Takeout Possibilities in the Mobile Ecosystem

On the heels of the pending transaction between Hewlett-Packard (HPQ) and Palm (PALM) as well as announced Google (GOOG)-AdMob and Apple (AAPL)-Quattro Wireless, we are left wondering what other players are potential takeover targets for either strategic reasons or opportunistic ones.

Little action in mobile device manufacturers...for now. In our view, we are not likely to see many mobile hardware transactions at least not yet. We say that because in our view the smartphone business is taking on players and we would suspect buyers to be prudent and wait for the dust to settle as entrants both new and old battle it out. We have seen this movie before as it were in the PC space, basic mobile phones and other industries and verticals that had favorable growth prospects only to consolidate amid price competition as candidates jockeyed for market share. Despite the number of vendors entering the smartphone market either in response to the iPhone or because of the ability to utilize Google’s Android, we see price competition and margin pressure ahead as well as eventual consolidation. Longer term as the mobile device markets morphs into the larger connected device market, we question the viability of companies like Nokia (NOK), Research in Motion (RIMM) and others that lack presences in the portable computing market (like the iPad) and in the home (TV, set top box, gaming console and the like). Now we’re not suggesting that companies like Panasonic or Whirlpool (WHR) will merge with the likes of Nokia, Research in Motion or some other mobile device company. We do see those players with assets in all three areas of the connected device market as best positioned for the connected device market.

In our view, some of the obvious candidates are Apple, Google, Microsoft with other contenders as well that either have assets in some but not all of the connected device markets or have a lackluster position in one or more of them. An example of the latter in our minds would be Sony (SNE) which is a top-tier manufacturer of TVs, has a good but not great position in the computing space and a relatively weak position in mobile given Sony-Ericsson’s poor smartphone portfolio thus far.

Could the migration from smartphone to more connected devices spur merger and acquisition activity? It could but in our view the larger deals tend to the tricky ones where strategy and culture may or may not be truly in tune. The last thing a poorly positioned company would need is to become the next AOL-Time Warner as it tries to redefine itself in three verticals, not just one.

M2M and Zigbee on the RF chip side? On the RF semiconductor side, while Texas Instruments (TXN) announced several quarters ago its intent to exit the wireless baseband business, the group remains characterized by a number of players in different categories – application processors, cellular baseband, power amplifiers, switches, Wi-Fi, GPS, Bluetooth and others – from individual offerings to integrated modules. Some, such as Qualcomm (QCOM) play in several areas while other such as Anadigics (ANAD) participate in a more limited fashion. In terms of acquisitions, these have tended to be more nip and tuck as evidenced by Skyworks Solutions (SWKS) purchase of Axiom Microdevices last year and Qualcomm’s acquisition of RF Microdevice’s Bluetooth assets in 2006 as well as other more recent acquisitions including the AMD’s mobile graphic and multimedia assets and Mango Tech Products. While there have been some larger transactions, such as RF Microdevices linking up with Sirenza Microdevices and TriQuint Semiconductor (TQNT) bought ailing WJ Communications, we see the “nip and tuck” strategy continuing in this part of the mobile ecosystem.

With machine to machine (M2M) and embedded solutions catching on, we would not be alarmed to find out buyers are targeting these areas as well as those that have expertise in Zigbee, which targets RF applications that require a low data rate, long battery life, and secure networking. Examples of end markets that could incorporate Zigbee include Consumer Electronics, Energy Management and Efficiency, Health Care, Home Automation, Telecommunication Services, Building Automation and Industrial Automation. Players in the Zigbee and M2M space include Digi International (DGII) and RF Monolithics (RFMI).

What about patents? Earlier this month Nortel (NRTLQ) began soliciting bids for its patent portfolio, which spans more than 4,000 patents and covers several wireless technologies including WCDMA and LTE. Per the financial media, several companies have already expressed interest in the portfolio including RIMM, Mosaid Technologies MSD and Wi-LAN Inc. WIN The last two companies have measureable patent portfolios, 800 and more than 1,900 respectively but with little exposure to LTE. At the same time, others players are likely to want to shore up their LTE position as well.

Per data from the European Telecommunications Standard, Qualcomm has s 22% share of the essential patents for LTE technology, followed by InterDigital (IDCC) with a 13% share and Asian competitors Huawei, Samsung and LG, which hold 11%, 10% and 9%, respectively. To be fair there are more than a few guesstimations as to LTE patent portfolio position. Consider Informa’s view that InterDigital owns 21% of the global LTE patent portfolio followed by Qualcomm with 19%, Huawei at 9%, Samsung at 8% and Nokia, LG and Ericsson (ERIC) each having 7 percent.

As we noted in our March 17, 2010 note, we believe the completion of the Nortel patent sale will have an impact on InterDigital shares. First and foremost the Nortel patent sale will help establish a valuation framework. Second, there is the scarcity factor to consider. In our view, after Nortel’s patents are sold, InterDigital with its shares trading at less than 9x Street consensus earnings and roughly 2x on an enterprise value to 2010 revenue basis becomes a compelling asset even before counting its more than $10 per share in net cash. Who would be interested? The short answer is any one of the players in a weak LTE position or looking to augment its position. In theory this would suggest Qualcomm, Nokia, Huawei and others, including Ericsson, which in 2009 bid and acquired the parts of the Carrier Networks division of Nortel that related to CDMA and LTE technology in North America. What could it be worth? After the recent market pull back, the Think 20/20 IP & Licensing group of companies is currently trading at an average P/E of 21.2x 2010 Street consensus earnings and 3.4x on an enterprise value to 2010 Street consensus revenue. Applying the latter metric suggests a $39 target for IDCC shares before a takeout premium is applied. Utilizing the peer average P/E of 20x derives a far more aggressive price target of $58 per IDCC share. Whether or not IDCC is ever taken out, we would argue that given its LTE patent position as well as the strength of the balance of its patent portfolio, InterDigital shares are undervalued at current levels and we would not be surprised if a well funded, opportunistic player were to try and capitalize on that.