Litigation Dependence And Licensing Volatility Threaten Future Earnings And Growth

Key Takeaways

• Legal disputes and the potential expiration of key licensing agreements introduce volatility in revenue and increase legal expenses, impacting net margins.
  
• Dependence on litigation for revenue and expansion into new technology areas like VR/AR involves significant execution and legal risks, affecting long-term growth.
  
• InterDigital's focus on expanding 5G assets, successful legal battles, and new licensing agreements with major tech companies signifies potential for long-term revenue growth and increased net margins.

Catalysts

Operates as a global research and development company with focus primarily on wireless, visual, artificial intelligence (AI), and related technologies.

• The ongoing litigations with companies like Lenovo and the potential for future disputes with other licensees could increase legal expenses and uncertainty, negatively impacting net margins and future earnings.
  
• Expiration of significant licensing agreements, such as the 2023 expiration of the Huawei agreement, could lead to volatility in revenue if new or renewed agreements do not materialize or are less favorable, impacting revenue stability.
  
• The dependence on winning court rulings to secure licensing fees and enforce patents, as highlighted by the appeal court decision requiring Lenovo to pay increased fees, introduces risk to future revenue predictability and growth, particularly if future rulings are unfavorable or litigation outcomes vary.
  
• Heavy reliance on litigation wins and court orders for revenue, such as the injunction against Lenovo in Germany, may not be a sustainable long-term strategy and could lead to challenges in maintaining and growing revenue.
  
• The strategy of expanding licensing into new technology areas such as VR/AR and cloud-based services, while potentially beneficial, carries execution risk and may require significant investment in innovation and legal battles to defend patents, impacting net margins and long-term earnings growth.

Assumptions

• Analysts are assuming InterDigital's revenue will decrease by -10.5% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 38.0% today to 15.1% in 3 years time.
• Analysts expect earnings to reach $79.3 million (and earnings per share of $2.86) by about September 2027, down from $278.3 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 42.8x on those 2027 earnings, up from 11.9x today. This future PE is greater than the current PE for the US Software industry at 34.9x.
• Analysts expect the number of shares outstanding to decline by 4.84% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.91%, as per the Simply Wall St company report.

Risks

• InterDigital's new device license with Google for Pixel smartphones and Fitbit wearable devices, covering cellular, WiFi, and HEVC video patents, suggests potential revenue growth from major tech companies, impacting revenue and earnings positively due to the expansion into 5G assets.
  
• Multiple court wins, especially the UK court of appeal decision against Lenovo that significantly increased the licensing fee Lenovo must pay, indicate a strong legal precedent for enforcing patent rights, which could lead to increased licensing revenue from other companies as well, positively affecting net margins.
  
• The announcement of a new license agreement with Panasonic covering 4G, 5G assets, WiFi, and HEVC video patents could result in increased revenue streams, impacting revenue and possibly expanding market reach and net margins.
  
• Strengths in video innovation, particularly in HEVC and VVC patents, position InterDigital advantageously as video compression standards evolve and are adopted more widely, suggesting potential for long-term revenue growth from a broader range of devices and services, impacting revenue and net margins.
  
• High adjusted EBITDA margin and robust cash flow, supported by successful licensing agreements and litigation wins, indicate strong financial health and operational efficiency, possibly leading to increased investor confidence and further investment in innovation, impacting earnings positively.

Valuation

• The analysts have a consensus price target of $132.25 for InterDigital based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $153.0, and the most bearish reporting a price target of just $100.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $525.3 million, earnings will come to $79.3 million, and it would be trading on a PE ratio of 42.8x, assuming you use a discount rate of 6.9%.
• Given the current share price of $132.23, the analyst's price target of $132.25 is 0.0% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.