Semiconductor IP Sector Overview

There has been a boom in the wireless industry driven by increased demand for smartphones such as the iPhone, Palm Pre, and BlackBerry and for netbooks as well as evolution of high-speed technology. Just yesterday, Nokia announced its new netbook, Booklet 3G. According to Gartner, smartphone sales grew 27% to 41 million units in Q209, while mobile phone sales declined by 6% to 286 million. Sales of mini-notebooks or netbooks are expected to reach 21 million in 2009, and 30 million in 2010, while PC shipments are likely to shrink by 6% to 274 million this year. In this post, let’s examine how semiconductor IP players Tessera, InterDigital, and ARM are benefiting from this boom.

ARM’s chips are used in most mobile devices including the iPhone, BlackBerry and Palm Pre. ARM licenses its technology to partners, and this business model has reaped the company benefits during the downturn. It now aims to repeat this success in the netbook space with its Cortex processor in the newly-launched Google Chrome OS, which is built for cloud computing. ARM’s new processor will be the main rival of Intel’s Atom processor. As ARM’s processor is Linux-based, the corresponding devices can sell at a price that Intel would find hard to match. According to The Information Network, the Atom will hold more than an 80% share of the 23.5 million netbooks sold in 2009, but the ARM processor is expected to gain 55% market share of the 96.0 million netbooks sold in 2012.

Nokia’s new netbook is also based on the Atom and is being heralded as a step forward in the convergence device movement. Meanwhile, Nokia also announced the launch of a financial service with Obopay, in which it earlier bought a minority stake earlier. My interview with Obopay CEO Carol Realini is available here.

As for its financials, ARM Holdings plc (NASDAQ:ARMH) reported its second quarter results on July 28. Q2 revenue was down 18% to $105.5 million or £64.8 million. EPS was 0.50 pence and normalized EPS was down 19% to 0.95 pence. Analysts were expecting revenue of £66.7 million pounds and EPS of 0.78 pence. Earlier coverage is available here.

By segment, Processor Division (PD) dollar revenue was down 13% to $70.8 million. Physical IP Division (PIPD) dollar revenue was down 23% to $17 million. Development Systems was down 36% to $10.3 million while Services revenue was down 12% to $7.4 million.

Total dollar license revenue declined 10% to $38.7 million, accounting for 37% of total revenue. Total dollar royalty revenue declined 19% to $49.1 million, or 46% of total revenue.

Gross margin increased to 91.2% compared to 90.2% in Q1 2009 and 89.1% in Q2 2008, mainly because of a higher proportion of PIPD engineering time being classified as operating expenses rather than cost of sales. The company ended the quarter with net cash of £88.2 million compared to £91.3 million in the previous quarter.

ARM expects full-year dollar revenue to be at least in line with market expectations of $470 million or £285 million. The stock is currently trading around $6 after hitting a 52-week high of $6.70 on August 4. It was downgraded by UBS from Buy to Neutral on July 29. But the future of the company looks pretty bright to me.

On August 4, Tessera, an IP licensing company and a miniaturization technology provider with annual revenue of $248 million, reported its Q2 results. Q2 revenue was up 11% to $62.3 million. Net income was $11.8 million, or $0.24 per share including non-cash charges of $7.2 million for stock-based compensation and $2.9 million for the amortization of acquired intangibles. Q1 analysis is available here.

Micro-electronics revenue was up 13% to $55.6 million including a license fee and options fees from Motorola, which recently became a licensee. Imaging & Optics revenue was $6.6 million. Within this, royalties and license fees were up 209% y-o-y and down 20% q-o-q to $4.2 million while product and service revenue was $2.2 million, down 57% y-o-y and 11% q-o-q mainly due to the slowdown in semiconductor equipment purchases.

Largely because of the company’s decision to terminate its Subcon ITC case in March, its litigation expenses decreased and its GAAP expenses were down 19%. It ended the quarter with $378.2 million in cash and no debt. Tessera spent $9 million on purchasing intellectual property and technology in the quarter.

On May 20, the U.S. International Trade Commission ruled that Tessera’s patents are valid and were infringed by Qualcomm, STM, Motorola, Freescale and Spansion, which are banned from selling infringing products in the United States. The patent in question is No. 6,433,419 related to semiconductor packaging technologies used in the wireless industry. This patent expires in September 2010. In June Tessera received a Right of Appeal Notice for the reexamination of the patent. The claims of a patent undergoing reexamination remain valid, and the reexamination process usually takes more than five years. The claims of the patent will thus remain valid well after the patent expires in September 2010, and Tessera can continue to collect royalties.

For the third quarter, Tessera expects revenue between $60 million and $62 million, down from $63.5 million in 2008. Micro-electronics revenue will range between $54 million and $56 million. Imaging and optics revenue is expected to be $6 million. Litigation expenses are expected to be higher in the third quarter. The stock is currently trading around $26 with market cap of about $1.3 billion. It hit a 52-week high of $30.50 on August 5 following its earnings report release.

On the other hand, InterDigital, an IP licensing company with annual revenue of $228.5 million, recently had a setback in its infringement suit against Nokia filed in 2007. The chief administrative law judge overseeing the suit found no violation by Nokia in an initial determination. The final ITC hearing is expected in December. InterDigital controls 50% of the 3G market, and if it had settled a deal with Nokia, it would have been controlling 80% of the market. Nokia, Sony Ericsson, and Motorola are major unlicensed vendors that account for about one-third of the 3G market.

Early in the year, InterDigital had settled a similar lawsuit with Samsung for $400 million. For a detailed analysis of the company, refer to guest author Vijay Nagarajan’s deep dive available here.

On July 28, InterDigital (NASDAQ:IDCC) reported its second quarter results. Q2 revenue was up 28% to $74.9 million. Net income was $26.4 million or $0.59 per share, more than four times the profit in Q208 driven by revenue from the company’s Samsung deal. Q1 analysis is available here.

Patent licensing royalties revenue was up 29% to $72.7 million with $25.7 million coming from Samsung; this number is partly offset by a $10.4 million decrease in per-unit royalty revenue due to declining handset sales. Technology solutions revenue decreased 12% to  $2.2 million. Samsung accounted for 34% of revenue and LG 19%.

InterDigital bought back shares for $14.7 million and ended the quarter with $216.6 million. The stock is currently trading around $21 with market cap of about $900 million. It hit a 52-week high of $32.73 on January 26.