Interdigital, Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

InterDigital, Inc. is a global research and development company focused on wireless, video and related technologies, generating revenue primarily through licensing its extensive patent portfolio across various industries.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

InterDigital, Inc. (IDCC) is a research and development company primarily operating in the wireless and video technologies sectors. They focus on creating and licensing innovative technologies that are core to the functioning of modern communication and entertainment systems. The company’s expertise spans various fields including:

  • Wireless communications (5G, 4G, WiFi, and emerging technologies)
  • Video technologies (compression, coding, and streaming)
  • AI based research for these technologies.

InterDigital is not a vertically integrated company but rather it focuses on R&D, the licensing and the commercialization of intellectual property. The company makes a significant amount of investment into R&D which they believe would help maintain the value of their long term patents.

Revenue Distribution

The majority of InterDigital’s revenue comes from licensing its intellectual property portfolio to various companies, primarily manufacturers of mobile devices, telecommunications equipment and consumer electronic products, in the telecommunications, mobile, and consumer electronics industries. The revenue streams can be segmented into three broad categories:

  • License Agreements: Revenues from patent licensing agreements with various manufacturers and service providers. This is the largest component of their revenue.
  • Technology Solutions and Other Revenue: This includes primarily providing engineering services, research and development agreements, test capabilities or technology consulting.
  • Other: Includes revenue for other financial transactions, like settlements, or agreements.
  • Wireless Technology Advancement: The wireless industry is in a state of flux as 5G is still being implemented with 6G soon to come. As a result, the companies that can innovate in the space are better able to get higher license prices or longer licenses from companies utilizing the technologies.
  • Video and Multimedia Standards: With the growing consumption of video content, the video compression technologies are continuously upgraded to maintain speed and quality. Companies that own patents on these technologies will benefit.
  • AI Integration: There is a strong push toward implementing AI in technology especially in the wireless space, and any company that can benefit from these new innovations will gain great value.

Competitive Landscape

  • Patent Aggregation: The industry is characterized by a few significant technology innovators who hold critical patents in key technology spaces, including 5G and video technology. Many companies such as Nokia and Ericsson have huge amounts of essential patents related to telecom and mobile devices. Companies are also looking for a position in the standardization process of new technologies to gain some form of IP protection. The competitive landscape also includes many companies that license patents instead of developing the IP in house.
  • High Barriers to Entry: The high cost and complexity of research and development, coupled with the need for deep expertise, create significant barriers to entry in the industry. The need for large patent portfolios, which are very hard to build, also makes competition difficult.
  • Licensing Competition: While many companies like to engage in cross-licensing agreements with their competitors to be able to utilize each other’s patents without worrying about lawsuits, companies with a significant competitive advantage would not need such arrangements.

What Makes InterDigital Different?

  • R&D Focus: Unlike many players that focus solely on manufacturing devices, InterDigital’s core competency is in research and development which helps them to stay abreast with new technology and gain valuable patents.
  • Extensive Patent Portfolio: They possess a vast and diverse portfolio of patents, which are essential to the functioning of a number of widely adopted technology standards which gives them negotiating power.
  • Long Term Focus: They are focused on the long-term revenue generation from their patents, instead of selling their patents and obtaining one time cash benefits.
  • Strategic Collaborations: They enter into strategic alliances with many companies within the industry to broaden their reach and value to the patents they have.
  • Standardization Involvement: InterDigital is involved in the standardization process of technologies, especially as that results in new patents or improves the value of the existing ones.
  • License Revenue Model: Instead of focusing on building and selling physical hardware, which requires huge capital investments, InterDigital creates most of its revenues from royalties. It is a very unique and innovative approach.

Financials

  • Revenue: InterDigital has shown consistent revenue generation from their licensing contracts. Revenue is projected to be roughly $438m in 2024.
  • Margins: The company maintains good gross margins with a large amount of free cash flow generated from operations. The operating margin is generally around 20%.
  • Profitability: Net income was $65.5 million in 2022 with the company projecting earnings of $48.8 million for 2023, mostly driven by changes in non operating expenses.
  • Cash Flow: Free cash flow generation is consistent and is an important metric to look at.
  • Balance Sheet: The company’s balance sheet shows that they have $471m in cash equivalents as of December 31, 2022, and a low amount of debt. The large amount of cash they have on hand gives them flexibility for strategic decisions.
  • Share Repurchases: The company has also been engaging in buybacks and have approved share buyback program for 2023 as well.
  • Debt levels: They maintain relatively low levels of debt relative to equity on their balance sheet.

Moat: 3 / 5

InterDigital has a narrow moat. Here’s the detailed justification:

Strengths of the Moat:

  • Intangible Assets: The company benefits from intellectual property through a large number of patents that are essential to technology standards, particularly in the wireless and video segments. This includes patents for standards like 5G, 4G, WiFi, and various video compression techniques, which provide considerable power for the company as they are needed to implement a lot of different applications.
  • Regulatory Approvals: Their ability to license these patents to various different parties is also very important. Given how difficult and complicated the regulatory environment related to IP rights are, it helps that they have a well established legal process.
  • Switching Costs: Although not as apparent, switching costs exist for a lot of manufacturers that use InterDigital patents. For companies to redesign their products and re-engineer their supply chains to remove the use of a specific technology, creates a lot of pain for them which is not easy to overcome.

Weaknesses of the Moat:

  • Patent Expiration: Patents have a limited life, meaning they can be challenged, and new technologies can render existing patents irrelevant. Given the nature of technology, the moat might decay rather quickly and it is extremely difficult to predict if new patents will be as valuable as prior ones.
  • Competition: Though there are relatively fewer companies with very high number of patents, new players can emerge and older players can also make a comeback. The ever changing nature of the technology environment means new inventions can occur and previous ones can be rendered obsolete.
  • Lack of Control Over Pricing Power: While licensing IP offers some control over pricing, this is different from a scenario where you are selling a consumer product directly. Hence the overall revenue is based on how many devices are being produced, and on whether a manufacturer is ready to license the technology.
  • Limited Customer Base: While the company’s revenue is spread over numerous customers in different countries, their business is very dependent on a relatively small group of players. If these players have issues, or change strategies, that can directly affect their bottom line.

Understandability: 3 / 5

The business model is somewhat complex and a bit difficult to understand, as it is based on the licensing of a vast intellectual property portfolio. It is quite opaque as there is no public data on how the prices or license agreements are set. The technology landscape is also continuously evolving.

Balance Sheet Health: 4 / 5

The balance sheet health of InterDigital is excellent. The company has large amounts of cash, and little to no debt. This means they have enough flexibility and liquidity, making for a fairly resilient and low risk investment.

Legitimate Risks That Could Harm The Moat

  • Failure of R&D Efforts: InterDigital is heavily reliant on its R&D efforts. Failure to develop and patent new technologies can lead to a massive hit on the value of the company.
  • Patent Expiration and Challenges: The expiration or challenge to key patents would substantially reduce the company’s revenue base. There are always lawsuits regarding IP and a small win to a well-funded entity can affect the company adversely.
  • Technological Disruption: New technologies could render existing patents obsolete faster than anticipated. This is a significant risk especially in fast-moving industries like wireless and digital communication.
  • Changes in Licensing Practices: The willingness of companies to engage in licensing or the ability of InterDigital to enforce its patents through litigation can have a direct impact. Given the litigious nature of IP enforcement, that is a serious risk that can affect the company’s revenue base.
  • Economic Downturns: Any negative effects to the global economy will likely lead to reduced sales of products by their customers and subsequently lower licensing revenues.
  • Geopolitical Risks: The business operates across different geopolitical regions, so any issues, like trade tensions, or sanctions, between any countries can also affect the long term financial position of the company.

Recent Concerns/Controversies

  • Lawsuits: A number of court cases are ongoing that affect InterDigital’s licensing. Any significant adverse ruling can have negative impacts for the company’s future revenue. It is very difficult to predict how such cases can evolve and what the company’s strategy may be if their ruling does not go their way. The management has indicated that they are ready for protracted litigation and continue to maintain a very strong position on the cases. They have further stated that they are in the last phases of preparation for 5G trials.
  • Macro Economic Uncertainty: The company is facing some near-term headwinds related to the economic slowdown and high inflation in markets where they do their business, but they are confident that their business will perform well over the long term.
  • Loss of Key Clients: The company is dependent on a small group of clients for its overall revenue. It is a strategic risk that needs to be monitored.

Management’s Thoughts

The management is confident of the company’s business model and believes that they are well positioned for the future, as a leading technology innovator. Management is committed to maintain high profitability, by protecting their patents and focusing on long term value. They also plan to look for new licensing opportunities and also grow its other technology segments.

The management views its diversified client base and the long-term nature of the licensing agreements as strong mitigants. The company is constantly involved in research into newer technologies to ensure that they stay ahead of the curve. And finally they have been engaging in share buybacks, which they feel would add value to shareholders.