The chipless chip company
By Lisa Meyer
Red Herring
April 17, 2001
Engaged in a high-stakes poker game, Rambus (Nasdaq: RMBS) just upped the ante. The semiconductor licensing company plunked down a hefty $7.3 million in legal fees during its fiscal second quarter (which ended in March), up from $4.3 million in the previous quarter and $660,000 in the fiscal second quarter of last year.
"The fight is over the next interface architecture," says Dan Scovel, analyst at Needham & Company. "If Rambus wins, it can own the DRAM [dynamic random access memory] world."
Indeed, the company is accustomed to fights. It gains a good portion of its revenues from winning them. Rambus is the poster child of an intellectual property company. Its revenues are based on royalties from the high-bandwidth chip connection technologies it licenses to semiconductor companies like Intel (Nasdaq: INTC) and Matsushita (NYSE: MC). If any of these companies refuse to pay, Rambus sues them. To be sure, the company has become more of a law firm than a semiconductor company.
ITS DAY IN COURT
Rambus has won many battles. As a result, the company has been able to sit back and collect royalty checks. That, in turn, has produced high gross margins -- margins have been above 90 percent during the past three quarters. But did Rambus go too far this quarter? The company's high legal fees, coupled with plunging DRAM prices, cut into its profits. Rambus earned 8 cents per share, 3 cents less than Wall Street expected and 4 cents down from the previous quarter. With weak demand for chips because of a struggling PC market, should Rambus have sunk so much of its money into court costs?
We think so. Because Rambus's business is based on intellectual property, the company needs to spend some of its cash to secure its presence in new areas of growth. Basically, the company wants a bigger piece of the DRAM pie. In the most recent court battles, Rambus says that Micron Technology (NYSE: MU), Infineon (NYSE: IFX), and Korea's Hyundai are using technology patented by Rambus in synchronized dynamic random access memory (SDRAM) and double data rate (DDR) SDRAM, which competes with the company's proprietary offering, Rambus dynamic random access memory (RDRAM). Rambus has convinced eight other companies, including Samsung, Toshiba, and Hitachi, to pay for use of such technology.
"While it would be tempting to focus attention on income before litigation expense, we need to point out that royalty revenue from the eight companies who have licensed our patents for use in SDRAM-compatible integrated circuits [ICs] still far exceeds the cost of litigation against the three companies who have chosen to go to court," said Rambus's CEO Geoff Tate in a press release accompanying the earnings report.
Included in the company's second fiscal quarter results was $23.6 million in royalties, nearly seven times the amount reported in the same period last year, but down 12 percent from the previous quarter. Although the company didn't break out revenues received from the eight companies paying royalties on SDRAM and DDR SDRAM, J.P. Morgan analyst Eric Chen calculated this to be $13.7 million, down from $17.8 million during the first quarter. Mr. Chen attributes the decrease to plunging DRAM prices.
And because there is a lag between the time Rambus records royalty payments and the original sale, revenues for the company's fiscal third quarter (ending in June) will reflect the severe drop in DRAM prices that occurred during the March quarter. Keeping that in mind, Mr. Chen predicts that Rambus's royalties on SDRAM and DDR SDRAM will drop to $6 million in its third quarter.
SKITTISH INVESTORS SOLD OFF STOCK
The courts are expected to issue some decisions regarding the patents for the SDRAM and DDR SDRAM chips during the next few months. If Rambus loses, it still has existing licensing agreements, which bring in a steady stream of revenues, influenced slightly by pricing. But if Rambus wins, it will gain 1 to 2 percent of a $30 billion industry, and the company's stock stands to gain substantial upside.
But investors are growing more and more spooked over Rambus's prospects in court. The company's stock has been in a free-fall since a court ruling on March 15 that limited the definitions of some of the patents terms -- making Rambus's case more difficult. The company's stock fell 34 percent on the news. The stock closed on Monday at $18.41, 85.8 percent off its 52-week high. At this price, Rambus is trading at 38 times its 2001 estimated earnings, a valuation that is far more reasonable than where the stock was when we wrote about Rambus in November. Back then, Rambus was trading at 106 times 2001 estimates. At least now much of the litigation risk is priced into the stock.
Rambus may still have Intel as a sugar daddy, but investors are wondering for how long. To date, Intel's Pentium 4 processor can't work without Rambus's proprietary RDRAM, and a number of chip makers are producing RDRAMs to catch that marketing window with Intel. But Intel is currently working on a chip set that will work with SDRAM and DDR SDRAM.
"Which technology Intel will ultimately use depends on price performance," Mr. Chen says, adding that, at present, DDR is the most expensive, then RDRAM, and finally SDRAM. And unless Rambus wins those three remaining lawsuits, it won't be able to take full advantage of Intel's diversification away from RDRAM.
Indeed, it is not Rambus's fundamentals but rather the judicial system that will decide the company's future. In essence, Rambus's earnings are meaningless until all the verdicts are in. Rambus has been and will most certainly continue to be a volatile stock going forward. So if short-term investors want to play Rambus, they might do better to retain a lawyer than call a broker. |
