Friday, January 18, 2013

Buy, Sell, or Hold: InterDigital

It would seem that the near- and mid-term future for a company that offers wireless connectivity solutions and improved bandwidth worldwide would be golden. But blanket assumptions can lead to nasty surprises for investors, so let's take a closer look at why you might want to buy, sell, or hold InterDigital (Nasdaq: IDCC  ) .

Buy
Lots of InterDigital's numbers look quite promising. Its revenue and earnings have been growing by double digits, and their growth rates have been growing, too. Over the past year, revenue grew 33%, and earnings 76%. When earnings grow faster than revenue, it suggests that the company is becoming more efficient, wringing more profit out of each dollar of sales than before.

Meanwhile, those net profit margins are fat, topping 30%, while the stock's forward price-to-earnings (P/E) ratio is just 16, suggesting that it's not wildly overvalued at all.

Sell
On the negative side, InterDigital ranks near the bottom of its industry in terms of research and development (R&D) spending. That's not auspicious, since investments in R&D can lead to new technologies, patents, licensing deals, and profits. Of course, a company can choose to just buy new technology instead, and InterDigital has done a fair amount of that.

Another issue of concern is the arena in which InterDigital competes -- that of technology patents. As my colleague Anders Bylund has pointed out, the system is broken, with many companies (and consumers) hurt when some companies are able to patent algorithms or ideas. Companies such as VirnetX seem to be basing their business models around patent litigation, while others, like Universal Display, are focused on patents, but also spend significantly on R&D and maintain profitable operations. It's useful for investors to distinguish between the two.

Hold
A big reason to consider staying on the fence about InterDigital is that it has expressed interest in putting itself on the block, partially or completely. If such a sale happens, shareholders will see a big chunk of change arrive -- presumably more than $1 billion and potentially several billion.

But there doesn't seem to be a long line of companies bidding for InterDigital. And even if the company is sold, that will leave shareholders with either some money or shares of the acquirer -- whose attractiveness is not yet known. That's not the ugliest proposition. Receiving a chunk of change is nice, and if you get shares of the acquirer, those can always be sold.

Speculation abounds on which company or companies might be interested in InterDigital. Patent-grabbing is of great interest to many. Google and Intel were recently outbid for Nortel Networks' patent portfolio by a group of companies including EMC and Research In Motion.

In the meantime, the company is positioned to profit from patent-licensing deals, which can be announced at any time. But that kind of uncertainty can make it hard to value the company.

The verdict
InterDigital certainly has a lot going for it, but ideally, I'd rather be invested in a company that seems committed to growing and building its business rather than putting itself up for sale. Such a company would have a more unlimited upside.

I'm cautiously bullish on InterDigital's future, but for now, I think I'll steer clear.

If you're in the market for another portfolio candidate in the wireless connectivity field, check out -- for free -- our special report, "The Next Trillion Dollar Revolution," which details a company set to benefit strongly from the mobile revolution.

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