortel Auction Highlights Value in Wireless Patents
This morning, Nortel announced that a consortium of vendors including Apple, EMC, Ericsson, Microsoft, Research in Motion, and Sony are the winning bidders for the company's patent portfolio. At $4.5 billion, the winning bid was substantially higher than Google's $900M stalking horse bid, and thus in our view highlights the importance placed on the company's patent portfolio, particularly on its wireless assets. Other vendors that were reported to be a part of the process (e.g. Nokia, Intel, IDCC, Google, RPX, Motorola Mobility, etc) ended up empty handed, potentially setting many up to seek out additional strategies to address what has been a highly competitive and increasingly litigious area within the industry. We highlight that all of the OS platforms are represented among the bidders, though Android only minimally so.
A Material Step Up from Initial Bidding Round
A winning bid of $4.5 billion was a material step up for the $900M stalking horse bid by Google, highlighting the importance placed on Nortel's patent portfolio. While details on specific vendor's shares and associated rights are still forthcoming (RIM has a $770M contribution while Ericsson's contribution is $340M) the size of the aggregate bid highlights: 1) the importance of intellectual property as an asset; and 2) the need for vendors to continue to add to their respective portfolios in order to bolster their defensive and, in some cases, offensive position. With roughly 6,000 patents and patent applications encompassing wireless, internet search, social networking, data networking, optical, voice, service provider, and the semiconductor sector, the Nortel portfolio was one of the largest pools of patents available for bid in recent years. We have less clarity on the distribution of the patents across the various winning bidders. However, we do not expect that RIM is likely overly interested in semi patents, for example.
Embedded Rate of ~1% Seems at the High End
While it is difficult to assess the true value of the patents to each company (taking into account factors such as lower litigation risk, potential competitive implications etc) our back-of-the-envelope calculation suggests a potential royalty rate in the ball park of 1% implied by the purchase price. The first seven years of W-CDMA unit volumes were ~1.0 billion, with the first 10 years unit volumes in the range of 2.0 billion. If LTE devices follow a similar curve, this deal costs the consortium $2.25 per phone. Assuming an ASP in the $200-$250 range, this implies a royalty of ~1% per device. In our view, a 1% royalty seems to be on the high end of what these patents might command; however, there is likely some unquantifiable value to lowering the risk of litigation and potentially bolstering one's position vs. competitors.
Android Ecosystem Noticeably Absent
With the exception of Sony and Ericsson, members of the Android ecosystem were noticeably absent in the winning consortium. Given Google's vocal position that: 1) patents are a necessary asset in order to compete in the wireless world, and 2) its acknowledgment that its own internal portfolio is comparatively weaker, we would be interested in what steps the company as well as the broader Android ecosystem takes having not participated in the winning bid. In our view, the size of the winning bid may spur increased demand / attention on other assets that may be available in the market.
Separately, we highlight a few thoughts on Apple, RIM, and Nokia
· Apple's participation within this auction is likely to offset its loss to Nokia
· While Nokia was not part of the bidding process, it is likely covered via Microsoft
· RIM's cash balance of ~$2.9B at the end of F1Q (not including the $770M paid on this auction) is likely to limit the company's ability to buyback stock.
QUALCOMM, InterDigital Pure Plays in Wireless IP
Out of our coverage universe, QUALCOMM and IDCC remain pure plays in the wireless IP space. QUALCOMM retains one of the largest and more established wireless IP portfolios in 3G, LTE, and of course CDMA. The company currently commands an average royalty rate of approximately 3.4-3.5% across its entire patent portfolio. We do not believe QUALCOMM participated in the auction or needed too as it was unlikely to materially bolster its current royalty rate.
With respect to IDCC, while it is difficult to make a direct comparison on the implications of the $4.5 billion bid to IDCC's portfolio, the value ascribed to the assets clearly serves as a positive for the company. On declared essential patents (which we acknowledge is not a pure measure of standard contribution), InterDigital has a higher share than Nortel in the LTE arena. Moreover, InterDigital 1) has been investing in new technologies over the time period in which Nortel has been in bankruptcy, and 2) its patents are designed with licensing in mind and thus could prove to be an attractive asset. We highlight that IDCC's market cap is less than $2B, less than half of what was paid.
Apple is covered by our IT Hardware team led by Ben Reitzes, Google is covered by our Media and Internet team led by Anthony DiClemente, Microsoft is covered by our Software team led by Israel Hernandez, and Qualcomm is co-covered with our Semiconductor and Semi Cap Equipment team led by CJ Muse.
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