Sunday, February 26, 2012

Acacia Research ( Nasdaq - ACTG ) -- Another Acquisition in the Pipeline

Acacia Research (ACTG $41.00) reported Q4 results that were below our expectation.  The company's financial performance is impossible to predict over the short term, though, because it rarely if ever discounts the value of the patent settlements it negotiates.  Acacia does own some patents outright, which the company is free to price any way it wants.  But most of the intellectual property it manages is handled in partnership with the original inventors.  Royalties on those patents entail a fiduciary responsibility to maximize value, eliminating any potential for managing short term results.  In Q4 Acacia generated $20.8 million of revenue, which was well below our estimate.  We thought the company and some of the large corporations it was dealing with might settle up before year end.  By and large, that didn't happen.  Non-GAAP fully taxed income finished at a loss of $.02 a share.  For the year income declined 19% to $.69 a share.

Volume has accelerated so far in 2012.  Acacia indicated that revenue hit $75 million in January alone, fueled by the recent Adaptix acquisition and a series of other settlements.  Further gains appear to be in store as a lot of the patents Acacia picked up in 2010-11 start to be asserted -- it usually takes the company 6-18 months to develop and implement a money making strategy.  Activity in general is increasing, moreover, as more companies become involved with IP licensing.  Patent valuations may have reached a plateau.  But more transactions are being generated per patent, lifting the potential market.

Acacia recently signed a letter of intent to purchase a private company that holds an extensive patent portfolio.  To help finance the deal the company recently issued 6.12 million shares in a private placement at $36.75 apiece, raising $225 million in fresh capital.  The contemplated acquisition is scheduled to be finalized in April.

Our 2012 estimates are essentially unchanged.  We have reduced our earnings estimate by $.15 a share to $1.25 a share to reflect the dilution from the recent stock underwriting.  But our view of revenue, margins, and taxes remains the same as before.  (Note - We use a normal 35% tax rate when calculating estimated earnings.  Acacia still has $100 million in net loss carryforwards, however, so cash outlays in 2012 will be lower.)  A stronger showing could emerge if the proposed acquisition is finalized.  Acacia usually prices new patent portfolios aggressively at first to recoup its cash outlay quickly.  Once the initial investment is retrieved the company then tends to adopt a less conciliatory attitude.  The company's ability and willingness to wait it out often yields significantly higher paydays.  Interestingly, that track record is beginning to persuade infringing companies to settle earlier.  A growing number of deals are being completed without litigation.  Both sides also benefit by avoiding the legal fees involved. 

In 2-3 years fully taxed earnings (excluding non cash stock option expense) could reach $3.00 a share.  At that point Acacia realistically could have another $2.00 a share of potential annual income in the pipeline -- patents the company hadn't yet begun to enforce.  Acacia is the leading independent provider of intellectual property services, moreover.  A growing number of major corporations are just now starting to explore ways of enhancing their own IP portfolios.  Some of that will be done in-house.  But a sizable piece promises to be outsourced.  If that happens Acacia could keep expanding at an above average pace well into the decade.  Our 2-3 year target price remains $100 a share.

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