|Shares Out. (in M):||114||P/E||18||0|
|Market Cap (in $M):||222||P/FCF||10||0|
|Net Debt (in $M):||-101||EBIT||8||0|
|TEV (in $M):||121||TEV/EBIT||16.5||0|
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· Ticker: QTRHF on OTCQX (~10% of daily trading volume), QTRH.TO on TSX (~90% of volume)
· Shares: 114.3 million, fully diluted 116 million
· Market Cap: USD $222 million
· Cash: USD $101 million (reported as CAD $126.4 million at 3/31/2021)
· Debt: $0
· Enterprise Value: USD $121 million
*(Potential) Off balance sheet asset -- $109 million final judgment awarded in District Court, currently in Appeals, zero recognition on balance sheet and P&L consistent with IFRS.
**Unless noted as CAD for Canadian Dollar, currency figures are USD and in some cases converted at relevant exchange rates.
Quarterhill is a holding company headquartered in Toronto. Stock price could double over the next 18 months for either of two reasons. 1) Resolution in a patent infringement suit against Apple currently awarded at $109 million, accruing post-judgment interest and with the potential for additional consideration via other iPhone models not specifically named in the original litigation, and 2) broader recognition by the market of the company's aggressive capital investment plan that will drive up to CAD $400 million ( ~$320 million) over the next 5 years through the company’s Intelligent Transportation Systems business via organic and acquisitive spending. This unit already has a track record of top line growth and margin expansion that is overshadowed by the size and inherent volatility in the company’s Patent Monetization business.
Material downside is mitigated as a result of the company’s large net cash balance and steady-growth Intelligent Transportation Systems business. A 2020 business disposal, a new CEO with tech M&A experience, and a massive infrastructure spending tailwind all serve to streamline and accelerate growth.
Why does this opportunity exist?
The company’s primary assets (in USD) are:
1) $110 million of cash.
2) Two operating businesses:
o Business #1: Intellectual Property ("WiLAN") – WiLAN is Quarterhill’s patent monetization arm, pejoratively referred to by some as a patent troll. Investors may mistake the actual business that exists here. WiLAN generated $59 million and $80 million in revenues in 2020 and 2019, respectively. EBITDA was $22 million (37% margin) and $38 million (47% margin) in ’20 and ’19. Amortization charges, added back to EBITDA, do reflect real economic charges as patent IP has a finite legally enforceable life. The entirety of WiLAN’s D&A is amortization of patents at $10 million for the 2020 calendar year.
o Business #2: Intelligent Transportation Systems ("International Road Dynamics" or “IRD”). Quarterhill acquired IRD in 2017. The company was publicly traded under the same name and filings prior to acquisition are available on SEDAR. IRD generated $50 million in revenues in each of years 2020 and 2019. EBITDA was $10 million (20% margin) and $6 million (11% margin) in ’20 and ’19. Almost the entirety of D&A in IRD is amortization charges, at about $5 million annually and reflects an equal mix of developed software and amortized intangibles from acquisitions such as customer relationships and brand – things that are less reflective of real charges or reduced earnings power going forward. A $2.1 million CEWS Canadian government payment as part of COVID stimulus offsets some of the effects of delayed project work during the year.
o A third business, Viziya, was acquired by Quarterhill in 2017 and was sold for $40 million (CAD $49.4 million) in May 2020 to Prometheus. Quarterhill paid $26 million before earnouts. Earnouts were never realized and never paid. Viziya generated positive cash flow during Quarterhill’s ownership. Management cited as the reason for the sale an unsolicited attractive offer and transaction multiples in the B2B and SAAS space that made tuck-in acquisitions difficult to justify. Essentially, the company is diverting management’s attention and shareholders’ capital to opportunities within IRD’s core and adjacent spaces that are less competitive.
· 3) A June 2020 final judgment against Apple for $109 million inclusive of $24 million of prejudgment interest. Apple has appealed the judgment and hearings are scheduled for Fall 2021 with the timing of a decision anticipated in early 2022. While IFRS and GAAP require recognition of contingent liabilities in the event of potential lawsuit damages, accounting standards prevent booking any award until certain. The judgment is entirely unrecognized on Quarterhill’s books as a result. The potential liability is too small for individual notation/recognition in Apple’s SEC filings.
WiLAN is Quarterhill’s predecessor entity and its patent monetization unit. It has more than 4,800 active patents primarily in the communications and technology spaces (W-Fi, Bluetooth, 4G, V-Chip in TVs, etc.). Revenues from this segment are typically reported as “Licensing” in financial statements.
While the company has organically generated some of its own patents, it largely acquires patent portfolios and monetizes them primarily through licensing and in some cases through litigation. Most investors pejoratively label this type of practice as a “patent troll”. This is a real business where experience and success begets even more. Universities and for-profit technology businesses in many cases don’t know how to fully monetize their patent book. Or are simply too busy to do so. WiLAN provides a method for patent owners to seek liquidity and monetization. Agreements have been structured as a single transaction sale or in a royalty fashion (where WiLAN is a partner more than a purchaser). WiLAN is also a recurring customer to law firms to litigate in cases of patent infringement, typically engaging counsel on a contingency basis (roughly 1/3rd of proceeds is the typical take-rate for legal counsel). Contingency fees eliminate large out-of-pocket expenses for WiLAN and align counsel to a seek a large lump sum award.
The 2015 Annual Report, pages 12-13, does a good job of breaking down the various models for acquiring (or partnering with IP owners) and monetizing patent portfolios. https://s22.q4cdn.com/422713964/files/doc_financials/quarterly/2015/WiLAN_2015_Annual_Report.pdf
Given the sales cycle, it helps to step back and look at revenues on a multi-year basis.
What is this business worth? Amortization which amounted to CAD $14 million and CAD $19 million in 2020 and 2019 respectively, varies wildly given the nature of patent expiries and new patent portfolio acquisitions. It’s is a real charge reflective of using up the economic life of the patent assets.
At yearend 2020, the company reports CAD $46 million in Patents on their books, net of accumulated amortization, or roughly $36 million in USD. This gives no value to law firm relationships (who are willing to litigate on contingency) or experience/reputation in acquiring and reselling (via licensing). There’s also litigation aside from Apple that is essentially a call option requiring little out of pocket with the potential to snowball in the court system into a material figure.
WiLAN is worth somewhere in the range of $30 million to $60 million. The higher end if you value using 2020 EBIT and a 5-6x and in the lower end if you value based on Patent Carrying Value on books (net of acc. Amort.) of $36 million or at a 5-6x multiple on average annual EBIT or average FCF, which both come in just under $5.0 million.
International Road Dynamics (IRD)
International Road Dynamics was acquired by Quarter in 2017 for $47 million (CAD $63.5 million). In 2019, the business generated CAD $13.1 million in EBITDA or CAD $11 million if we back out the CAD $2.1 million CEWS payment. Rish Malhotra, who has been with the company for over a decade, was promoted to President of the business in 2020. Here’s a 2011 video of Rish as a representative of IRD talking in India about highway tolling (https://www.dailymotion.com/video/x15mciz). IRD revenues are reported as Intelligent Transportation Systems in Quarterhill’s filings. The unit employs around 250 people.
IRD has a steady track record of sales and margin growth. Notably, upon Quarterhill taking ownership, the terminated certain unprofitable sales which led to the 2016-2018 revenue dip but also the Operating Profit bump.
IRD competes with companies such as Switzerland-based Kistler (also a customer of IRD providing a quartz-based scale that they sell under Kistler’s brand name), Mettler-Toledo, and Cardinal Group. Cardinal builds scales across a range of applications, not just highway, including recycling operations, livestock, industrial/pallet, and healthcare pediatric/physician. As a result they are less robust on the highway “system” despite a presence in the hardware. Mettler-Toledo is also a broadly supplying weigh systems across a range of industries and applications.
IRD has products installed in 20,000 lanes globally. Among other toll and traffic oriented transportation products, IRD is one of the largest providers of Weigh-In-Motion systems. These systems are cheaper to install and cheaper to operate relative to static scale weigh stations that reside on the side of highways and create a congested line of 18-wheelers waiting for pass through. Essentially, cash-strapped governments need to reduce road congestion and properly toll freight transporters to recover highway maintenance costs. Many of IRD’s products are enjoyed by both the purchaser (highway transport departments) and truckers (shorter or non-existent wait times in moving product from A to B). IRD’s entire product portfolio is focused on highway and urban transportation to properly assess, toll, and collect data. This allows transportation departments to determine roadway budgets, design, and timing/size of new projects.
IRD has a history of expanding relationships with transportation departments. For example, NY State DOT awarded IRD a $4.8 million 5-year contract in 2016, in 2017 NYDOT expanded the scope with a $7.34 million 5-year contract, and in 2021NYDOT upped the scope to a $13 million 5-year deal. The work is for data collection, traffic monitoring and maintenance services.
In April 2021 the company announced the acquisition of VDS, a German based provider of traffic monitoring devices. Consideration paid is CAD $2.8. VDS, with expectations of post synergy $5 million in revenue and $600,000 in EBITDA annually. VDS makes high-precision traffic monitoring systems. To understand the opportunity in this space, look what Rekor Systems is doing with the state of Oklahoma – receiving fees to sending notices to uninsured drivers and also receiving commissions from insurance carriers. In the U.S. there are 32 million uninsured drivers.
In January 2021, IRD acquired Germany-based Sensor Line for $6 million. Management expects CAD $4 to $5 million in revenues in 2021 and CAD $0.7 million to $0.8 million in EBITDA contribution. Sensor Line makes fiber optic sensors for road and rail – given IRD a toehold in rail traffic – and has more than 50,000 system installed globally.
Quarterhill CEO Paul Hill said the company has plans to invest ~$400 million through IRD into core and adjacent opportunities over the next 5 years. The Biden infrastructure bill and a global need to reduce urban congestion and “connect” the transportation grid serve as tailwinds to IRD’s product lineup.
This is increasingly a technology business with long-life customer relationships owing to installed hardware. Some of this hardware, such as Weigh In Motion systems, has a useful life exceeding two decades, generating years of software usage. At an 8x to 10x multiple, this business is worth USD $80 million to $100 million. Quarterhill’s acquisition price in 2017 implied 9.2x 2016 EBITDA. The business has low capital intensity (CAD $6.3 million of the CAD $6.6 million in 2020 D&A is amortization charges from acquired intangibles) and growing exposure to recurring revenues.
The June 2020 final judgment for $109 million is available here: https://www.docketbird.com/court-documents/Apple-Inc-v-Wi-Lan-Inc-et-al/FINAL-JUDGMENT-Signed-by-Judge-Dana-M-Sabraw-on-6-16-2020-aef/casd-3:2014-cv-02235-00906 Apple has filed appeal and hearings at the Federal Circuit Court of Appeals are anticipated for Fall 2021 with a decision in early 2022 (typically 3-6 months after hearings).
Notably, the last paragraph written by District Judge Dana Sabraw was “As to the iPhone 8, 8 Plus, X, Xs, Xs Max, and Xr sold by Apple through May 21, 2019, the parties are working on a separate stipulation and agreement to provide royalties consistent with this judgment and are reserving their respective rights.”
Also paragraph #9 of the final judgment leaves the door open for WiLAN to file for remuneration of attorneys’ fees, which is typical for a case like this. In other words, if successful, the ~1/3rd contingency payment would be paid by Apple as a separate add-on charge rather than paid by WiLAN from WiLAN’s award.
While the term patent troll is thrown around frequently, in this litigation the patents at issue are two patents developed by WiLAN itself and include an inventor who, to this day, remains on WiLAN’s payroll at CTO.
Sources: https://patents.google.com/patent/US8457145B2/en, https://patents.google.com/patent/US8537757B2/en?oq=8%2c537%2c757
Through both Substantial Issuer Bid and Normal Course Issuer Bid, Quarterhill repurchased 4.9 million shares total in 2020 for CAD $10.6 million. Approximately 9 million shares remain available to purchase under the NCIB plan.
Management and Board
Quarterhill’s board is influenced by a few large personal shareholders who have been involved or employed by the company previously. Michel Fattouche owns 1.9 million shares and co-founded WiLAN in 1992. He’s labeled as non-independent due to CAD $75,000 of consulting compensation received in 2018 from WiLAN. James Skippen owns 452,000 shares and previously served as Board Chair and interim CEO of WiLAN during 2018. Skippen acquired shares on the open market in 2019. John Gillberry currently serves as Board Chair and owns 115,400 shares. Gillberry served as CEO from October 2019 until the June 2020 hiring of technology-veteran Paul Hill. Quarterhill hired Paul Hill as CEO in June 2020. Paul has since acquired 240,000 shares on the open market. The company has a recent history of high turnover at the C-level. I believe this is due to a demanding and involved Board. For example, Gillberry has been willing to speak with investors.
Both Paul and Rish are accessible by phone and email. Paul clearly has a strategic focus and several ideas for driving IRD’s growth. Paul views IRD as a platform to which the company can expand organically and acquisitively. Acquisitions will focus on core and adjacent opportunities within IRD’s industry. Rish is very open to conversation about ideas and parallels from other industries – far from close minded.
Court of Appeals decision in early 2022
Continued Growth and Acquisition activity in IRD/intelligent transportation space
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