Friday, July 20, 2012

Acacia Research ( Nasdaq - ACTG ) -- Outlook Becomes Uncertain

Acacia Research (ACTG $35.00) reported Q2 results that were below our expectation.  The company's deal flow continued to accelerate.  It also acquired a substantial inventory of new patents to enforce.  A major settlement with Cisco Systems yielded less money than expected, though.  We had raised our estimates earlier in the year in anticipation of that deal, plus some additional large agreements that are in the pipeline.  In the past Acacia Research licensed virtually all of its patents when it made these so-called structured transactions.  Previous deals were made with Oracle, Microsoft, and Samsung.  This time only a portion of Acacia's portfolio was included, yielding a smaller one time payment.  Even so, earnings came in at $.21 a share on sales of $50.5 million. 

We are maintaining our full year earnings estimate at $1.65 a share (excluding stock option expense).  Margins on Acacia Research's regular business continue to improve as fewer cases are resolved in court, reducing litigation costs.  More revenue is being produced by the company's fully owned patents, as well.  Historically, Acacia Research partnered with small patent holders, dividing the winnings after deducting expenses.  When the company enforces patents that it owns by itself, all the proceeds are retained.  We have reduced our revenue estimate, however, by $25 million to $300 million, to reflect the smaller structured settlement payouts.

The long term outlook remains generally positive.  One reason Acacia Research agreed to its arrangement with Cisco Systems was to establish a business relationship where the two companies would enforce Cisco patents against other corporations.  The details of how that will play out remains to be seen.  But the deal could serve as a template for additional Fortune 500 partnerships. 

Serial infringers like Apple Computer are trying to persuade the U.S. Congress to reduce their liabilities.  The big cell phone maker recently won a surprising court verdict in a case brought by Eastman Kodak, as well.  It remains to be seen if that decision (which also included Nokia) sets a meaningful precedent.  Acacia Research earns a lot of its current income from wireless patents.  If that intellectual property becomes more difficult to enforce income could be affected negatively.

We estimate 2013 income will advance 36% to $2.25 a share.  Above average gains appear achievable well into the decade.  Those figures assume the company's patent inventory has not been impaired by Apple Computer's recent court victory.

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