Immersion Corporation's Story Finally Unfolding

Executive summary:

• Immersion Corporation (IMMR) reported Q4 and fiscal 2013 results last Thursday night.


• Total revenues in Q4 2013 were $12.1 million (+ 36% Y/Y). Royalty and license revenues of $11.6 million (Immersion's most important metric) were up 52% from Q4 2012.


• Revenues for fiscal 2013 were $47.5 million (+ 48% Y/Y). Royalty and license revenues for fiscal 2013 totaled $46.2 million, an increase of 59% compared to 2012.


• A change in accounting method adopted in Q4 2013 and the release of a tax valuation allowance relating to net deferred tax assets make it a bit complicated to decipher the company's quarterly performance.


• Bottom line: 2013 was a breakthrough year for Immersion. While mobility has been the real revenue driver so far, other verticals and new business initiatives will boost growth going forward. Our TP: $20.

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Q4 and fiscal 2013 highlights

• Total revenues in Q4 2013 were $12.1 million (+36% Y/Y)


• Royalty and license revenues were $11.6 million (+52% Y/Y)


• Gross profit was $12 million, or 99% of revenues


• Net income for Q4 2013 was $37.4million, or $1.26 per share, which included the release of all company's deferred income tax valuation of $36.8 million


• The change in accounting, related to the decision to expense all patent costs rather than amortizing them, had a $800.000 negative impact on the quarter


• Included in the quarter were $627,000 of litigation-related expenses (from a lawsuit versus HTC)


• Total revenues for 2013 were $47.5 million (+48% Y/Y)


• Royalty and license revenues in 2013 were $46.2 million (+59% Y/Y)


• Adjusted EBITDA for 2013 (excluding the impact of the change in accounting) was $12.8 million


• The revenue breakdown by line of business is as follows:

1. Mobility (also includes chip partners) 66%


2. Gaming 21%


3. Medical 8%


4. Auto 5%

Overview: Q4 2013 a slight miss, however most data bullish for the future

Excluding the impact of the new accounting method for patent costs and excluding the release of the NOL carryforwards, Immersion recorded a profit of $0.05 per share in the quarter, slightly shy of consensus ($0.07). Revenues were also $340,000 short of analyst estimates.

The company guided for 2014 revenues of $54 million to $62 million (14% to 31% growth over 2013), and non-GAAP EPS (excluding stock-based compensation) in the $0.27 to $0.50 range, versus pre-earnings consensus of $61.3 million and $0.47 (not really comparable) .

2013 has been Immersion's first profitable year since becoming a public company. The conference call was very upbeat, with several data points indicating that the company has reached its inflection point in several verticals, and its market might actually be larger than we first anticipated.

The company is targeting to embed haptics into mobile video encoding, and expects this new business line to produce visible contribution to revenues starting from 2H 2014 / 2015. Added investments for this new vertical partially explain the increase in costs (and the EPS Q4 miss vs. consensus), but show bigger revenue ambitions than we modeled previously.

Here is a quick look at Immersion's performance (royalty and license revenue only) since Q1 2008 - as Q1 traditionally represents the company's strongest quarter, we used a different color for it to help visualize the recent trend:

(click to enlarge)

Here is a similar chart, highlighting 2013 revenue performance on a Y/Y basis:

(click to enlarge)

We also broke down revenues by line of business, but highlighting the revenue contribution deriving from the old Sony settlement, worth approximately $750.000 per quarter (new revenues from Sony related to PS4 are included in gaming and partially explain the Q4 positive performance, as they started in the last quarter):

On Friday, shares of Immersion Corporation gained 3.3%, as the market seemed to appreciate Q4 results but especially the positive commentary at the conference call.

Here is a quick snapshot of analyst ratings and price targets:

• Feltl - BUY, TTP $16


• Sidoti - BUY, TP $19


• Dougherty - BUY, TP $ 16

Automotive vertical: now a matter of when, not if

During the conference call, Immersion's management discussed the company's business opportunities in this vertical on several occasions.

Here are some of the highlights:

Vic Viegas - Chief Executive Officer

As automotive OEMs view the car user interface as an extension of their brand and a key factor in the overall consumer satisfaction with the car experience, we are now engaging directly with OEMs at a much higher level in the design and specification phase.

This is an exciting elevation in our level of engagement and speaks to the value that OEMs are placing on haptic technology. While these engagements have long design cycles, the enthusiasm we are seeing leaves us feeling very optimistic about the future of haptics in the automotive interior.

I am also pleased to announce that we recently entered into a multiyear licensing agreement with Continental, one of the world's largest tier one auto suppliers and a leading international provider of interface solutions for auto interiors. Under this agreement, Continental will offer Immersion haptics for its touchscreen, touchpad, and button interfaces.

The first design concept to come out of the Continental agreement was a recently previewed 2015 Mercedes touchpad for the C-class which uses a unique backlit touchpad with haptics to navigate the automotive UI.

As part of its solution development, Continental performed research to evaluate key safety metrics for touchpad interfaces with and without haptics which generated some compelling results. Their published research shows that the driver's gaze is diverted away from traffic 23% less with haptic feedback and that tasks were completed 33% quicker with haptics technology than without.

In spite of very long adoption cycles for new technologies, the automotive industry has also shown a relatively quick "me too" utilization approach to established technological improvements.

As several high end haptics implementations have already shown their effectiveness, we expect that Immersion's new and existing relations in the vertical will start delivering a sensible contribution to revenues starting from 2015.

Early adopters of Immersion's technology were Rolls Royce (OTCPK:RYCEY), BMW (OTCPK:BAMXY), Mercedes and Lexus.

As a reminder, here is a partial list of partnerships in the vertical: Daesung Electric Co. Ltd., a leading Korean automotive original design manufacturer and major supplier to Hyundai (OTC:HYMLF) and Kia (OTC:KIMTF), Visteon (VC), ALPS Electric, Tokai Rika, Valeo, Densitron, Panasonic, Methode Electronics, Inc., Sanyo, Continental and SMK. As you may have noticed, there is also a very good presence of Asian partners, which represent an interesting potential for the vertical as half of new car production is now happening in the Far East region, as shown by this analysis by Asymco:

For those interested, here is the link to Continental's study conducted in partnership with the University of Kassel (Germany), and mentioned during the conference call.

Lenovo's acquisition of Motorola a positive for Immersion (now official)

As we speculated, Lenovo's announced acquisition of Motorola may represent a positive for Immersion, which we described as a potential 5 to 10 multiplier for the revenue stream that Motorola alone could have represented for the company (emphasis added):

Jeff Schreiner - Feltl and Company

Can you just talk about the recent acquisition by Lenovo of an Immersion licensee, Motorola? First, is the license transferable and is there any risk to revenues from this transaction in calendar year '14?

Vic Viegas - Immersion Corporation - President, CEO

I don't believe that that transaction has actually occurred yet so that is still subject to the normal closing process. We see that as a net positive for Immersion. We don't see it as a significant risk with our Motorola relationship. We think that Motorola has a bright future and if anything, Lenovo probably helps support their growth efforts so we see this as a net positive.

Obviously, with a relationship directly with Motorola we would like to think that we can continue to work with Lenovo and eventually sign them to a license agreement for Lenovo branded products. To be clear, the Motorola agreement I don't believe is transferable and it really is covering the Motorola branded products.

Paul Norris - Immersion Corporation - CFO

That's right, Jeff. It covers Motorola branded product and it is an IP license and so as we go forward, talking currently with the Motorola group and in the future, to the extent the acquisition goes through with Lenovo, we will be focused on opportunities to expand the license scope and to shift the attention from IP to higher quality TouchSense solutions as well.

While China is often characterized as a country where it is difficult to get recognition for IP, Immersion's recent direct OEM agreement with Xiaomi, which represents 6% of the Chinese market, future presence through the soon-to-be-relaunched Motorola brand, and indirect sales through chip partners (basic haptics) may ensure that the company takes a good share of this increasingly important smartphone and tablet market. We also noticed that Immersion's management hinted at negotiations to increase the company's presence in the region through new partnerships.

Strong Samsung partnership unaffected by OS utilized

To clear any doubt about what might happen if the next Samsung Gear watch is based on Tizen rather than Android, as speculated, we asked the direct question:

Paolo Gorgo - Nortia Research

Just a quick comment if you can, there is a rumor that the next Samsung watch might not have Android but Tizen as OS. Would this change something as to Haptics implementation or your relationship with Samsung related to this vertical?

Vic Viegas - Immersion Corporation - President, CEO

We have worked with Samsung on both the Tizen OS and the Android OS and there could be certain reasons why they would launch one product with one operating system and another with another but from our standpoint, each represents an opportunity.

Strong cash position as several licensees pre-paid their fixed annual rate

At the end of January, Immersion Corporation's cash portfolio totaled $86.6 million, compared to $71.1 million as of December 31, 2013, and including the re-purchase of $4.4 million of stock.

In other words, Immersion's cash position improved about $20 million in January, as the company collected payments for fixed-based 2014 annual royalties, which we believe include for example Samsung (in a similar fashion to last year) and Sony, as to the new PS4 console. We expect Sony to contribute with PS4 per-unit-sold royalties, too, throughout 2014.

Patent value and EPS/Revenue multiples potentially make Immersion a $20 stock

In a best case scenario, assuming positive developments in the automotive and the new media/content verticals, combined with a positive conclusion of the HTC litigation, we see Immersion's share worth $20.

Here are some of the catalysts that make us optimistic about Immersion's capacity to keep growing revenues:

• Wide touchscreen adoption, with Android leading the front as the most sold OS (and basic haptics requiring a license)


• Growing basic haptic royalties - both because of growing Android unit sales and because of new agreements with Android OEMs that do not license haptics from Immersion yet (we estimate that the company is collecting basic haptic royalties for roughly half of the Android devices sold in the market at the moment)


• Growing advanced haptics revenues - both in unit number and ASP


• Automotive line of business finally taking off (with relatively high per-unit royalties)


• New media/content line of business getting traction. Mobile ads are estimated to reach a significant level, in the tens of billions of dollars, and just a small piece of the cake could already be significant to Immersion.

We forecast that Immersion could reach revenues of over $ 70 million in 2015, and non-GAAP EPS of about $0.50, with a positive cash position of $110 million at year-end (or roughly $3.33 per share).

We believe that the high margin, mostly fixed costs and protected (by a strong set of patents) business model, combined with the growing market opportunity in front of the company deserves a relatively high multiple on forecasted EPS.

Assuming 25x estimated 2015 EPS, and adding the cash we estimated at year's end, we get to a TP of $15.83, in line with most analysts covering the company. A higher 30x multiple would lead us over $18.

However, we believe that this calculation doesn't take into full consideration the value of Immersion's IP, which might deserve a premium.

Patent costs are increasingly important for smartphone and tablet OEMs:

Mr White of Bristol York estimates that device makers already have to pay royalties for 200-300 patents for a typical smart-phone. Patent costs are 15-20% of its selling price, or about half of what the hardware components cost.

Cross-licensing has become the name of the game recently among the most important OEMs.

Ben Thompson underlined about the Google (GOOG) - Lenovo deal that although Google retained most of the patent portfolio, the right to cross-license was key for the acquirer:

Motorola was worth more to Lenovo than almost anyone else because the deal included the right to cross-license Motorola's patents.

Immersion's powerful patent arsenal, that potentially includes the right to collect a royalty from each and every Android OEM for basic haptics, may become more valuable than just a multiple on earnings to a smartphone and tablet producer like Samsung or any other company wishing to strengthen its negotiating ability with other patent holders in the sector, and/or differentiate its high end product through the more advanced localized haptic effects the company has recently been developing.

Even outside of this hypothesis, and assuming there is no value in the other lines of business while mobility represents about 70% of our 2015 forecasted revenues, Immersion would be generating about $50 million a year mostly from a key category like smartphone and tablet producers.

We still may see a scenario where the market puts this number in the 10x revenue club, due to the combination of huge growing market / high margin / IP protected position. Add the estimated cash on hand, and a price target of $20 becomes a possibility under this reasoning, with new license agreements acting as short term catalysts to attract new investors.

Source: Immersion Corporation's Story Finally Unfolding

Disclosure: I am long IMMR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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