Analysis: Pendrell Corporation (OTCMKTS: PCOA)

Pendrell Corporation (OTCMKTS: PCOA) is an illiquid, closely held microcap which is currently trading below its net cash position. This document contains an independent analysis of the company. Information on my investment philosophy can be found here.

Disclaimer: The author is currently long PCOA. All of the views expressed in this document are solely those of the author and do not reflect the view of any other person or company. I am not receiving compensation for it. I have no business relationship with the company whose stock is mentioned in this document. All investments involve the risk of permanent capital loss. I encourage everyone to do their own due diligence and to reach their own conclusions. Under no circumstances should this document be considered an offer to buy or sell any securities mentioned within.

Summary

  • PCOA is currently trading below net cash value even after applying a 20% liquidity discount and 5% dilution. This provides significant downside protection.
  • Upside optionality:
    • Legacy memory and storage patents are still generating income ($90/share in AR as of Q3 2017).
    • Legacy content rights management patents have shown promise in the motion picture distribution industry. Licensing agreement signed with Disney in Q3 2017.
    • Net operating loss (NOL) carryforward would have some non-zero value if the company can execute on its acquisition strategy.
  • De-listing and de-registration of the stock have led to forced selling and created an attractive entry point. The market is currently betting that management is going to turn every $1.00 in cash into $0.60.
  • Disciplined management with a large equity stake in the company.
  • Uncorrelated from the market at a time when valuations are stretched.
  • Can be viewed as an alternative to holding cash with significant upside potential.
  • Illiquid and may take a decade or more to reflect value.

Company Background

1995 to 2011 (Satellite Phase) – In 1995, ICO Global Communication was founded to develop and operate a next-generation mobile satellite communications system. In 1999, after failing to secure additional funding, ICO Global filed for Chapter 11 bankruptcy. In 2000, telecom billionaire Craig McCaw acquired ICO Global out of bankruptcy and doubled down on their plan to develop a satellite system.

In 2004, progress again came to a halt after a disagreement with Boeing – the manufacturer and launch manager of their satellites – resulted in ICO Global filing suit for breach of contract. The legislative battle lasted until 2011 when ICO Global threw in the towel and divested their satellite assets. The exit generated ~$2.4 billion in net operating losses which begin to expire in 2025, with a significant portion expiring in 2032.

2011 – 2017 (IP Managment Phase) – In 2011, ICO Global changed its name to Pendrell Corporation and sought to purchase a business with high operating margins and low depreciation that would enable them to eat through that NOL. Managment decided on the intellectual property management business (patent trolling) and purchased Ovidian Group, a well-known company in the space, as a launching pad.

In late 2011, Pendrell purchased a stake in ContentGuard Holdings, Inc., a licensor of digital rights management and content distribution patents. In 2013, Pendrell purchased a stake in Provitro Biosciences, a licensor of commercial-scale plant propagation methods. In 2013, Pendrell purchased a patent portfolio from Nokia covering a range of memory and storage technologies used in electronic devices.

Results were disappointing. ContentGaurd lost numerous legal battles and Provitro failed to monetize. In 2014, Lee Mikles, a former money manager and CEO of FutureFuel Corporation, was brought on to replace the CEO. Mikles quickly began writing down the failed acquisitions. Provitro was completely sold off in 2015 and a minority stake in ContentGaurd was sold off in 2017.

This period wasn’t all bad though – those memory and storage patents acquired from Nokia turned out to have some value, generating ~$110 million in fees by 2016. ContentGaurd also showed some promise with a patent for transferring content rights that appealed to motion picture distributors. Warner Bros, Sony Entertainment, and The Walt Disney Company are all current licensees.

All in all, this venture into IP management led to a lot of write-downs, three licenses with movie studios, five licenses with the largest memory and storage manufacturers, and a number of licenses with smaller memory and storage manufacturers.

Present (Private Equity Phase) – In 2015, then new CEO Lee Mikles saw the writing on the wall and began pivoting away from the IP business, only retaining the most valuable assets. Mikles wanted to refocus the companies attention on acquiring a business with more reliable cash flow characteristics.

There was a problem though, the booming market meant that valuations for private businesses were extremely inflated. Instead of paying up, the company began cutting costs and preserving cash to be used when the market environment became more favorable.

In late 2017, management decided to perform a reverse stock-split and de-list from exchanges. The purpose was to fractionalize and redeem enough shares of the Common Stock to reduce the number of record holders to fewer than 300, thereby relieving them of reporting requirements. Management argued that this would lead to significant cost savings in excess of $1 million and increase optionality when purchasing businesses.

Investment Thesis

Boomtime profits, full employment, and record valuations aren’t exactly conducive to a value investing strategy. Longtime readers of this blog will know I tend to avoid the euphoria and instead focus on industries that haven’t shared in the boom (energy and mlps most recently) and special situations. Pendrell can be filed in a deep value, sit and wait category.

Over the last two decades, Pendrell’s management has made a series of capital-destructive decisions – overpaying for satellites, patents, and bamboo production – and the market has zero faith that it won’t be more of the same going forward. As such, the market has completely discounted Pendrell’s real, income producing assets, and is assuming that management is going to take every dollar of cash on the balance sheet and turn it into 60 cents.

On top of all that, Pendrell recently de-listed and de-registered its stock, sending the price down further, and moving trading over to the over the counter markets where volumes are non-existent. The most recent trade took place at $551. The current bid is $568 and the current ask is $580. As a contrarian, I find this negative sentiment attracting.

One of the greatest advantages an investor can have is a long-term time horizon. This allows us to enter illiquid, deep value bets that could take years or even decades to play out. Returns in these situations depend on three things: 1) our entry point is at a sufficient discount to underlying value, 2) management isn’t actively siphoning off nor impairing that value and 3) the market eventually accounts for that value in the share price.

  1. Pendrell currently has ~$820 per share in current assets (mainly cash and accounts receivables), net of debt. Assuming those assets do nothing for the next ten years and then are realized for full value, buying at the current discount would represent a ~4% annualized return (similar to a bond). However, if those assets are able to compound at a rate of 10% (Pendrell still has profitable income streams and hidden assets), buying at the current discount would represent an attractive ~15% annualized return.
  2. As for management, certain characteristics at least help to ensure that a company’s capital allocation approach is aligned with outside investors. In this case, large insider ownership, large share repurchases (management recently repurchased a 10% stake from Highland Crusader Partners at ~$650), and strong incentives for cash generation (using up the NOL).
  3.  Wait and see.

Floor Valuation

Assuming a 5% dilution of shares (about 1% dilutive options actually outstanding) and a 20% liquidity discount, we arrive at a floor valuation of $557.98 based solely on the cash available, net of debt. This doesn’t include:

  • Memory and Storage patents that are currently licensed to the largest five manufacturers in the industry. ($90/share in AR from Toshiba alone).
  • Content Rights Management patents that are currently licensed to three movie distributors.
  • Future acquisitions that may take advantage of Pendrell’s significant NOL tax asset.

PCOA Asset Valuation.png

The Bear Case

Management has a history of failure – Prior CEO, Benjamin Wolff, spent much of a decade purchasing a series of companies that were subsequently written down to zero and sold off by the current CEO, Lee Mikles. Mikles has yet to make any capital allocation decisions other than cutting costs to bare-bones levels and signaling a disciplined approach to acquisitions.

Closely held – Craig McCaw’s investment arm and management together represent the largest owners of PCOA stock and it’s their call if they want to put the money in a giant Scrooge McDuck style vault and go swimming in it. Minority investors don’t have much say.

NOL is worthless – The company has about a decade left to use up its NOL and tax reform package further reduced its value.

Illiquid and Nonreporting – The company rarely trades and information from management will be unforthcoming. Even if you wanted to build a position, it would take time to acquire the scarce shares and even more time to divest them.

Recommendation

In my opinion, PCOA is a buy below $560 with asymmetrical return characteristics and could be viewed as an alternative to cash with significant upside optionality.

Advertisements

2 thoughts on “Analysis: Pendrell Corporation (OTCMKTS: PCOA)”

  1. The reasons provided for privacy from federal disclosure requirements point in the direction of the acquisition of a business in stealth mode. It is inconceivable to think of a stealth-mode business with stable, recurring revenues. So I’m going to chalk that line up to management fluff.

    They’re falling head first into a trap. Craig is a multi-billionaire. Here, he sees $200M cash with $1B+ NOLs. How do you generate pre-tax income without doing something utterly asinine with the $200M? Well, you buy a stealth-mode company that’s taking a moonshot at something ultra-high risk with an ultra-high reward.

    You’ll have more fun at the Roulette wheels. At least the girls are pretty.

    Liked by 1 person

    1. Thanks for the comment. It’s entirely possible the future plays out as you’ve described.

      This thesis is more focused on getting the downside right. If we can buy an asset with a significant margin of safety, the odds of a favorable outcome tilt in our favor despite the unknowable future.

      For example, If we assume that management is only interested in taking a flier on a lottery ticket with that cash (I don’t actually believe management is incentivized to be this reckless with their own money), we can throw some back of the envelope odds on the outcomes. Let’s say 90% of stealth based startups fail and 10% return 10x (we will ignore the 100x examples for the sake of conservatism).

      So, 90% chance the cash on the balance sheet goes to zero and we are left with about $90 per share of net tangible assets (receivables and property less liabilities), and 10% chance the cash on the balance sheet goes to $2 billion and we are left with about $7,700 per share. The expected value of this bet is still a positive 55% return at current prices (90% chance we lose $460, 10% chance we gain $7,200).

      If we put more weight on management actually looking for a stable cash flowing business, as I do, the range of outcomes tightens. Either way, the risks are asymmetric.

      Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s