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IP? Chips? Which way?

by Paula Schaap  |  Published March 1, 2013 at 3:53 PM
By most accounts, Tessera Technologies Inc. does one thing really well: make money from patents, and if that was all it did, Tessera would be a respectable company -- perhaps a profitable one -- in a good business with nice chunk of cash on its balance sheet. But Tessera also has a division that makes chips for cameras. That could be good business. Or it could be a complete bust. Right now its future is not clear.

What is clear is that a debate over whether Tessera should pursue the chip business or stick to its patents has ignited a proxy fight and a public battle among board members that resulted in two highly regarded directors issuing an ultimatum to the chairman: Either you leave or we will. The future of the company -- whether in intellectual property or new product development -- depends on the outcome of the dispute.

The governance thunderbolt came in the form of a regulatory filing Feb. 25, announcing the planned resignations of two independent directors, John Goodrich and Kevin Rivette, who said they would quit, effective March 1, unless chairman Robert Boehlke left the board by the close of business that day.

The resigning directors complained that Boehlke was out of line when he directed the company's CEO, Robert Young, to meet with activist investor and 6% stakeholder Starboard Value LP, without involving the rest of the board. The company said in a statement responding to the tendered resignations that Boehlke was going nowhere, and that, therefore, Tessera expected Goodrich and Rivette to be off the board come March 1.

Tessera officials and Starboard have held talks since the resignations were submitted, according to a person familiar with the matter, but it is unclear where those discussions might lead.

The spat arises from San Jose, Calif.-based Tessera's two businesses. In one, the company holds a patent portfolio that technology companies use in the tiny chips and wafers that power just about everything in the post-industrial world. For that part of its business it acts as a packager or integrator, helping companies with expertise and licensing and, at times, suing them when it believes its patents have been infringed upon.

The company also has an optics division that it acquired in 2006 when it bought Digital Optics Corp. for $59.5 million in cash.

Starboard is exercised that Tessera hasn't moved ahead with a possible sale or spinoff of the optics unit, which was on the table after the company hired GCA Savvian Advisors LLC in April 2011.

The reason it got nowhere with the split, the activist contends, is that the business isn't profitable. What's more, Starboard said in a Feb. 19 letter to Tessera's board, the company's pursuit of the latest, and it hopes, greatest, in miniaturization for camera optics -- MEMS (microelectromechanical systems) -- will be a financial black hole for some time to come. Starboard wants Tessera to stop throwing money at MEMS -- $132.4 million for 2012, according to the hedge fund's calculations.

Tessera reported a net loss of $20.6 million in the fourth quarter of 2012 as compared to net income of $2.6 million for the same time the year before and a full-year loss of $30.2 million that was about 57% more than the loss in 2011. The company has a market capitalization of about $928 million.

What's more, according to Bank of America Merrill Lynch analyst Krish Sankar, with R&D projected at about $84 million in 2013 and $86 million in 2014, as well as other costs, the company won't see profits from the division until, at the earliest, 2015.

"With [management] pushing out expectations around the timing of a ramp in DigitalOptics we expect initial revenue recognition for MEMS-based camera modules is likely a 2Q13 phenomenon (we estimate ~20K units in 2Q), with any meaningful pick-up in volume likely to occur in the back-half of the year," Sankar wrote in a Feb. 8 note.

Starboard said it's fed up with waiting, and is pushing the company to meet expectations for its optics business, or dump it.

The activist, not uncoincidentally, is urging the company to take some of its $442.6 million in cash on the balance sheet and instead of chasing returns from optics, give some of that back to shareholders.

That is Starboard's sweet spot, one industry watcher noted; finding companies where it can tell them to monetize what they do well and get rid of what they have no business doing. It's not unlike the hedge fund's campaign last year at AOL Inc. In Tessera's case the money-making business would be patent monetization, in AOL's its legacy dial-up Internet business, while the place where Starboard wants the company to stop bravely going where it hasn't gone before is the optics business for Tessera. At AOL it was new media.

In AOL's case, Starboard didn't win its proxy fight because CEO Tim Armstrong persuaded investors to give him more time to move the company into its new model.With Tessera's board rift out in the open, Starboard's hand is stronger.

Observers familiar with proxy fights say the public nature of the directors' resignations was unusual, with one source calling it "extraordinary."

Damien Park, the founder of Hedge Fund Solutions LLC, which advises on proxy contests, said the split had to benefit Starboard because normally investors want to see the board working as a cohesive unit.

In addition, Park noted, since Tessera moved up its 2012 annual meeting in what Starboard considered a bid to thwart its ability to nominate directors -- it would have had to rush its nominations through during the Christmas and New Year's holiday season -- shareholders are likely to be more sensitive to directors themselves raising corporate governance issues.

Also these directors are not just any retired CEOs who have time on their hands and are happy to collect fees for not much work. Goodrich is a retired lawyer, but he retired as a name partner from technology-focused Wilson Sonsini Goodrich & Rosati. In the world of tech attorneys, he is, as one legal source put it, "a serious guy."

Meanwhile, Rivette, a registered patent attorney, has also been around in Silicon Valley. In fact, his firm, 3LP Advisors LLC, advised Tessera on the acquisition of some of its patent portfolios before he was asked to come on the board in 2011.

In the letter to the board, the dissident directors wrote, "Mr. Boehlke has arrogated to himself necessary board review and guidance of management, and indeed, in our opinion, has acted in many instances as a senior operating executive. ... As one of many examples, the Chairman's failure to call a meeting of the board to respond to a letter addressed to the board from our largest shareholder, and his direction that our CEO should meet directly with that shareholder without notice to or input from the board illustrates arrogation of power that properly resides in the board."

There has been no word on whether the nascent proxy contest might be settled, despite the contact between Starboard and Tessera. Starboard has placeholder nominations for seven out of eight board members, but has yet to decide how many it will ultimately nominate, according to someone familiar with the firm.

And investors are also talking to Starboard, another industry source confirmed.

Starboard and Rivette declined to comment. Calls to Tessera and Goodrich weren't returned.

But one observer said that if the corporate dust settles and the company does the right thing by the optics business, which means, in this person's view, giving into Starboard's demands, Tessera could still be the premiere patent monetization company in tech valley.

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Tags: 3LP Advisors LLC | AOL Inc. | Damien Park | Digital Optics Corp. | GCA Savvian Advisors LLC | Hedge Fund Solutions LLC | John Goodrich | Kevin Rivette | Robert Boehlke | Robert Young | Starboard Value LP | Tessera Technologies Inc. | Tim Armstrong | Wilson Sonsini Goodrich & Rosati

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