Tessera Technologies Activist Situation Report
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Tessera Technologies Activist Situation Report



tessera, technologies, activism, activist

tessera, technologies, activism, activist



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Tessera Technologies Activist Situation Report Tessera Technologies Activist Situation Report Document Transcript

  • The Shareholder Communication Strategists The objective of the Activist Situation Report is to highlight key issues that might be raised by the Dissident investor in a proxy contest. This report is not intended to provide advisory vote recommendation. For a more detailed discussion of our analysis, please contact Waheed Hassan, CFA at whassan@allianceadvisorsllc.com or 202-549-8399. Summary • The proxy fight for board representation at Tessera Technologies (“Tessera,” “TSRA” or “the Company”) initiated by Starboard Value LP (“the Dissident”) is in the initial stages. Neither side has yet presented their detailed arguments to shareholders in support of their nominees. • We believe the Dissident will focus on the following issues: sub-par Total Shareholder Return (“TSR”); lack of core revenue growth; the nominal impact of R&D and acquisition spending on top- line growth; the recurring losses in the Digital Optics segment which appears to be a drag on Company profitability; and the capital allocation strategy which has resulted in 68% of Total Assets being held in Cash/ST Investments resulting in a depressed ROE. • Our assessment of TSRA’s performance and corporate governance practices suggest that shareholders are likely to conclude that some change may be warranted at the board level. However, considering that the Company has proactively taken steps to bolster its management team, inducted new board members with significant industry experience and more importantly, has outperformed its peer group and benchmark indices in terms of share price performance since appointment of the new CEO in May 2011 – shareholders are unlikely to be supportive of all three Dissident nominees. • Furthermore, the fact that Starboard is seeking three seats on a six-member board has the potential to create a gridlock situation and could yield majority board representation to the Dissident if one of the incumbent nominees were to resign. • Lastly, while the management and board changes are steps in the right direction, in our experience, activists often contend that the board’s decision to appoint a legacy director as the CEO – in absence of a formal CEO search process by an independent executive search firm – is indicative of an “entrenched board.” Additionally, the Dissident could legitimately question the rationale for selecting as the CEO a director from the same board that has overseen periods of sustained share price underperformance. Dr. Young has been a director of TSRA for over 20 years (since 1991). Target: Tessera Technologies, Inc. (Nasdaq: TSRA) Activist/Dissident: Starboard Value LP (1.3% holder) At stake: 3 seats on a 6-member board Board composition: Annually elected board with all 6 seats up for election Meeting date: March 30, 2012 Probable outcome: Settlement/Dissident gets board seat (s) January 30, 2012
  • The Shareholder Communication Strategists 2 Analytical Framework Alliance Advisors utilizes the same two-pronged analytical framework that Institutional Shareholder Services (“ISS”) and many institutional investors use when evaluating contested solicitation efforts. As Starboard is seeking minority board representation – one board seat just shy of control – the Dissident must prove: 1. That board change is preferable to the status quo; and 2. That the Dissident slate will add value to board deliberations including, among other factors, by considering issues from a different viewpoint than the current board members. Question 1 – Is Change Needed? In determining whether change is needed at the board level, some of the performance factors that shareholders are likely to focus on include Total Shareholder Return (“TSR”), operating performance, corporate governance practices, and management’s current operating plan. If the conclusion is that change is indeed warranted, the second prong of this analytical framework would then apply – can the dissident slate add value to the board? Management Changes Tessera is likely to contend that the board has been proactively engaged in overseeing management, and therefore a significant change in the board composition is unwarranted at this time. More specifically, on May 11, 2011, Robert A. Young, Ph.D. was appointed as President and Chief Executive Officer. Dr. Young has served as a member of Tessera’s Board of Directors since 1991 and served as Chairman of the Board from 1996 to 2002. Dr. Young replaced Henry R. Nothhaft – then-President, Chief Executive Officer and Chairman of the Board. Following Mr. Nothhaft’s departure, the board separated the role of Chairman and CEO and appointed Robert J. Boehlke as Chairman of the Board. Apart from the CEO changes, the Company has replaced more than half the senior management team (new head of Digital Optics Corporation, Intellectual Property group, and Chief Administration Officer), added two new directors to the Board (Kevin G. Rivette and Anthony J. Tether), and retained a financial advisor to help refocus its strategies to address emerging market opportunities. Notwithstanding the above, the Dissident could contend that the board has been “reactive” in making the necessary changes. First, the decision to appoint Dr. Young as the CEO might appear to be in response to Mr. Nothhaft’s resignation. More importantly, there is little information on the board’s deliberations on whether to conduct a formal CEO search process prior to appointing Dr. Young the CEO. Moreover, the Dissident is likely to question the board’s decision to appoint an incumbent director who oversaw period of sustained underperformance as CEO.
  • The Shareholder Communication Strategists 3 Total Shareholder Return • TSRA has consistently underperformed both its peer group and benchmark indices over 1-year, 3- year- and 5-year periods. The peer group is comprised of companies mentioned in TSRA’s 2011 proxy statement and 10-K filing with $1.5 billion or less in market capitalization. • The appointment of Dr. Young as the new CEO seems to have restored the market’s confidence in TSRA’s strategy. Since his appointment on May 11, 2011 to-date, TSRA’s share price (up 5.2%) has outperformed both its peer median (up 0.2%) and the benchmark PHLX Semiconductor Index (down 6.5%). • As shareholders are impacted most by share price, TSRA’s sustained relative underperformance could support the Dissident’s case for change. Relative TSR Performance Source: Thomson Reuters. TSR data is annualized. Peer group is comprised of AMKR, CYMI, ELX, MCRL, MPWR, OVTI, OSIS, PLT, PMCS, POWI, STEC, SMCI, SYNA. Total Shareholder Return (1/27/2012) 1-year 3-year 5-year AMKOR TECHNOLOGY, INC. -30.2% 31.5% -11.5% CYMER, INC. 4.2% 32.2% 4.6% EMULEX CORPORATION -7.5% 15.2% -9.4% MICREL, INCORPORATED -11.7% 18.9% 4.1% MONOLITHIC POWER SYSTEMS, INC. 11.2% 8.9% 6.1% OMNIVISION TECHNOLOGIES, INC. -46.6% 29.2% 4.3% OSI SYSTEMS, INC. 42.9% 68.9% 19.3% PLANTRONICS, INC. 6.6% 50.0% 14.8% PMC-SIERRA, INC. -25.8% 12.2% 0.6% POWER INTEGRATIONS, INC. -2.6% 23.7% 10.5% STEC, INC. -54.4% 29.0% -2.4% SUPER MICRO COMPUTER, INC. 23.2% 42.6% 14.3% SYNAPTICS INCORPORATED 29.4% 15.6% 15.4% Peer Mean -4.7% 29.1% 5.4% Peer Median -2.6% 29.0% 4.6% NASDAQ COMPOSITE 2.2% 23.2% 2.9% PHLX SEMICONDUCTOR INDEX -8.4% 23.9% -2.2% TESSERA TECHNOLOGIES, INC. -6.2% 18.5% -12.5% TSR
  • The Shareholder Communication Strategists 4 5-Year TSR Source: Thomson Reuters; PHLX Semiconductor Index data from FactSet. Peer group is comprised of AMKR, CYMI, ELX, MCRL, MPWR, OVTI, OSIS, PLT, PMCS, POWI, STEC, SMCI, SYNA. Operating Performance • Revenue: TSRA’s revenue has a high degree of variability due to one-time litigation/arbitration related payments. After adjusting for such variability, it appears that the Company was unable to maintain the momentum in ‘core revenue’ growth, which got a boost from the DOC acquisition in mid-2006, but has stalled since FY2008. We calculate ‘core revenue’ as Reported Revenue less arbitration/litigation-related payments. Revenue Source: Thomson Reuters; Company press release and 10-K filing 0 20 40 60 80 100 120 140 160 180 200 29-Jan-07 29-Mar-07 29-May-07 29-Jul-07 29-Sep-07 29-Nov-07 29-Jan-08 29-Mar-08 29-May-08 29-Jul-08 29-Sep-08 29-Nov-08 29-Jan-09 29-Mar-09 29-May-09 29-Jul-09 29-Sep-09 29-Nov-09 29-Jan-10 29-Mar-10 29-May-10 29-Jul-10 29-Sep-10 29-Nov-10 29-Jan-11 29-Mar-11 29-May-11 29-Jul-11 29-Sep-11 29-Nov-11 5-year Total Shareholder Return (as of 1/27/2012) TSRA Peer median NASDAQ COMPOSITE PHLX SEMICONDUCTOR INDEX $131.6 $195.7 $248.1 $238.8 $286.4 $254.6 $77.1 $0.0 $0.2 $60.6 $15.0 $0.0 $0 $50 $100 $150 $200 $250 $300 $350 2006 2007 2008 2009 2010 2011 Revenue Mix (in millions) Core Revenue Litigation/Arbitrationpayments
  • The Shareholder Communication Strategists 5 • R&D/Acquisitions: The Dissident is likely to question the efficiency of TSRA’s R&D and acquisition spending as neither has translated into meaningful top-line growth. R&D expenditure accounted for approximately 25% of TSRA’s total revenue in FY2010 (30% in FY2011) compared to an average 15% for the peer group in 2010 (please note that 2011 financial data is not available for all peer companies). Furthermore, continued R&D spending, together with rising SG&A costs, has adversely affected profit margins (excluding write-offs/impairment charges) – down from 47.4% in FY2006 to 16.6% in FY2011. • With respect to R&D/acquisitions, the Company is likely to contend that it takes time to integrate acquisitions and technology. More importantly, 2012 is likely to be transitional year for the Digital Optics business, which accounts for most of the acquisitions. The acquisitions and R&D have enabled TSRA to design a “game changer” solution for mobile cameras, which will enable the Company to compete in the highly fragmented $1 billion MEMS auto-focus market. R&D/Acquisition Spending vs. Revenue Source: Thomson Reuters; Company press release and 10-K filing $20 $38 $62 $66 $74 $76 $60 $18 $39 $5 $15 -$60 -$40 -$20 $0 $20 $40 $60 $80 $100 $120 $140 2006 2007 2008 2009 2010 2011 R&D and Acquisition Spend vs. Revenue Change (in millions) R&D Acquisition Change in Total Revenue
  • The Shareholder Communication Strategists 6 Operating Margin Source: Thomson Reuters; Company press release and 10-K filing • Segments: A segment-wise analysis suggests that despite two major acquisitions – FotoNation for $39 million in 2008 and Digital Optics Corporation for $59.5 million in 2006 – the Digital Optics business continues to be a drag on the Company’s overall performance. It appears that the Micro- electronics segment has subsidized the Digital Optics business, which has yet to achieve profitability. Though management would contend that the Digital Optics segment is at an inflection point due to the “game changer” nature of the new MEMS products, the Dissident would likely argue that such claims are subject to (normal) execution risks and that historically the Company has failed to demonstrate a successful game plan for the segment. Segment Operating Performance 2008 2009 2010 *LTM (Sept 2011) Micro-electronics Revenue $214.5mn $269.7mn $264.1mn $235.6mn Operating Exp 123.9 63.8 61.7 79.2 Operating Income/(Loss) $90.7 $205.9 $202.4 $156.4 Digital Optics (formerly Imaging and Optics) Revenue $33.8mn $29.7mn $37.3mn $42.7mn Operating Exp 69.1 75.6 93.1 140.0 Operating Income/(Loss) ($35.4) ($45.9) ($55.8) ($97.3) Source: Thomson Reuters, SEC filings. *Segment-wise operating expense data is not currently available • Litigation: Since FY2006, TSRA has annually spent an average 12% of its revenue on litigation expenses (11.5% of total revenue in FY2011). The Company has engaged in litigation and arbitration proceedings to directly or indirectly enforce its intellectual property rights and the terms of the license agreements, including proceedings to ensure proper and full payment of royalties. Though the high level of recurring litigation expense seems unusual, the Company has managed to recover a significant amount through arbitration and litigation awards. 47.4% 33.8% 6.5% 39.3% 34.6% 16.6% 61.1% 45.2% 40.4% 48.0% 41.9% 28.2% 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 2006 2007 2008 2009 2010 2011 Operating Margin Operating Margin(incl. litigationexp) Operating Margin(excl. litigationexp)
  • The Shareholder Communication Strategists 7 Litigation Expense vs. Recoveries Source: Thomson Reuters, SEC filings • Capital Allocation: The Dissident is also likely to be critical of TSRA’s capital allocation strategy, which apparently is to retain Cash and ST Investments on the balance sheet. Cash/ST Investments accounted for 68% of Total Assets in FY2011 (ending Dec. 31, 2011). As Cash/ST Investments tend to generate nominal returns, TSRA’s overall Adjusted Return on Equity metric has suffered as a consequence of the capital allocation strategy. We added impairment/write-off related charges to reported Net Income to compute Adjusted Net Income – $54.9 million in FY2011. TSRA’s Capital Allocation vs. Adjusted ROE Source: Thomson Reuters, SEC filings. $28.6 $51.0 $135.3 $161.4 $183.3 $212.6 $77.1 $77.1 $77.3 $137.9 $152.9 $152.9 $0 $50 $100 $150 $200 $250 2006 2007 2008 2009 2010 2011 Litigation Expense (cumulative) vs. Amount recovered (cumulative) (in millions) Litigation Expense Past Production Payments/Arbitration awards 60.4 65.2 55.1 62.9 66.7 68.4 25.3 12.5 1.1 13.7 9.3 5.3 0.0 5.0 10.0 15.0 20.0 25.0 30.0 40.0 45.0 50.0 55.0 60.0 65.0 70.0 75.0 2006 2007 2008 2009 2010 2011 Capital Allocation vs. Adj. ROE (%) Cash/STInvestment % of Total Assets (LHS) Adjusted Return on Equity (RHS)
  • The Shareholder Communication Strategists 8 Management’s Plan • With a new CEO assuming charge in May 2011, the Company is likely to contend that it needs sufficient time to execute its new strategy. Meanwhile, it will also likely highlight the following achievements and targets to suggest that it is on the right track: • Successful renewal of two large revenue-generating licenses held by Samsung and Hynix. • The Company has positioned the Digital Optics business with the right technologies and people to exploit a large and growing market that has yet to see the kind of transformative innovation which has been common in other consumer electronics businesses. • The new Digital Optics’ products will target the multi-billion dollar market for mobile camera modules – a fragmented market in which low-margin assemblers compete with similar designs and commoditized components. TSRA technologies will enable a new generation of feature-rich camera modules within several well established markets including mobile phones. • The Company is discussing its offerings with Tier One OEM, manufacturers of wireless handsets, and expects to ship the new Digital Optics’ game-changing products in late 2012. • First half of 2012: TSRA will sign its first design win for the use of MEMS optical imaging technology in a new cell phone. • Second half of 2012: TSRA will announce major steps toward high-volume manufacturing of devices using this MEMS technology. • TSRA does not provide financial guidance. The stock is covered by only one sell-side analyst, who has a Buy rating with a $32/share price target. The Company is likely to contend that despite low coverage, Wall Street sees value in a new roadmap as reflected in a substantially higher target price. The Dissident however, would argue that a history of sustained share price underperformance is indicative of investors’ lack of confidence in the current management/board’s ability to execute. Corporate Governance • Although TSRA has a few shareholder friendly corporate governance practices such as an annually elected board, no shareholder rights plan (“poison pill”), and a majority voting standard in uncontested elections, it still maintains several provisions that are viewed as pro-management. Non-Shareholder-Friendly Provisions • Board is authorized to increase or decrease the size of the board without shareholder approval. • Directors may only be removed for cause and only by the vote of 66.67% of the shares entitled to vote. • All vacancies on board are filled by remaining directors, including vacancies as a result of removal or an enlargement of the board. • Shareholders may not act by written consent. • Shareholders cannot call special meetings. • Supermajority vote requirement (66.67%) to amend certain charter and all bylaw provisions. • Board is authorized to issue blank check preferred stock. • Board is authorized to adopt, amend or repeal bylaws without shareholder approval.
  • The Shareholder Communication Strategists 9 • While noting that TSRA proactively adopted a majority voting standard and separated the role of Chairman and CEO in 2011, the Dissident is likely to contend that if elected, its nominees would advocate for more shareholder-friendly corporate governance provisions at the Company. Question 2 – Can the activist nominees effect change? • Starboard has nominated Maury Austin, Peter A. Feld and Jeffery S. McCreary as potential board members at TSRA. Most recently, Mr. Austin was the Vice President and CFO at MIPS Technologies – another company where Starboard threatened a proxy fight and agreed to settlement for board representation. Mr. McCreary was one of Starboard’s nominees to the MIPS board. The Dissident will assert that its nominees have relevant industry and public board experience and will bring valuable shareholder perspective to TSRA’s board. • The Company is likely to counter by asserting that it recognized the need for additional perspective at the board level, well prior to Starboard submitting its nominations. As a result, in March 2011, it appointed Kevin G. Rivette and later in August 2011, Anthony J. Tether to the board – both of whom have significant relevant industry experience. Conclusion Our assessment of TSRA’s performance and corporate governance practices suggest that shareholders are likely to conclude that some change may be warranted at the board level. However, considering that the Company has proactively taken steps to bolster its management team, inducted new board members with significant industry experience and more importantly, has outperformed its peer group and benchmark indices in terms of share price performance since appointment of the new CEO in May 2011 – shareholders are unlikely to be supportive of all three Dissident nominees.
  • The Shareholder Communication Strategists 10 Disclaimer: No information available through this report is intended to constitute advice or endorsement of any investment, tax or legal matter. Alliance Advisors believes the information contained in this report to be reliable and correct. However, Alliance Advisors makes no representation or warranty (express or implied) as to the accuracy, completeness or continued availability of the information, materials and data available in this report. To the fullest extent permissible under applicable law, Alliance Advisors accepts no responsibility or liability of any kind with respect to the accuracy or completeness of the information, materials and data in this report. Copyright © 2012 by Alliance Advisors, LLC. ALL RIGHTS RESERVED.