Undervalued Wi-LAN a buying opportunity

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A big part of Wi-LAN Inc.'s business model relies on success in the courtroom – hardly a recipe for predictable revenue.

So when the company lost a couple of big patent infringement cases, its stock was punished for good reason. But it's hard to come up with a scenario by which Wi-LAN is not currently undervalued, according to observers.

"Once you go to trial, it's a crap shoot. And investors got spooked," said Stephen Takacsy, chief investment officer at Lester Asset Management, which is a long-time Wi-LAN shareholder. "But one thing is for sure, it's worth a lot more than it's trading at."

The Ottawa-based company's business is built on a portfolio of 3,000 patents, which it cashes in on through both licensing and litigation. Wi-LAN signs agreements allowing use of its technology by communications and consumer electronics companies, while enforcing its patents through the courts.

Wi-LAN started life in 1992 and became an exemplar of the tech bubble, riding its wireless technology up to an $80 share price in 2000 before plummeting by 90 per cent within the year. In 2006, the company refocused solely on turning its patents into cash flow. Some brand Wi-LAN a "patent troll," for making money off of technology it has no intention of commercializing. But the company is distinct for its high-quality portfolio, much of which it invented itself.

The company's chosen direction requires the favour of the courts, which means its stock price is aligned to the whims of the legal system. This year, Texas juries have not been kind to Wi-LAN. In July, the company lost a lawsuit against a group of device makers over wireless data processing patents. The stock dove by more than 30 per cent. Then in October, jurors decided that Apple Inc. had not illegally used Wi-LAN's communications technology in its devices.

"I thought it was a slam dunk," Mr. Takacsy said. "Even Apple couldn't believe it." Wi-LAN had first launched a wave of lawsuits in 2011 against seven companies. Six of them, including Alcatel-Lucent, Dell Inc., Hewlett-Packard Co., HTC Corp., Novatel Wireless Inc. and Sierra Wireless Inc., settled out of court, a pretty strong indication that the patents were valid, he said.

Apple was the only holdout. The surprise verdict sent a message to investors that even lawsuits with good prospects for victory can't be relied upon. Wi-LAN stock fell to $3.10, its lowest level in three-and-a-half years. It closed Friday at $3.26 in Toronto That may be an overreaction, for a number of reasons.

First, the fight against Apple isn't over. "Since Wi-LAN's patents cover fundamental technology for wireless communications, display technologies and [Internet protocol television], we expect Apple to sign licensing agreements within the next 12 months," Al Nagaraj, an analyst at Industrial Alliance Securities, said in a note. Wi-LAN's technologies are too important to Apple's products to risk prolonged litigation, which could prove far more costly for the device maker than settling, he said.

Alcatel-Lucent and HTC both signed agreements with Wi-LAN a few months after winning in court in a separate lawsuit, Mr. Nagaraj said, reiterating his $7.70 target on the stock.

Secondly, the company is undervalued by almost every measure. At the end of the second quarter, Wi-LAN had no debt and $160-million in cash, or about $1.31 per share. Add in the value of the company's current licensing agreements and you can easily get to $3.50 a share, Mr. Takacsy said. "And that gives zero value to the 3,000 patents they have."

Wi-LAN is trading at about 7.5 times its estimated 2014 earnings, which is less than half the average multiple of the company's peers. Plus, the company has a dividend yield of 4.9 per cent, which is 50 per cent higher than its competitor with the next highest yielding dividend. And Wi-LAN has plenty of cash to further reward shareholders. "We look for at least one dividend increase before year-end," Ralph Garcea, an analyst at Global Maxfin Capital, said in a note putting a "strong buy" recommendation and a $7 (U.S.) target on the company.

Wi-LAN may be a buying opportunity in more ways than one. The company announced last week it was considering a possible sale, arguing that it "does not believe that its current share price accurately reflects its strong balance sheet, the value of its signed license agreements, its business prospects or the residual value of its broad intellectual property portfolio."

At the current valuation, the company is a prime target for a hostile takeover, Mr. Takacsy said. Best to act pre-emptively and try to control the sale process, he said, while distributing some cash to shareholders.

"The legal expenses are going way down and the cash is going to come pouring in from all the new licensing agreements they signed," he said. "They might as well either increase the dividend or pay out a special dividend in the meantime so an acquirer doesn't get the cash on the cheap."