0:00

A quick announcement ahead of the

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multi-day event with David Sendera in

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September. It's going to be a

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business breakdowns and founders collaboration. And

0:10

if there's one thing that you learn

0:12

from studying these businesses, from studying founders,

0:15

just existing in the business community, it's

0:18

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0:21

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the investment community. We're gonna review

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0:32

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0:34

And the event is structured to foster relationships.

0:37

It's gonna be on a private location. The

0:39

only people on site will be attendees of

0:41

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0:43

limited main stage talks. And instead we're

0:45

gonna have a lot of smaller breakouts,

0:48

panels and significant time for one-on-one conversations.

0:51

All of the details can be found

0:53

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0:55

be a link, or you can go

0:57

directly to joincolossus.com/events. And I'll

0:59

leave you with this. I attended David's event in March

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1:03

just yesterday, I was looking at my phone,

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yesterday that I had met for the

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to foster relationships, and

1:18

who knows where these relationships might go over

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time. When you gather these groups

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1:25

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1:29

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1:34

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as a basis for investment division. Welcome

3:21

back to Business Breakdown. Today

3:23

we are diving into Interdigital. Interdigital

3:28

is one of those really interesting businesses

3:30

that sits completely under the radar for

3:32

most investors. If you're unfamiliar

3:34

with the name, join the club. That was

3:36

me prior to this episode. But

3:39

Interdigital has the foundational technology,

3:41

the foundational patented technology, which

3:44

makes mobile phone communication and

3:46

device to device communication possible.

3:50

Everything revolving around 2G, 3G, 4G, 5G,

3:52

the Internet of Things, all of these

3:54

devices in the world that are communicating

3:56

with one another is underpinned

3:59

by Interdigital. technology.

4:01

My guest is Jenny Wallace, co-founder

4:03

of Summit Street Capital Management and

4:06

portfolio manager of the US Equity

4:08

Value Fund. We get into

4:10

the history of Interdigital. This business has been

4:12

around for five decades and always

4:15

focused on this area of technology.

4:17

We talk about their patent portfolio.

4:19

They have 30,000 patents

4:21

and what that means and

4:23

one of the most interesting dynamics about this

4:26

business is that they have to keep that

4:28

strong balance sheet because when you have patents

4:30

and when you have licenses oftentimes

4:32

you need to enforce those patents. So

4:34

there's some interesting dynamics here that actually

4:37

remind me a bit of our episode

4:39

on a line. Two completely

4:41

different businesses but something similar underpinning

4:44

them in terms of the litigious

4:46

nature that you need to have

4:48

when you work around patents. Now

4:50

please enjoy this episode on Interdigital.

4:55

Alright Jenny, I am excited

4:57

to have you here. Excited to

4:59

cover Interdigital, maybe not the sexiest

5:02

or most exciting name from the

5:05

outside but maybe try to

5:07

bring it to life a little bit.

5:09

It's a company with five decades of

5:11

history and it's still small in

5:14

many ways but the history is there and

5:16

that really stood out to me. I thought maybe we could

5:18

just start very high level off the

5:21

top describing what Interdigital

5:23

actually does. It is

5:25

one of the most important companies

5:28

that you have never heard of. Interdigital

5:30

develops the

5:33

underpinning technology by

5:35

which all wireless communication

5:38

using our phones and other

5:40

devices is possible. Since

5:43

the company's founding the

5:45

engineers at Interdigital

5:47

have led the development of a

5:49

wide range of innovations that

5:52

are used in digital cellular and

5:54

wireless starting with the original 2G

5:56

cell phone in the mid to late

5:58

90s. 3G, 4G,

6:00

5G, and today even looking forward

6:03

to 6G. Also,

6:05

your consumer electronics that

6:07

speak to one another, whether it's your

6:09

connected dishwasher or your

6:12

smart TV, the

6:14

Internet of Things, and even

6:16

automobiles. Inter-digital technology

6:19

has actually been licensed to more than 7

6:22

billion devices over the last decade,

6:25

and the company is one

6:27

of the largest pure research

6:29

and development and licensing companies

6:31

in the world. I don't know what

6:34

the world population is today, but 7 billion

6:36

devices basically got 100%

6:38

of the population of the world understanding

6:40

there's some numbers to finagle around there.

6:44

Today our cell phones obviously have

6:46

a lot of different things going

6:48

on beyond the communications. It sounds

6:50

like what inter-digital is doing is

6:52

very much revolving around communication between

6:54

devices. Is that technology

6:56

working with satellites? Can you break that down

6:58

a little bit just in terms of what's

7:01

actually going on with our technology? What

7:04

makes inter-digital sort of hard to understand,

7:06

slightly unsexy as you point out, is

7:09

that its patents help with

7:12

connectivity because at the end

7:14

of the day cellular connectivity

7:17

is simply the utilization of

7:19

electromagnetic spectrum. Governments

7:23

own essentially the spectrum and

7:25

auction off different

7:28

bandwidths of spectrum

7:30

to wireless carriers. But

7:33

kind of like oceanfront property in

7:35

Florida, some of it's nicer than others,

7:37

so different spectrums may be more efficient

7:40

or better for different use cases, and

7:42

there's a finite amount of it. To

7:46

the finite amount of differentiated

7:48

quality spectrum and

7:51

of course an ever increasing

7:53

set of technological demands for

7:55

using this spectrum, it's

7:58

really important to have

8:01

standards and efficiency

8:03

at the forefront of

8:06

how voice and data

8:08

and video is transmitted over

8:10

the spectrum. So, for example,

8:12

in 2009, the United States

8:14

made a transition from analog,

8:16

you know, the U.S.H. signals

8:19

to digital TV. This

8:21

freed up the 700 megahertz

8:24

spectrum, which is considered very

8:26

valuable because it's low frequency

8:28

and as a result allows

8:30

better transmission of cell signals,

8:33

particularly in less populated areas.

8:35

At the end of the day, what interdigital

8:38

engineers develop is

8:40

a digital pattern of zeros

8:43

and ones that efficiently

8:45

transmits data in

8:47

this electromagnetic spectrum in

8:49

a standardized way so

8:52

that your phone can communicate

8:54

to the wireless towers. You

8:56

may have AT&T and you

8:59

are in a location where there is

9:01

a Verizon cell tower. Because of

9:03

the standardized nature of

9:05

data transmission, your phone can

9:08

connect to the wireless tower of

9:10

a different carrier and communicate

9:13

again then off to another phone that

9:15

may have a totally different carrier. So,

9:18

what is it that makes a

9:20

technology get chosen as

9:22

part of a standard? Well, what

9:25

it really is, is the

9:27

efficiency, the effectiveness of the

9:29

division or the utilization of

9:33

the spectrum. And then once

9:36

in the standard, it

9:38

is simply a pattern of zeros and ones.

9:41

If we can go back in time, five decades,

9:44

this business has been around, it

9:46

was named interdigital then, what foresight they

9:48

add into the future in terms of

9:50

the communications that would happen. Bring

9:53

us back in time in terms of what this

9:55

company looked like maybe at the beginning and whether

9:57

there were key players and the milestones that they

9:59

had. hit because the market that they were

10:01

operating in then looks a lot different than what

10:03

they're operating in now. So Interdigital

10:06

was actually incorporated in 1972 under

10:08

the name International Mobile Machines, which

10:13

is also a forward-looking name.

10:16

So as you mentioned, it's a small company. It has

10:18

only about 400 employees.

10:21

It has a $3 billion market

10:23

capitalization, but it

10:25

plays this, as I mentioned, indispensable

10:28

role in the smartphone

10:30

market, which is a half a

10:32

trillion dollar market by most estimates.

10:35

The other players in this space are people

10:37

you might think of household

10:39

names like Qualcomm, Ericsson,

10:41

Nokia, but these companies

10:43

interestingly all have market caps somewhere between

10:46

six and 60 times

10:48

that of Interdigital. The

10:51

founder of Interdigital is

10:53

a man by the name of Sherwin Selleggson,

10:57

and he was really a true visionary. He actually

10:59

dropped out of high school and made a fortune

11:01

in the stock market in the

11:03

60s while he was still in his 20s. He

11:06

was a guy that remained passionate about stocks,

11:09

but he also likes being at the

11:11

Jersey Shore with his family. What

11:13

he wanted was access to

11:15

live information about news and

11:17

stock quotes and to be able to

11:19

communicate with his broker without ever leaving

11:21

the beach. This really inspired

11:23

Selleggson to develop a

11:25

portable data machine, and that was

11:28

the origin concept, if you will,

11:30

of Interdigital. Obviously, his

11:32

vision took many years to

11:34

come to fruition, but in 1976,

11:36

during the United States

11:40

Bicentennial celebrations, the

11:43

company actually demonstrated the

11:45

first wireless telephone ever

11:48

and chose to demonstrate it in

11:50

Franklin Park in Philadelphia, which

11:53

is the same exact place

11:55

that Alexander Graham Bell made

11:57

his first demonstration of the wired

11:59

phone. phone 100 years prior.

12:02

So there is a deep history of

12:05

innovative communication at

12:08

Interdigital. But interestingly,

12:11

obviously a terrific and great

12:13

accomplishment. It still took this

12:15

company a while to find its footing.

12:17

They had developed digital

12:20

cell technology, but there

12:22

was at the time no market for it.

12:25

In the mid 80s, this company pivoted to

12:28

what is known today as fixed

12:32

wireless or wireless local loop.

12:34

And they built product that they sold to the

12:37

phone companies, basically to

12:39

provide telephone services to

12:41

rural areas. They called it

12:44

the ultra phone. And communication

12:46

was basically possible through a system

12:48

of radios. They were

12:51

called cluster boxes. And they

12:53

had antenna and they transmitted telephone

12:55

signals to a taller antenna miles

12:57

away that then transmitted the signal

12:59

into what you would think of

13:02

at the time as the wired

13:04

telephone system. What this

13:07

allowed was voice communication to

13:09

and from rural areas without

13:12

incurring what had been

13:14

the holdup, which is this sort of prohibitive

13:17

cost of laying the proverbial

13:19

last mile of copper that

13:22

had previously been required. The

13:24

company's motto became dial

13:26

tone anytime, anywhere.

13:28

And while obviously

13:31

it seems like a given today in a world

13:34

of ubiquitous cell phones,

13:36

this was actually a revolutionary innovation

13:38

at the time. If

13:41

there's a way that you can bring to

13:43

life the capabilities that they had

13:45

that were allowing them to continue to sell

13:47

into this market, it seems like a theme

13:49

here that for decades and decades, they've

13:51

been providing technology to this market.

13:54

What were some of the ways in terms of real

13:56

world application or stories that you can share in terms

13:58

of how it was happening? A

14:01

great story that highlights Interdigital's unique

14:03

capabilities as an early

14:05

developer of secure digital wireless harkens

14:08

back to 1990 when

14:10

an Avianca airline flight from Bogota

14:13

to New York encountered

14:15

bad weather and tragically ran

14:17

out of fuel. The plane

14:19

actually ended up crashing in a remote

14:21

location of Long Island which

14:23

had no telephone service. As

14:26

the first responders arrived, they

14:28

realized that this plane had

14:30

been loaded with diamonds and

14:32

drugs that they found

14:34

scattered over a wide radius of

14:37

the crash site that while remote,

14:39

enough not to have phone service, was

14:41

also less than 50 miles from the

14:43

huge population center of Manhattan. Under

14:46

ordinary circumstances, first responders would

14:48

have communicated using radios, but

14:51

radio communication wasn't secure and

14:54

they absolutely did not want the public

14:56

to know about the diamonds and the

14:58

drugs. So a secure means

15:00

of communication for this remote location was

15:02

needed and there were other

15:04

companies out there building analog, but

15:06

analog could certainly be hacked with a scanner

15:09

as we have seen over history. Interdigital

15:12

was already well known to several

15:14

government organizations as the only company

15:17

developing digital communication. The

15:19

national communication system called Interdigital to see if

15:21

they could help and the company

15:23

was able to get a secure communication system

15:26

up and running almost immediately because

15:28

it had basically already been building

15:30

these mobile base stations and

15:33

for the prior eight years have been providing

15:36

secure communication systems to the

15:38

White House so that they could

15:40

link one end of the Reagan

15:42

Ranch to the other while

15:44

the president was out horseback riding. I

15:47

love these really unique use cases that

15:49

are coming out of this, some

15:51

of the better stories that we've heard and I

15:53

feel like I need to look up some history

15:55

on that diamond drug crash. It's

15:58

clear that there's something. something

16:00

differentiated into technology, but at the

16:02

same time, it was eventually being

16:04

adopted by the largest players in

16:07

the space. You've referenced where

16:09

Nokia, it sounds like they were a competitor. I

16:11

imagine they could have been a customer as well.

16:14

Did the evolution of the business really take

16:16

off once mobile phones rose to

16:18

dominance in this 21st century era? Was

16:22

there a big shift then? There was

16:24

a big shift and actually a big

16:26

turning point in Interdigital's business model. Interdigital

16:28

was then and frankly still is small,

16:31

but its intellectual presence has been

16:34

quite significant in the

16:36

communications industry. So much so that you

16:38

talked about Nokia. In the

16:40

late 90s, Nokia was the world

16:42

leader in cell phone communications. They had

16:45

40 plus percent market share, but

16:47

they reached out to Interdigital

16:50

to help develop technology for

16:52

TDD, which is time division duplexing,

16:54

which is a way of splitting

16:57

bandwidth, but to develop

16:59

the TDD standard of

17:02

3G communication and to figure out

17:04

a way to make belief from 2G

17:06

to 3G commercially viable. This

17:09

was a really important turning point

17:11

for Interdigital and it went

17:14

at that moment from being a

17:16

creator of these proprietary

17:18

technologies, the mobile base station or

17:20

something that they sell to the

17:22

phone company, to a developer

17:24

of what's called today standards-based

17:27

technology. So what that means

17:29

is instead of developing and

17:31

selling products themselves, the

17:33

company was developing and

17:36

patenting processes by

17:38

which all wireless products would communicate.

17:40

And the basic importance of standardized

17:43

technology is back to this idea

17:45

of interoperability. I think we've

17:47

seen many examples whether in

17:50

credit cases like the FICO

17:52

score or even the 80-20

17:54

rule with underwriting, mortgages,

17:57

you can name industries, standards,

17:59

and so standardization of the logistics box

18:01

and how that started to work with

18:03

Intermodal, how much it unlocks an industry

18:05

and is a complete game changer. You

18:08

reference that can lead to commoditization

18:11

of so many different people are using

18:13

it. Here it seems like patents are

18:15

very key in the process. In

18:17

the center of this all, it seems like the

18:19

main asset is your engineering

18:22

and technological capabilities and right

18:24

next to it is the

18:26

patenting of those capabilities. Is

18:28

that a fair representation? Yes.

18:31

Interdigital has around 400 employees. Half

18:35

of them are engineers and

18:37

nearly all of them have advanced degrees.

18:40

What's interesting about these standard processes

18:42

is that there's actually a committee

18:45

of engineers that comes

18:47

together to decide what technology will

18:50

be in the standard. All

18:52

people may develop a method by

18:54

which some type of

18:57

communication can occur. The

19:00

engineers on the standard committee come

19:03

together and they debate,

19:06

promote, argue and

19:08

decide what are the best

19:10

processes, the best patents to

19:13

bring into the process. What's

19:16

interesting is Interdigital of their

19:18

200 engineers

19:21

has leadership positions

19:24

on 100 different

19:27

important standards committees. Technology

19:31

has always been and continues to

19:33

be the DNA of this company,

19:35

always looking at what's next. To

19:39

have that kind of a presence, not just

19:41

on the committee but to be in

19:43

a leadership position is really

19:45

important. First, it's a good indicator that

19:47

the Interdigital engineers are among the best

19:49

of the best. Being

19:51

given a leadership position certainly means that

19:54

your engineers have the respect of

19:56

their peers but it also

19:58

puts Interdigital in a position. to

20:00

advocate for its technology.

20:03

Most of the other licensing

20:06

and patent developing companies

20:09

are also manufacturers of

20:12

devices and product one way

20:14

or another. Interdigital is a

20:16

pure research company so that gives

20:19

it this interesting non-biased image

20:21

and ability to be

20:24

perceived not as a competitor by

20:26

anybody. Independently without that

20:29

same conflict of interest. When

20:31

they are thinking about the various

20:33

technologies that get incorporated into a

20:35

new standard or various patents I

20:38

think you referenced in that previous

20:40

question, is it ultimately just coming

20:42

down to efficiency and

20:45

size requirements for certain technologies to be

20:47

mixed together? I'm sure there's interoperability between

20:50

the different technologies and how that's going

20:52

to work. Is there anything else that

20:54

goes into that decision-making? I when I

20:56

was first looking at this assumed one

20:58

patent one technology for this use case

21:00

never really thinking that you're ultimately combining

21:03

a bunch of these together. Well you

21:05

are but the other interesting thing is

21:07

the evergreen nature of the patent portfolio.

21:10

You might have a 5G phone but

21:12

you can call someone with a 2G

21:14

phone and speak. All of

21:16

the patents and the

21:18

communication mechanisms in

21:21

the most sophisticated phones have

21:24

to have the ability to work reverse

21:27

to less sophisticated phones and that's

21:29

really interesting because what that

21:31

does for Interdigital is it creates

21:35

almost an evergreen patent

21:38

library but that doesn't mean

21:40

they're not looking forward. Over the last six

21:42

years its patent portfolio has grown by 60%. Today

21:46

this company holds 30,000 patents across wireless

21:50

video DTV. Interdigital

21:52

normally issues or

21:54

receives new patents every day

21:57

and 90% of its patents are

21:59

basically developed. in-house? I

22:02

was wondering about that 30,000 number.

22:04

I saw it and it seemed impressive but

22:06

I stepped back and didn't really have context for what it meant. I

22:08

think they grew from 19,000 to 30,000. You mentioned

22:11

the percentage growth which is

22:14

an eye-catching number but if

22:16

you told me there's four or five patents

22:19

that actually drive 90% of

22:21

revenues that would be one thing and

22:23

then the patent portfolio is maybe just

22:25

more vanity. Can you mention anything just

22:27

about those 30,000 or a

22:29

large percentage of them being used? How do

22:31

you view it just as an investor? Is

22:33

that a number that you want to see

22:35

consistently growing? Does it carry much meaning besides

22:38

what you mentioned before? They're getting new patents

22:40

every day. There's clearly a lot of engineering

22:42

work going on. If they were

22:44

to miss out in certain

22:46

standards, you would start to wonder

22:48

it's not just do they have the patents, are they

22:50

getting new patents but are they the best patents? Are

22:52

they the ones that will be used? That

22:55

is absolutely what's critical. There's

22:57

a cost every single year to sustaining

23:00

an old patent. From

23:03

an inter-digital standpoint, those 30,000 patents

23:05

are not free. Once you get a

23:08

patent, you still need to pay to

23:10

maintain that patent. As an investor, we're

23:12

interested in how does all of this

23:15

innovation lead to

23:17

profits. Since the 90s, as

23:20

I said, their business model has been to

23:22

develop these technologies on which it then secures

23:24

a patent and then a license to device

23:26

manufacturers who pay

23:28

inter-digital to use the

23:30

technology. Its customers include Samsung, who's

23:32

been a customer since 1995, Apple,

23:37

Xiaomi, Lenovo, LG,

23:40

Panasonic, Sony, and even

23:42

Amazon and consumer electronics. Some

23:46

of the auto companies like Toyota. What's

23:48

interesting from a business standpoint is

23:50

that about 90% of

23:52

its license agreements are on a fixed

23:55

price basis. It doesn't matter

23:57

if smartphone purchase are

23:59

going up. going down. And

24:01

in fact, Interdigital technology

24:03

today is in literally every

24:06

single smartphone. So in

24:08

2023, there were over a billion

24:10

sold. But also, of course, as

24:12

I mentioned, all of the older wireless

24:15

standards. That said, from

24:17

a business standpoint, only 50% of

24:20

the smartphones are paying to

24:22

use Interdigital's patents through license agreements.

24:24

The other half are

24:27

using Interdigital's technology without paying. Can

24:29

you go into that a little bit more? So

24:32

at this point, the vast majority

24:34

of non-payers are manufacturers that produce

24:36

and sell devices in the Chinese

24:38

and to a lesser extent,

24:40

the African markets. They include companies

24:43

like Lenovo, OPPO, Vivo,

24:47

and a smaller company called Trangin. To

24:50

say it delicately, these markets have

24:52

historically had a different set of

24:54

business practices around the use of

24:57

and payment for intellectual property.

25:00

Historically, it's been tough to

25:02

break through those business

25:04

practices and enforce fair

25:07

compensation. The good news is

25:09

that many of these companies are now

25:11

exporting their devices and selling into global

25:13

markets. And as

25:15

such, they are now

25:17

subjected to globally accepted

25:20

business practices. By and

25:22

large, Interdigital does come to

25:24

agreements with its customers through

25:27

bilateral negotiations. However,

25:29

occasionally, it is forced to

25:31

litigate. And the company has a

25:34

very strong track record in litigation.

25:36

Recently, Interdigital was awarded an injunction

25:38

against Lenovo in the German courts.

25:40

And the courts had some strong

25:43

words for Lenovo and for their

25:45

behavior. And Interdigital

25:47

also received a positive ruling from

25:49

courts in Germany and India against

25:52

OPPO. So they are making

25:54

progress, but it does bring up

25:57

a very important point about

25:59

the Interdigital balance sheet. Interdigital

26:01

has a very strong balance sheet. Today

26:03

has over a billion dollars in cash,

26:05

which is a lot for a $3

26:07

billion total market cap company. But

26:10

it's critical because as a

26:12

small company negotiating and potentially

26:14

litigating with much larger companies,

26:17

we view this cash as

26:19

sort of an essential competitive requirement.

26:22

The threat of litigation by a

26:24

small company is not very concerning

26:27

if you're Apple and the small

26:29

company doesn't have the financial ability to back

26:31

it up. From an investor standpoint,

26:33

somebody might from the outside look and say,

26:35

wow, they have all this cash, we can

26:37

deploy it to give it to shareholders. We

26:40

actually view a good portion of that cash

26:42

as necessary for the company to hold.

26:45

Apple, for example, the second largest company

26:47

in the world is a key customer and

26:50

interestingly has been since the very

26:52

first iPhone. But when we look

26:54

at the value of the

26:57

patents, as you asked earlier,

26:59

Interdigital renewed its license agreement

27:01

with Apple in 2022. Seven-year

27:03

deal valued at just under a billion

27:06

dollars, so that's over $130 million a year

27:08

at importantly a 15% price increase versus the expiring

27:16

agreement. And that

27:18

previous agreement was it in a similar seven-year

27:20

context? Most of these agreements

27:22

are in long-term contracts. So if

27:25

you think about Apple shipped

27:27

probably $225 million

27:29

smartphones in 2022, 60

27:32

cents of the cost of every iPhone

27:35

goes to Interdigital.

27:38

Before we get too far away from the

27:40

patent and litigation point, when you look back

27:42

in history, were there major

27:45

litigations that took place that

27:47

solidified Interdigital or

27:50

they won and

27:52

showed that they are willing to go

27:54

to bat? Because to your point, that

27:56

50% number is a staggering number just

27:58

in terms of the those that are not paying

28:01

to use the technology. We've followed

28:03

and invested in Interdigital for a

28:05

long time. And a

28:07

long time ago, Interdigital was

28:10

spewed negatively in the marketplace

28:12

by anyone who knew them as

28:15

more of a patent troll than an

28:17

innovator. And when we started

28:19

to look at the company, we realized that

28:21

it was actually an innovator developing new

28:24

technologies, securing patents, not just

28:26

going out to buy other

28:29

patents that existed. There was a

28:31

case that drove

28:33

home. But what's become

28:36

increasingly more important

28:39

is that if you look at the competitive

28:41

landscape, it's typical for an

28:43

industry standard to have multiple competitors, like

28:45

5G. There are more than 130

28:47

companies worldwide that

28:50

hold 5G patents and contribute to

28:53

the standard. But the top 10,

28:55

which include Qualcomm, Samsung, and

28:57

Interdigital, account for more than

29:00

three quarters of the 5G

29:02

patent families. Over time, what's

29:04

become clear is that Interdigital is not

29:06

fighting this battle alone. We

29:09

can shift back to the revenue point

29:12

on an agreement with the likes of

29:14

Apple. You see the seven-year

29:16

renewal 15% higher. Comparing

29:19

that to what has happened to Apple

29:21

smartphone sales over that same period, it

29:24

is an increasingly small

29:26

percentage of their sales. From

29:28

your perspective, the upfront

29:31

fixed fee could

29:33

certainly benefit if we're to

29:35

see the mobile market decline. But

29:37

it seems like it would have been a

29:39

net negative in that growth of the market

29:41

where you had so many more units being

29:43

sold. I'm just curious just in

29:46

terms of the fee, the contract structure, if

29:48

there's conversation around that ever changing, if you think

29:51

about the right model, it does stand out to

29:53

me where you have this period of time where

29:55

the market is growing substantially. They might not be

29:57

able to get a meaningful percentage.

30:00

back growth? So I

30:02

think any negotiated outcome,

30:04

if it's a good agreement,

30:06

will reflect the business preferences

30:08

of the parties in the

30:11

negotiation. It turns out that

30:13

for various reasons, device

30:15

manufacturers tend to prefer fixed pricing

30:17

models. It gives them a level

30:19

of certainty and Interdigital,

30:22

quite frankly, as a small company. So

30:24

if they were to have

30:28

variable agreements,

30:31

they would then be in a

30:33

position of auditing sales, auditing unit

30:35

sales, and doing sort of royalty

30:37

audits on their customers. What

30:40

that would do is create sort of an administrative

30:43

nightmare and be sort of

30:45

an adversarial relationship with their

30:48

key partners. So they have

30:50

almost exclusively agreed to fix

30:52

price. It's also really much

30:55

easier for Interdigital to run

30:57

its business thinking forward. What

31:00

are we investing for R&D? What are we

31:02

likely to spend on our

31:04

patents and potential litigation? And

31:06

then what is our revenue going to look like? So

31:09

in many ways, we

31:12

think a better model than a

31:14

variable price model would be. But there's

31:17

a trade-off, right? And there's a risk on both sides.

31:20

Interdigital is also very secretive

31:22

about its contracts, obviously

31:25

for competitive reasons. The

31:27

Apple contract is public, and

31:30

if you were to look at a $500 smartphone that has both

31:33

3G, 4G, as well as wireless

31:36

and HEVC, which is

31:38

the video technology, Interdigital probably earns $1.15

31:40

on a fully loaded $500 smartphone. Over

31:47

the last 20 to 22, they probably

31:49

renewed 99% of their recurring revenue.

31:56

They signed 30 new licenses over

31:58

the last three years. with a

32:00

contract value of two and a half billion

32:03

dollars. They had this turning point.

32:05

They really needed to fight to

32:08

get recognition for

32:10

their standards. And

32:12

now they have moved almost to a

32:14

new phase where their standards

32:16

and their engineers are

32:19

not just world class, but known in

32:21

the industry to be world class. An

32:24

important part of Interdigital today is

32:26

the management team. The

32:28

CEO is a guy by the name of

32:30

Liren Chin who came to Interdigital in 2021

32:33

from Qualcomm. He

32:36

at Qualcomm was the head of

32:38

licensing and he has been a

32:41

big part of the spark

32:44

that has helped Interdigital

32:46

renew existing licenses, advocate

32:49

for its technology and sign many

32:51

new licenses. At the

32:53

same time, he's also enhanced the

32:56

shareholder friendliness of the

32:58

capital allocation. As I

33:00

mentioned, there was a period where

33:02

in its history of being a

33:04

public company where Interdigital was very

33:06

misunderstood. Liren has an

33:09

MBA, a law degree, and

33:11

I think himself has personally 28

33:13

or so patents in the

33:17

US and over 100 worldwide. He

33:20

really has focused on improving

33:23

not just the shareholder friendly

33:26

aspect of the capital allocation approach,

33:29

but also communicating better

33:32

with shareholders and working

33:34

to make this a company that can be

33:36

more easily understood. It's one of those

33:39

swords that can swing in both

33:41

directions where management teams, you

33:43

want them focused on the business, but

33:45

some ability to tell what is a

33:47

complicated story is useful and

33:50

certainly when that extends into the

33:52

industry, as you mentioned, having

33:54

that application being on so many different

33:56

committees, I think for something like this,

33:59

it seems incredible. important. One

34:01

thing I wanted to touch on was his

34:03

background being head of licensing at Qualcomm. Seems

34:06

like that backlog number is quite big

34:08

just in terms of contract value. You

34:11

mentioned there's some volatility in the revenue

34:13

stream or in the earning stream for

34:15

the business. What drives that with such

34:17

a high retention rate and visibility theoretically

34:19

in the contract value? Revenue

34:21

today, if you just think about

34:23

interdigital, is basically divided 85% smartphones,

34:27

15% consumer

34:29

electronics and IoT and

34:31

auto. That will change

34:34

over time within the existing space

34:37

CE and IoT are growing quickly. It'll

34:39

probably be like a 75-25 split

34:42

in the next year or two. But what

34:44

makes interdigital tough

34:47

to analyze from the outside

34:49

if you don't really delve down is

34:52

this notion of recurring revenue

34:55

versus one-time payments.

34:58

Every new license includes

35:01

an agreement that we will

35:03

pay you X dollars on

35:06

a go-forward basis and

35:08

a recognition that we

35:10

have been using your technology for

35:13

some period of time either before

35:15

we've signed an agreement or between an expiration

35:17

of an old agreement and a new agreement

35:20

where we agree to a catch-up

35:22

payment. That catch-up

35:24

payment essentially carries a hundred

35:26

percent gross margin but

35:28

both the timing amount etc.

35:31

are uncertain. Even sophisticated

35:33

people on Wall Street on

35:35

the sell side seem to have a hard time

35:38

modeling because the revenue

35:40

you have the recurring nature and then you get

35:43

these lumpy 100% gross

35:45

margin payment. Your revenue starts to

35:48

look volatile and is and

35:50

your profitability looks volatile

35:52

so it could raise a

35:54

question. For example, last

35:56

year there was a large

35:58

payment from Lenovo. That won't

36:00

happen this year there may be a payment from

36:02

samsung still to be determined but

36:04

in the first quarter of twenty three inter

36:07

digital had an operating margin. Nearly

36:10

sixty percent and a net margin of

36:12

fifty one percent that will not repeat

36:15

it is not a function of inter

36:17

digital being declining growth

36:19

company or anything like that.

36:22

But it is a function of how

36:25

they are paid unique model

36:27

in that sense what is the

36:29

margin profile of the traditional business

36:32

putting aside the one time payments.

36:35

The margin profile is actually quite

36:37

attractive on a recurring revenue basis

36:39

from a current base of recurring revenue

36:42

of about four hundred million. We

36:44

expect the next year to the company

36:46

as clear line of sight to recurring

36:48

revenue of around six fifty.

36:51

We expect the company to earn

36:53

a gap even margin of more

36:55

than forty percent on that that

36:57

includes share based comp and anything

37:00

else that might otherwise be left out of

37:02

an adjusted number on the

37:04

gnar view the most punitive look

37:06

this is a very very profitable

37:09

company. Is that always been in

37:11

that range of the forty percent even margin

37:13

has there been a massive

37:15

shift over time. The way

37:17

to understand the margin profile of

37:20

inter digital is to acknowledge

37:22

yes there is some operating leverage which i

37:25

guess is good and bad in any

37:27

company we do expect the company

37:29

to become more profitable as revenue grows

37:32

but the ongoing business has

37:34

a fairly stable margin profile. The

37:36

exception if you were to look

37:39

back is for a three year

37:41

period from twenty eighteen to twenty

37:43

twenty margins were

37:46

lower but they were lower

37:48

because during that period the

37:50

company made a basically two

37:52

part acquisition of technicolor

37:54

they bought the patents and then they

37:56

bought the people the engineers and

37:59

so it was during. During that period

38:01

of time, prior to the

38:03

pandemic, that Intradigital was really

38:05

integrating the technology

38:08

A and B. Then in the early

38:11

days of the pandemic, there were

38:13

some lines of business, the Technicolor

38:15

operated in that were essentially unprofitable,

38:18

that Interdigital moved out of those

38:20

lines of business. People

38:23

snicker when you talk about

38:25

non-recurring charges, but in Interdigital's

38:28

case, this career

38:30

period when the company appears to

38:32

have been less profitable and

38:34

had a less attractive margin profile,

38:36

it is actually

38:38

a genuine one-time event. And

38:41

in fact, laid the groundwork for

38:44

much of what Interdigital

38:46

looks to now, which

38:49

is the video coding and

38:51

decoding technology. On the

38:54

R&D, which I am sure is

38:56

just a big chunk of the

38:58

focus and one of the

39:00

key expense lines, do they manage

39:02

that as a percentage of revenue? Does

39:06

it swing massively? Is

39:08

there some fixed element to it? How do you

39:10

frame that? Because it seems to

39:12

be such a key piece of this particular story.

39:15

The company invests about $200

39:17

million a year into R&D

39:19

and spends another $80 million a

39:22

year on licensing and litigation. And

39:25

that's, as I said, just whatever it

39:27

costs to keep patents live,

39:29

to issue and get credit for new

39:31

patents. The rest is basically return

39:33

to shareholders. It's a capital-light

39:35

business. CapEx is basically less than

39:38

1% of revenue. It's

39:41

very interesting just in terms of how light

39:43

the CapEx is. On

39:46

the return of capital to

39:48

shareholders, the cash balance

39:51

that you mentioned of a billion dollars

39:53

being necessary both from a signal standpoint

39:55

but also if it needs to be

39:57

put to use, does that

39:59

number... stay capped at $1

40:01

billion where in theory as they generate

40:03

more cash, less has to be swept

40:06

across to stay on the balance sheet

40:08

and more can be distributed to shareholders.

40:11

That's certainly a possibility. Over

40:13

the last probably 10 years, the company

40:15

has reduced shares outstanding by like 50% and

40:19

shows no sign of slowing down. The

40:21

company pays a dividend. It's not huge. It's

40:24

like a one and a half percent dividend yield. I

40:27

look at the one-time payments

40:30

as upside to the profitability of

40:33

the business, timing and

40:35

amounts uncertain but upside. I'm happy to have

40:37

uncertainty as long as I know it's good.

40:40

Free call option in some way. We

40:42

have not even really begun to talk about

40:44

the true free call at Interdigital which is

40:47

streaming and video. Streaming

40:50

and cloud is considered another half

40:52

a trillion market that

40:54

I would say is fully greenfield. Almost

40:57

no one is paying for it. Yet

41:01

6G will not come to fruition for probably

41:03

another 8 to 10 years. Video

41:07

compression and decompression was

41:09

created years ago. Almost

41:12

every streaming company out there, Netflix,

41:15

Amazon, you name it, are

41:17

using standard video compression

41:20

technology. That's what

41:22

makes it possible for you to have

41:24

these downloads that are fast and viewing

41:27

experiences that are not glitchy or

41:29

lagged. Interdigital is

41:31

a contributor to this standard.

41:33

It has patents yet

41:36

almost all of the streaming companies

41:38

are using the technology without paying

41:40

for it. I mentioned sometimes it's

41:42

nice to have strong friends. Technology

41:45

innovators are working hard to get

41:47

paid fully. For example, last year

41:49

Nokia sued Amazon for prime video

41:51

use. Broadcom sued Netflix

41:54

and have received positive rulings

41:57

that there is infringement while

41:59

they're being paid today, it's

42:02

inconceivable that they will not

42:04

eventually be paid. Looking

42:07

forward, there's this market

42:09

size of half a trillion dollars

42:12

with the potential for

42:15

significant one-time payments. And

42:19

if Interdigital has any kind

42:21

of similar penetration, you

42:24

could imagine essentially almost a doubling

42:26

of the recurring revenue. Not tomorrow,

42:29

these things take time, but it's

42:31

interesting to see a company that has

42:35

highly profitable existing business, the potential

42:37

for free upside,

42:39

and then this whole free

42:41

call. But what's interesting about the

42:44

free call is you're not waiting

42:46

for proof of concept. This technology

42:48

is used by everybody

42:50

today. It is simply a matter

42:52

of getting paid for it. You

42:55

mentioned before that the change in

42:57

management has resulted in some better communication

42:59

with investors. I'm wondering if

43:02

they communicate around this topic at all,

43:04

how they go about enforcing

43:07

that patent usage, whether

43:09

it's a wait for some

43:11

of these large peers to have success

43:14

in court and use that as precedent,

43:16

whether they're already on the aggressive

43:19

attack and trying to negotiate privately.

43:21

Is there any sense

43:23

that they are making progress

43:25

there or anything that you think

43:28

you can track to have some line

43:30

of sight into when that may actually

43:32

happen? When I look at

43:35

what the management team is focusing on

43:37

now, the low-hanging fruit

43:39

is getting paid by the 50%

43:43

of the smartphone market not using. And

43:46

the further out fruit, at least right

43:48

now, you're seeing the no-kias and broad

43:50

coms of the world starting to fight

43:52

those battles, is getting

43:55

paid for the standards that

43:57

exist for the high-definition video

43:59

up-to-date. download, download, and then from an

44:01

engineering standpoint, the engineers are looking to

44:04

6G because if you think about it, the video

44:06

has already been created, that

44:08

technology. The duration

44:10

of these patents, it

44:12

sounds like there's usage of

44:15

this technology. Do they expire

44:17

where it's a risk of

44:19

major cliffs of revenue drop-off

44:22

at certain periods of time? That's a

44:24

great question. Patents are protected

44:26

in the Constitution but they

44:29

are protected for a limited period of time.

44:31

So all patents expire after 20

44:33

years. But unlike a pharma

44:35

company that might have

44:37

a patent cliff because of

44:40

a specific drug on

44:43

which a massive amount of its revenues

44:45

may depend, Interdigital is always

44:47

innovating. As I mentioned, they receive new

44:49

patents on a daily basis. They

44:52

have already been working and have

44:54

patents on 6G which likely will

44:56

not come to fruition for five

44:58

or even ten years. So yes,

45:01

patents expire, they renew

45:03

whenever is needed and

45:06

when they expire, usually it's

45:08

just so old at that point that

45:10

the technology would remain let's say in

45:13

a 2G phone but there's essentially

45:15

nobody selling 2G phones. So

45:18

they're not really losing anything because

45:20

they've gained the next from 2G

45:22

to 3G, 3G to 4G to

45:24

5G and then eventually to 6G.

45:27

So unlike a more typical kind of

45:30

patent business like a pharma company, no.

45:32

There is no patent cliff and when

45:34

you think about, well what does a

45:36

small company like Interdigital have that could

45:38

attract great engineers when the

45:41

competitors are Qualcomm and Broadcom

45:43

and Nokia? The reality

45:45

is the CEO of Qualcomm cares

45:48

but doesn't really look carefully at

45:50

the licensing business. It's a very profitable

45:53

segment but a tiny fraction of the revenue of

45:55

the Qualcomm. So when somebody

45:58

like a Liren leaves Qualcomm

46:01

to go to Interdigital, he does that

46:03

so that he can move from a tiny

46:05

business division in a

46:07

large company to being the whole

46:10

enchilada. So this is a

46:12

firm that engineers want

46:14

to come to because engineers at

46:16

Interdigital are the rock stars. They're

46:19

the ones who

46:21

get their research funded.

46:23

They get to be surrounded by the best of the best.

46:25

So there's a virtuous cycle to

46:28

that but also a benefit

46:30

to being a very focused research

46:33

business for people who want

46:36

to be surrounded by other researchers

46:38

and other engineers. I'm

46:40

going to almost record scratch some of the

46:42

positives that have been talked around this business,

46:44

that point being one of them, the independence

46:46

and how that can be beneficiary with conflict

46:49

of interest. I'm curious because

46:51

most of these divisions exist

46:53

within broader companies as Interdigital

46:55

ever been looked at as

46:57

an acquisition target for the

46:59

likes of an Apple or someone else. A record

47:02

scratch in the sense that that would certainly take

47:04

away some of those positives that I just referenced

47:06

but it does seem like a really interesting asset

47:08

to own. In

47:10

2012, there was a lot

47:13

of talk about Interdigital maybe being an

47:15

acquisition target. Ultimately, they

47:17

sold 1,700 patents to Intel for just

47:19

under $400 million which is interesting because

47:25

that says something about the value of these

47:27

patents. That was a long time

47:29

ago and no longer is a focus

47:32

of the company. Being

47:34

acquired, I just think

47:36

it's unlikely. I think there are a lot of companies that

47:39

would like to buy it but it

47:41

is an unlikely acquisition

47:44

for all the reasons that we discussed.

47:46

There's this tremendous benefit to being independent.

47:49

This notion of if you were to

47:51

be acquired, would you then lose many

47:53

of your engineers, your greatest assets, walk

47:56

out the door every day and have

47:58

chosen to come to the market? to a small

48:01

company like Interdigital for

48:03

the benefits that a small

48:05

company with stock options and everything else provide.

48:08

So I don't think it's likely, I think

48:10

it's far more likely that the share count

48:12

shrinks, that the capital return

48:14

to shareholders becomes

48:17

difficult to ignore and the

48:21

company grows into a market

48:23

cap more like what it deserves.

48:26

On the valuation framework for a business like this,

48:28

you mentioned it's capital light, unique

48:30

capital structure, a lot of cash on

48:33

that balance sheet. There's a lot of reasons

48:35

why between the earnings stream and the one-off

48:37

payments and some of those dynamics you mentioned

48:39

would put a quant model through some type

48:41

of hell. But from a

48:43

fundamental standpoint, how do you look at this

48:46

business valuation wise and just

48:48

think what the right framework would be to use for

48:50

something like this? You look at it and

48:53

really what is the recurring revenue at

48:55

the standard profitability of recurring

48:57

revenue? If

49:00

you put a 20 multiple on something

49:02

like that, capital light, pretty

49:04

attractive. As I said, you get a

49:06

market cap of around $4 billion which is

49:08

30% higher than today. If

49:12

you look at something like Adobe which

49:15

is basically the

49:17

same licensing business

49:19

model, they develop the standards, they

49:21

develop the technology and they license

49:23

it. Dolby, albeit has

49:25

a brand, Interdigital, nobody has

49:27

heard of. They got to

49:29

get their stickers and their logos on

49:31

laptops and cars. Exactly.

49:34

But over the last five years, I think

49:36

Dolby has had an average multiple of 23,

49:38

14 times EV2E,

49:41

but so you could apply any

49:43

one of these metrics and say that

49:45

Interdigital is 50 to 25%

49:48

undervalued, not giving credit

49:50

at all for potential

49:52

additional one time payments and not

49:55

giving credit at all for

49:57

the greenfield opportunity in video. and

50:01

cloud. We sort of think of those as additional

50:04

upside that you're not paying for and then

50:06

the cloud is free call. The

50:08

proof is in the pudding in the

50:10

fact that the technologies are being used

50:12

but they are yet to be compensated.

50:14

What do you view as the

50:17

risks beyond the cyclicality? What

50:19

are major threats here? Interestingly

50:21

because of the fixed rate

50:23

nature of the contracts there's

50:25

less cyclicality than you would imagine. In

50:28

our mind the risk is really if

50:30

there were to be a

50:33

massive global regime change and

50:35

focus on the value of patents and

50:37

the notion of patent protection

50:40

and fair compensation for

50:42

patent holders. Every

50:44

now and again you hear people talking

50:47

about that whether it's pharmaceutical

50:49

companies or what. The reality

50:51

is that patents protect innovators

50:53

and there would be significant global

50:56

innovation risk should

50:58

that come to pass.

51:00

When we think about the risk for

51:02

inter-digital that's really the risk. To

51:05

tease that out the patent

51:08

questions in pharmaceuticals a lot of it

51:10

seemed to stem from those that

51:12

were overexerting power on

51:14

price with the patent portfolio

51:16

that they had. In this case

51:19

it feels like that's certainly not

51:21

happening where there's a need to

51:23

collect and enforce more than anything.

51:25

Is that fair or is there

51:27

anything missing from that? No I

51:29

think that's absolutely fair. There's nothing

51:31

onerous or usury

51:33

in the way that they charge. On the

51:36

mobile phone I don't think we're

51:38

seeing anything change with mobile phone

51:41

usage in the future

51:43

but it's becoming almost a smaller

51:45

line item for some of

51:47

these businesses and you're seeing some drop off whether

51:49

it's chip purchases different

51:52

things. Is there anything there

51:54

related to that business that's a

51:56

fear thinking about maybe really far

51:58

ahead seven years. years from now, maybe

52:01

as that next Apple contract comes up,

52:03

how much focus do you put on

52:05

the strength of the mobile market as

52:07

everyone is looking to develop new devices

52:09

to take over that next regime

52:12

shift? The technology for devices

52:14

to communicate, I don't think

52:17

it's going anywhere. If it's not a smartphone,

52:19

if it's a headset, or if it's

52:21

an iPad, or if it's a watch,

52:24

they all rely on the technology. So

52:26

I doubt that. Does the

52:29

cost of using these

52:31

patents or the next generation of them

52:33

go down for Apple? No. Does

52:36

maybe become a smaller part of Apple's total

52:39

budget? Maybe Warren Buffett

52:41

was talking about Apple,

52:43

and he said most people

52:45

who have two cars

52:49

and a phone, an iPhone, would

52:51

choose to get rid of their second car before

52:54

they would choose to get rid of their iPhone.

52:56

So this notion that we're going backwards, tying

52:59

it back to Selleickson's

53:02

concept, he wanted

53:04

dial tone anywhere, anytime. And

53:07

we are now a society that demands

53:09

that, and companies

53:12

like Indredigital make it possible. It's

53:15

been an excellent conversation to close

53:17

things out here. We talk about lessons that you

53:19

can take away from this business and apply elsewhere.

53:21

Are there lessons that you would point to? But

53:24

I think it's sort of a key takeaway for

53:26

a company like this. At

53:29

Summit Street, we basically are focusing

53:31

on US public equities of generally

53:33

global companies. And we

53:35

want to compound our partner's

53:37

capital safely. We want

53:39

to do that by buying common stocks of

53:42

what we think are uncommonly good companies.

53:45

Indredigital, in our view, is a great

53:47

example of that. But only

53:49

when we can buy them at bargain

53:51

prices. The reality is that you

53:53

don't often find a great company at a bargain

53:55

price, unless there's a good reason. Increasingly,

53:58

there are structural issues. issues

54:01

in the market, why the price of

54:03

a good company can move

54:05

away from intrinsic value, particularly

54:08

small companies that are left out

54:10

of the large indices and

54:12

a company that's a little hard to

54:15

analyze by the sell side or on a

54:17

superficial level. As an investor,

54:19

this is exactly the kind of company

54:21

we look for. Interdigital is

54:24

sort of afflicted by both size and

54:26

complexity. But if you are

54:29

willing to sharpen the pencil as

54:31

an investor, to me that's where you can

54:33

find the sort of

54:36

opportunities that we're looking for. Thank

54:38

you so much, Jenny. It's been a masterclass in

54:40

learning about this business. I appreciate you coming on

54:42

and sharing the knowledge with us. Thank

54:45

you. It's been a pleasure to chat with you. To

54:48

find more episodes of Breakdowns ranging

54:50

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54:57

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55:05

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