InterDigital: Growing Fast By Monetizing AI For Video

seekingalpha08-09

InterDigital's recent stock upside was not impacted by tech volatility, showing the strength of its IP or intellectual property portfolio.The company's AI technology optimizes video streaming quality ...

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Ake Puttisarn/iStock via Getty Images InterDigital Inc. (NASDAQ:IDCC) is a midcap stock whose most recent upside coincided with the weakness suffered by the Invesco QQQ Trust ETF (QQQ) as shown in the chart below. While it is true that the company’s upbeat financial results for the second quarter of 2024 (FQ2) released on August 1 did help, the fact that it was not impacted by the general volatility engulfing tech names suggests strength. Comparing recent performance with the tech-heavy QQQ (seekingalpha.com) One of the reasons is its double-digit growth achieved by applying AI to improve video quality, while others, including the Magnificent 7 are still investing billions of dollars to build intelligent infrastructures. From this perspective, this thesis aims to show that InterDigital is a growth stock, as the above price action may signal that investors are starting to pay attention to companies already monetizing innovation rather than be influenced by AI hype. Therefore, it is a buy since its trailing price-to-earnings remains underpriced relative to the the IT sector by more than 50%, and there are chances of generating more sales than expected. First, I show what value this innovator brings to video streaming through its IP or intellectual property. Using AI to Optimize the Quality of Video Streamed About 82.5% of the internet's traffic consisted of video applications in 2023 as these have become increasingly popular on social media platforms as a way to communicate. However, there are challenges involved in transmitting video files over the internet, especially the high-quality ones when sent frequently throughout the day and night. The problem is these can strain even the most powerful networks resulting in buffering (delay), or even a disruption of the streaming experience when many users simultaneously use a platform. Now, there are techniques to address these issues, like compression to reduce file size, but this can impact quality. This is where InterDigital's technology, which makes use of AI, comes into play, both to optimize video compression and transmission. It differentiates itself by being uncompromising on quality while making sure the video is delivered in such a way the streaming experience is smooth, or without introducing delay. Such performances where minimal transmission errors can be tolerated are essential in mobile phones to handle video-related tasks, such as Alphabet's (GOOGL) (GOOG) Pixel smartphones and Fitbit wearables. Thus, a new licensing agreement with the search giant helped InterDigital to drive revenues to $223.5 million in FQ2 as shown below, or more than two times the amount initially guided, representing a 120% YoY surge. Second quarter earnings call presentation (seekingalpha.com) Other significant revenue contributors were a licensing deal with Panasonic (OTCPK:PCRFF) and Lenovo's (OTCPK:LNVGY). Following InterDigital's winning litigation cases against this Chinese company, the latter was ordered to pay licenses covering sales in the period 2007-2023, as I will detail later. Also, as shown above, non-GAAP EPS surged from the $0.7-$0.8 initially expected to more than $4.57, or more than six times. Highly Profitable, Deserving Better Based On Valuations and Sales Strength Diving deeper into profitability, its trailing gross margins are 78% which outshines the sector median and is explained by InterDigital not manufacturing nor selling physical products but mainly licensing its portfolio of patents. This means that to stay ahead of the competition, it has to invest in research which accounts for its trailing EBITDA margin of 53.6%, but still exceeding the median for the IT sector by more than 400%. Looking ahead, FY-2024's EBITDA margin guidance is expected to be 55%, up from 50% forecasted at the end of FQ1 which should translate into a non-GAAP EPS of more than $10.30 (midpoint), or more than $2.20 (27%) above the prior guidance. Therefore, with its ability to convert sales dollars to profits, the company deserves better, and for this purpose, its trailing P/E is undervalued relative to the IT sector by 51% as shown below. Now, doing a comparison with IP pureplay Rambus Technology (RMBS) which has benefited from its market positioning in AI memory chips and whose P/E is 19.74x, InterDigital could potentially appreciate by 41% (19.74 - 13.79)/13.79. This translates into a target of $195.5 (138.65 x 1.41) based on the share price of $138.65 at the time of writing. seekingalpha.com To further support my bullish position, firstly, the revenue outlook for FY-2024 which has already been upgraded by $70 million could benefit from additional agreements signed during FQ3. Secondly, the management highlighted the litigation case it won against Lenovo will set a precedent during future negotiations covering HEVC (High Efficiency Video Coding) patents implying incremental revenues during negotiations with customers. Based on these two points, there are more chances of beating FY-2024's topline expectations or raising guidance at the end of FQ3 for a company that has suffered from a miss only once during the last ten years. Faces Competition and Downside Risks In The Medium Term, But Innovation Can Help Now, in addition to HVEC, its overall portfolio also consists of wireless (like 5G) patents and applications, which means that it does face competition from established semiconductor players with enormous R&D budgets like Qualcomm (QCOM) and Broadcom (AVGO) just to name two. As for HVEC, it competes with video and entertainment play Sony (SONY) without forgetting MPEG LA which manages a patent pool for HEVC. Thus, there are risks that customers shift to competitors, thereby impacting revenue growth, especially after growing at 20% YoY FY-2023, and the 30% YoY expected for FY-2024 as shown below. By the way, this year's overall sales should benefit from an additional payment of $55 million from Lenovo (in July) and reimbursement of legal expenses incurred for the court case. To this end, analysts' estimate only $484 million of revenues for FY-2025 which would translate into a YoY decline of 32% as shown below, with growth expected to resume only in FY-2026. seekingalpha.com Therefore, after growing at a rapid pace, a double-digit decline may well not be digested by investors and is likely to result in volatility. Still, as evidenced by its ability to improve performance during FQ2 in a way that far exceeded the outlook, and continued execution of its strategy to strengthen its innovation pipeline, I believe FY-2025 could deliver a revenue growth. The driver for this is VVC, or Versatile Video Coding, the latest video compression standard that paves the way for new opportunities in streaming applications and network efficiency, namely through the application of AI. How AI Can Help to Sustain Growth Momentum in FY-2025 Digging deeper, while the VVC standard itself does not include AI, it is InterDigital's propensity to apply Machine Learning to optimize video networks for a better user experience across a large variety of use cases (including augmented and virtual reality) which should help it to drive its IP or intellectual property portfolio to new heights. To this end, a recent LexisNexis report stated that InterDigital is among the top seven patent holders for both HEVC and VVC, based on the quality and quantity of their patents. This strength saw it sign a patent license agreement with LG Electronics, the South Korean-based manufacturer of various consumer electronics products, last year also included VVC in addition to HVEC. To further solidify the competitive position of its video portfolio across diverse devices and services, the company is using deep learning techniques to disrupt the open-source library of CompressAI as shown below. AI Lab (www.interdigital.com/ai-lab) Thus, in a video streaming market that is expected to grow at a 19.3% CAGR from 2023 to 2030, it could continue to grow by double-digits next year. Estimating a 19.3% increase in sales for FY-2025 instead of a 32% decline as currently expected, the topline could increase to $855 million (484.6 x 1.193) based on the $484.6 million estimated by analysts. This would in turn increase the forward revenue growth from 1.9% to 16.9% as tabled below, putting it firmly above the sector median's 6.65%, thereby improving the company's growth grade. Table built using data from (seekingalpha.com) Monetizing AI In A Capital-Light Way, While Others Are Spending Billions Moreover, as I mentioned earlier, there are ingredients to potentially deliver a topline beat for this year, all thanks to leveraging its expertise in video compression and codecs to enhance user experience in video streaming. In this regard, the Deep learning technology (which it is using) is not as new as the much-hyped Generative AI, but, as evidenced by its financial results, can move the needle when it comes to driving long-term shareholder value. In so doing, it is not spending billions of dollars to acquire the latest accelerated computing GPUs produced by Nvidia (NVDA) as big tech is doing, but instead is spending relatively less capex on innovation, resulting in superior FCF margins of 30%. Finally, InterDigital's business model, which consists of generating revenues by enabling other companies to embed its innovations in their products, has been highly profitable. In this connection, with a cash balance of $760 million versus debt of $489 million at the end of FQ2, it can continue its policy of share buybacks and dividend payments while continuing to invest money to stay ahead of competitors. Therefore, it is increasingly likely for investors to reward companies like InterDigital whose IP is the basis for advancements in video and wireless and as the market's focus turns to the monetization aspect of artificial intelligence. Ending on a note of caution, given so many expectations about a rate cut in September already priced in asset valuations, there could be a lot of volatility if there is any delay by the Fed in loosening monetary policy.  Editor's Note: This article was submitted as part of Seeking Alpha's Best Growth Idea investment competition, which runs through August 9. With cash prizes, this competition -- open to all analysts -- is one you don't want to miss. If you are interested in becoming an analyst and taking part in the competition, click here to find out more and submit your article today!","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"1","news_tag":"","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2458139415"}