Pendrell Corp – Negative Enterprise Value

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The cheapest stock in our All Investable – Deep Value Stock Screen is Pendrell Corp (NASDAQ:PCO).

Pendrell Corp (Pendrell) invests in, acquires, and develops businesses with unique technologies that are protected by intellectual property (IP) rights in the United States. It manages four IP licensing programs comprising digital media, digital cinema, wireless technologies, and memory and storage technologies.

A quick look at the company’s share price history over the past six months shows that the share price is up 13.66%, to $6.45, fifteen percent off its 52 high of $7.59 back in August 2016.


(Source: Google Finance)

Negative Enterprise Value

What’s interesting about Pendrell is that its current market cap is $173.5 million. A quick look at the company’s balance sheet (below) for the trailing months shows that the company has $176 million in cash and cash equivalents and zero debt. In other words Pendrell has more cash and cash equivalents than its entire purchase price. As a result, when you subtract the total cash from the market cap, Pendrell has a negative Enterprise Value of ($3 million).

Quarterly Balance Sheet (amounts in 000’s)
Quarter: 3rd 2nd 1st 4th
Quarter Ending: 9/30/2016 6/30/2016 3/31/2016 12/31/2015
Cash and Cash Equivalents $176,307 $169,231 $169,944 $162,457
Short-Term Debt / Current Portion of Long-Term Debt $0 $0 $0 $0
Long-Term Debt $0 $0 $0 $0

(Source: Company Reports)

Companies with a negative enterprise value are extremely rare. In this case you’re going to spend $173.5 million to get $176 million in cash. Not only that but with the company’s current share price at $6.45, Pendrell is trading at a discount to both its Net Current Asset Value of $6.79 and its Tangible Book Value of $7.41. That’s why Pendrell is seriously undervalued.

ContentGuard vs Apple Inc

To understand why Pendrell is selling so cheaply we need to take a look at what happened in late 2015.

In November 2015 one of Pendrell’s subsidiaries, ContentGuard, took Apple Inc to court claiming Apple had infringed five antipiracy patents by making and selling its popular devices, which use the iTunes and iBooks applications, to distribute DRM-protected songs, movies, TV shows and books. Apple denied any infringement and said the patents were invalid.

A U.S jury ruled Apple Inc had not infringed the five antipiracy patents, owned by ContentGuard, but also found that Apple did not prove that the patents were invalid. No damages were awarded. This trial came shortly after a September ruling in the same court which cleared Google Inc of infringing the same five patents. Samsung Electronics Co Ltd was also cleared in that case.

This was clearly a setback for Pendrell, and the stock was subsequently oversold.

Net Operating Losses (NOL’s) Carried Forward

One thing that seems to get overlooked about Pendrell is the operating losses that it carried forward after exiting the satellite business in 2012. To better understand how these losses occurred and how they greatly benefit Pendrell its important to take a look at the history of the company.

In January 1995, ICO Global Communications, planned to build an MSS constellation in medium Earth orbit (in two 45°-inclined orthogonal planes), and had contracted Boeing Satellite Development Center (then Hughes) for 12 spacecraft in July of that year — ten operational spacecraft and two in-orbit spares.

After failing to reach an agreement with its bondholders, in August 1999 ICO eventually filed for Chapter 11 bankruptcy protection and subsequently emerged as New ICO in May 2000, following investments by Craig McCaw and others. When it became clear that the satellite business was not going to work out the company was renamed Pendrell Corporation in June 2011. It was then that Pendrell made the move into the intellectual property licensing space.

Pendrell’s exit from the satellite business generated approximately $2.4 billion in net operating losses (NOL’s). The upside is that these NOL’s begin to expire in 2025 so the company is well placed to offset taxable income in future years.

Following its exit from the satellite business, in October 2011 Pendrell acquired a 90.1% interest in ContentGuard Holdings, Inc. for $90.1 million in cash with the remaining 9.9% owned by Time Warner, Inc.

At the time of acquisition, ContentGuard was a leading inventor, developer and licensor of digital rights management (DRM) and related content distribution patents and technologies. ContentGuard’s intellectual property (IP) portfolio featured more than 260 issued patents and more than 160 pending patent applications worldwide. More than 50 percent of the world’s handset manufacturers had licensing agreements in place with ContentGuard.

ContentGuard had licensing agreements with leading technology companies including LG Electronics, Microsoft Corporation, Nokia, Panasonic, Sharp, Sony, Sony Ericsson, Toshiba, Casio, Hitachi, Technicolor, Time Warner, and Xerox Corporation.

New Licensing Agreements

One of the issues with patent licensing agreements, like Pendrell’s, is that they generate loads of free cash flow while they’re valid, but they do run out. For this reason it’s important that Pendrell finds new opportunities from companies wishing to use its IP.

In May 2016 Pendrell made the announcement that its subsidiary Memory Technologies LLC (MTL) had entered into a patent license agreement with Toshiba Corporation covering embedded memory technologies and secure digital memory cards. The license agreement enables Toshiba’s use of standards essential and implementation inventions.

“We are very pleased to enter into this agreement with Toshiba Corporation, which is a recognized pioneer in the memory technology space,” commented Mario Obeidat, Vice President of licensing for Pendrell. “This license agreement with Toshiba, which follows license agreements with other industry leaders such as Samsung and SK hynix, further validates the essential nature of our memory technologies, our leadership in the development of breakthrough next-generation memory solutions, and our commitment to entering into licenses on reasonable and non-discriminatory terms.”

This agreement highlights that Pendrell is well placed to generate new revenue from new business opportunities in addition to the run-off from its existing agreements.

Efficient Business Model

One of the things about the typical IP business model is that payments can be lumpy from quarter to quarter. Here’s a great illustration using Pendrell’s 2016 trailing twelve month income statements (below) where Pendrell had revenues of $45 million in Q2 2016 and zero in Q3 of 2016.

Quarterly Income Statement (amounts in 000’s)        
Quarter: 3rd 2nd 1st 4th
Quarter Ending: 9/30/2016 6/30/2016 3/31/2016 12/31/2015
Total Revenue $0 $45,003 $13,500 $662
Operating Expenses
Sales, General and Admin. $2,820 $2,863 $3,464 $5,021
Non-Recurring Items $308 $688 $2,727 $104,453
Other Operating Items $2,373 $2,377 $2,381 $3,175
Operating Income -$5,501 $21,103 $4,928 -$112,061

(Source: Company Reports)

While revenues are lumpy it’s important not to ignore what’s happening with the operating earnings of Pendrell.

Firstly, for the nine months ending September 30, 2016 the company had $20.5 million in operating income compared to negative ($9 million) for the pcp, an increase of 300+%. Secondly, in the more normalized first and second quarters of 2016 the company had operating margins between 35% and 45%. Thirdly, in Q3 2016 when the company recorded zero revenue its net loss was just $5.3 million.

Pendrell has a lean business model and is hell-bent on reducing its overhead. For the nine months ending September 30, 2016 Pendrell reduced its SG&A expenses by 57% from $13.4 million to $5.7 million compared to the pcp. At the same time it also reduced its stock-based compensation by 19% from $3.3 million to $2.6 million. All of these reductions were due mainly to a decrease in the company’s headcount and disposal of its corporate offices.

Real Value

While the company is generating new revenue, as illustrated above with the new deal with Toshiba, and continuing to reduce its operating expenses, what shouldn’t get overlooked is that the company is also well placed to find an accretive acquisition. Pendrell has $176 million in cash on its balance sheet, zero debt, and the ability to generate loads of free cash flow.

A quick look at Pendrell’s 2016 cash flow statements (below) for the trailing twelve months shows the company generated $11.5 million in operating cash flow and had just $40,000 in capex. This equates to free cash flow of $11.4 million and a FCF/Price yield of 7%.

Quarterly Cashflow Statement (amounts in 000’s)
Quarter: 3rd 2nd 1st 4th
Quarter Ending: 9/30/2016 6/30/2016 3/31/2016 12/31/2015
Net Cash Flow-Operating $6,214 -$710 $7,098 -$1,138
Capital Expenditures -$4 -$3 -$5 -$28

(Source: Company Reports)

Institutional Shareholders

One last thing I like to do when I’m analyzing stocks is take a quick look at their institutional ownership. One name that popped up during my analysis of Pendrell was Ariel Investments. One of our favorite investors, John Rogers is the Chairman, CEO & Chief Investment Officer at Ariel Investments. It seems John Rogers is also bullish on Pendrell, adding 3,309,667 shares to his portfolio in September 2016:

Date Action Shares
2016-09-30 New 3,309,667



Pendrell is a company that looks seriously undervalued. The company has a strong balance sheet, is lean on capex, has loads of free cash flow, and has NOL’s that it can carry forward to offset taxable income. In terms of its valuation, with the company’s current share price at $6.45, Pendrell is trading at a discount to both its Net Current Asset Value of $6.79 and its Tangible Book Value of $7.41. Pendrell also has an Acquirer’s Multiple of -0.57 and a FCF/Price yield of 7% (ttm). The Acquirer’s Multiple is negative because the company has a Negative EV.

The Acquirer’s Multiple is calculated as:

Enterprise Value / Operating Earnings*

*We construct the operating earnings figure from the top of the income statement down making it different to EBIT and EBITDA. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–earnings that a company does not expect to recur in future years–ensures that these earnings are related only to operations.

Disclosure: I currently have a long position in Pendrell Corp (NASDAQ:PCO).

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