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Trident Microsystems (TRIDQ) – Value in Bankruptcy

February 01, 2012 | About:
Trident Microsystems (TRIDQ) is a recent bankruptcy where there might actually be a substantial recovery for the equity. There appears to be a. downside protection in the form of substantial value to the equity in a liquidation scenario, b. upside in a reorganization of the company as a going concern, and c. a party that will go to bat for the interest of the equity holders.

Background

Trident designs and markets microchips. They started off in PC graphic design chips in the 90s. As that market consolidated they sold off the PC graphics business in 2000 and started making video controllers for digital TVs. They did well in that business until 2008 when the market shifted to an integrated video and audio chip and Trident was left behind. Trident acquired several small business lines from Micronas in 2009 for $17 million in stock. In February 2010 Trident purchased the digital TV (DTV) and set top box (STB) business lines from NXP Semiconductor for 60% of TRID stock. The DTV and STB lines are now their primary markets, and they sell to customers like Samsung and Sony.

The operating results since acquiring the DTV and STB lines from NXP have been terrible to say the least with CFO of -79 million in 2010 and -38 million through 9 months of 2011. This led TRID to file for bankruptcy on January 4th. In their filings, Trident describes the events leading up to their bankruptcy:

Like many technology based industries, the set-top box and television industries in which the Company focuses its operations have been undergoing rapid changes which have made it difficult for the Company to operate profitably. The Company has faced increased pricing pressure from Taiwanese SoC suppliers who have recently made great inroads in penetrating the market. Additionally, industry semiconductor inventory levels are currently elevated due to slowdown in consumer electronics markets primarily driven by slowdown in Western economies, which has forced all market participants, including the Company, to further adjust pricing to manage inventory levels. These pricing pressures have been compounded by set-top box manufacturers who have been slower than anticipated in launching new products. As a result, suppliers have been straddled with higher than anticipated inventory levels and high development costs that cannot be offset by next generation product sales. In addition to these pricing and inventory pressures, there has also been a shift in the industry’s supply chain dominated by Asian OEMs (original equipment manufacturers) and TV manufacturers are increasingly depending on manufacturing SoC and FRC (frame rate converter) components for high-end TVs in-house, reducing the need to look to outside suppliers for products. As a result of the above items, the Company has experienced continued operating losses which have resulted in declining cash over the past year.

It looks like there would be substantial value to the equity even if the company were to liquidate in bankruptcy. And while the intentions of the players involved are unclear at this point, the company may be attempting to reorganize itself as a pure IP licensing company, in which case there may be further upside. Let’s start with a liquidation analysis.

Assets

TRID’s goal is to sell off most of the operating assets of the company through the sale of the DTV and STB business lines. So that leaves current cash on hand and proceeds from those sales as their primary assets. There is also value in the remaining payment from the RDA Micro IP license and a note receivable from NXP.

Cash

According to Trident’s testimony at first day pleadings, the company filed with $55 million in cash. On their Q3 11 call, the company projected ending 2011 with $25-35 million in cash, inclusive of a $20 million sale/leaseback transaction on a facility in China that was completed in Q4. So it is not entirely clear where the extra cash came from. Part of the extra cash is a $7.5 million initial payment received from RDA Micro for an IP license. That still leaves $12.5 million above even the high end of their estimate. It is hard to imagine that the operating results came in that substantially above plan. TRID had said that NXP was going to loosen payment terms (TRID outsources manufacturing to NXP as part of the sale agreement), and they might have gotten some other vendors to stretch terms as well. If that is the case those increased liabilities will be accounted for in TRID’s stated pre-petition trade claims, although it is possible some of the extended terms also relate to off balance sheet purchase obligations.

So far TRID has only released cash flow projections for the two filing entities, which showed a cash balance of only $13 million as of January 16th. It appears then there is cash at other subsidiaries. TRID will begin filing both consolidated and entity-by-entity cash flow statements in February so we will have a better picture of their cash balance.

RDA Micro IP License Payment

On the day they filed, TRID also announced a $16 million IP licensing agreement with RDA Microelectronics. TRID has been paid $7.5 million and has yet to receive the remaining $8.5 million.

Sale of Set-Top Box Business

TRID will be auctioning off their STB business in a Section 363 sale process. Entropic Communications (ENTR) has placed a $55 million stalking horse bid for this business. The auction is scheduled to take place on February 23rd and a court hearing regarding the sale is scheduled for the 27th.

TRID provided stand alone financials for the STB business in their court filings on the asset purchase agreement with Entropic. The unit did $150.3 million in revenue and $34.6 million in gross profit from February to December 2010 and $95.2 million in revenue and $21.2 million in gross profit in the first nine months of 2011. Even if we annualize the 2011 numbers and assume $127 million in annual sales, ENTR’s bid is only .4X sales.

Beyond the current sales of the STB business, there is value for an acquirer in the IP and other capabilities that this unit can contribute to new chip designs. In both their PR and conference call regarding the stalking horse bid, ENTR made it clear that the STB business is an important strategic asset for them. In non-technical terms, ENTR’s main competitor in the STB business, Broadcom (BRCM), has developed a single chip that replaces two chips, while ENTR’s solution would still require that their customers buy two chips. (In technical terms BRCM is integrating MoCA into their SoC.) TRID’s STB technology will enable ENTR to develop an integrated chip to effectively compete with BRCM.

The stalking horse bid is low enough that the STB business will likely attract other bidders such as BRCM, STMicroelectronics (STM), or Asian players in the STB market. And given the strategic importance of TRID to ENTR I think it is likely they will be willing to pay more than $55 million if other bidders emerge.

NXP Note Receivable

As part of the NXP transaction, NXP issued a $20.9 million note receivable to TRID, which is good towards work-in-process inventory to be purchased from NXP (NXP serves as a contract manufacturer for TRID). Given that TRID will be selling its operating units as going concerns this note receivable should have value, although it is not clear how that value will be realized at this point. Interestingly, while working capital in the STB business is generally included in the asset purchase agreement with ENTR, this note receivable is excluded. It is possible TRID will package the note with the DTV sale. Only $8.7 million of the note was on the STB books, so it appears the rest resides with the DTV unit. Another possibility is that TRID uses the note to offset some of the unsecured claims from NXP. TRID listed NXP’s claims at $15 million when they filed, but in a recent filing NXP said that TRID owes them $22 million. While some value from the note should be realized I am not sure how this will play out, so I will discount it 50% in my valuation.

Sale of Digital TV Business

While TRID has not formally put the DTV business up for bid, they have mentioned in their court filings that they will explore the sale of their other business lines. More telling, in their motion for management incentives they have put in an incentive for selling the DTV business for at least $20 million and bonuses for additional executives if they sell it for $25 million. If the degree of difficulty of the other proposed incentives is any indication, we can be fairly certain management thinks they can get $25 million for the DTV business. Management has proposed incentives for selling the STB business for $45 million when they have a $55 million stalking horse bid in hand. And they have proposed incentives for recovering greater than 60% of unsecured claims when it is almost impossible to imagine a scenario where the unsecured claims are not met to that extent. (As you might imagine, the unsecured creditors have objected to the incentive plan.) Additionally, the unsecured creditors have filed an objection to force TRID to market the DTV business along with the STB business in the upcoming auction.

Backing out the STB business, TRID did $143 million in revenue and $35 million in gross profit in the first nine months of 2011. That is presumably almost all the DTV business (it is unclear what the lines bought from Micronas are contributing at this point but it appears to be very minimal). Assuming the DTV business is doing ~$180 million in annual revenue, $25 million seems like a conservative asking price.

Liabilities

Pre-Petition Unsecured Claims

One of the more interesting features of this bankruptcy is that Trident filed without any pre-petition interest bearing debt or DIP financing. Per first day filings, Trident filed with $215 million of unsecured trade claims, but $128 million of those are inter-company liabilities, which leaves $87 million of external claims. The inter-company liabilities are not “real” here, as they all sit at 100% owned subsidiaries so there is no point of making these claims against the parent.

A major question is what percentage of these claims will transfer with the sale of the DTV and STB business units. As those units make up substantially all of the sales of the company, it is likely that a large portion of the trade claims relate to them. The APA with ENTR basically says that STB working capital will be transferred with certain exceptions (mainly paid time off and severance accruals). In a court hearing, TRID estimated that $15 million in claims would transfer with the sale to ENTR. With the DTV business having larger sales than the STB business (~$140 million vs. $95 million in first nine months of 11), we probably can assume at least $15 million in liabilities would transfer with the DTV sale as well.

Rejection Claims

Per the Q3 10-Q, TRID has $15.4 million in remaining operating lease obligations, but if TRID rejects the leases the liability would be capped at one year’s worth of rent, which would be the $4.2 million owed in 2012. Also, some of these leases might be assumed in sales of the business lines.

The 10-Q also states that TRID had $25.4 million of purchase obligations to vendors, but with $16.2 falling in the last quarter of 2011 and only $9.2 coming thereafter. These purchase obligations “represent unconditional purchase order commitments with contract manufacturers and suppliers for wafers and software licensing”. It sounds like something that would be transferred in the business unit sales, but it is hard to know. I should note it is also possible that TRID might not have made all of the $16.2 million in payments in the fourth quarter of 2011. (This might be why NXP has said TRID owes them $22 million while TRID has only said $15 million in their initial filing.)

I’ll assume a third of the lease and purchase obligations (third of $13.4) get picked up in the asset sales and TRID has to pay the rest ($8.9 million).

Post-Petition Cash Burn from Operations

TRID had been operating at $-6.8 million in EBITDA per month for the first nine months of 2011 ($-7.1 million in Q3). The company has been trying to cut costs, and at the end of September they laid off 275 employees. The court filed cash flow projections for the 11 weeks starting January 16th show them projecting to burn $13.3 million in cash, which includes $2.9 million in bankruptcy related fees. So if we assume that is $10.4 million related to operations that would come to $3.8 million in monthly cash burn from operations. However, it is not clear whether any of that $10.4 million is being used to pay off pre-petition claims. Also, it is not clear if we are getting the full picture from the cash flow projections of only the two filing entities as it appears substantial cash is sitting at other subsidiary entities.

This is of course guesswork, but I will estimate they burn $5 million a month for three months until the STB business is sold (assuming it is sold by the end of March), and that they burn $3 million a month for three months after that until the DTV business is sold.

Restructuring Fees

I’ll estimate that they spend $20 million in legal and advisory fees related to the bankruptcy. On top of that, per the motion to pay the investment bankers they would owe them $2.3 million if the STB business sells for $55 million and the DTV business for $25 million.

Management Incentives

The debtors have motioned to approve approximately $4 million in management incentives for targets that they will almost certainly hit relating to the sale of the DTV and STB units and fulfillment of unsecured claims. The unsecured creditors have objected to the motion. I’ll assume it goes through and they have to pay the $4 million.

Here is the full model:

TRID-equity-value.png

This shows a recovery of about 21 cents. Admittedly there are many unknowns, but I think there is more upside than downside in the assumptions here, most notably regarding what the STB and DTV units will sell for.

Reorganization

The liquidation value provides downside protection, but there might be more value to the equity if TRID can remain a going concern. That process would involve them reorganizing as an IP licensing company. TRID holds around 1900 patents relating to a broad range of applications in the digital TV space. Here is an interesting exchange from TRID’s Q3 11 conference call (transcript courtesy of Seeking Alpha, Bastani is TRID’s CEO):

Raji Gill – Needham & Company

With your purpose to license IP, transforming yourself to an IP company who would you license the IP to? Other SoC suppliers, to TV OEMs, software companies, who do you have in mind?

Bami Bastani, Ph.D.

I would say in general we see a convergence of TV with mobilities and other aspects of the industry so the patents that we have, have a broad range of applicability in these markets. So it’s not a one unique market segment, but the area that plays to our strength as everybody knows in motion, picture quality, and other aspects of TV. So a very potential wide range of users that we are probing.

TRID has done several IP licensing deals over the past few years, and just did the $16 million RDA Micro deal in January. I have no idea how to value TRID’s patent portfolio, but the equity at 15 cents is being valued at only $27.6 million so it wouldn’t take much licensing revenue to justify a much higher valuation. IP licensing companies trade for multiples of revenue due to their minimal operating expenses and large profit margins. This is total speculation, but let’s say as a focused IP company they can do three IP deals a year the size of RDA Micro. That is $48 million in revenue and if you attach any multiple to that there is substantial upside to the current market cap.

One sign that this might be the end goal here- TRID is selling their STB IP to ENTR, but the asset purchase agreement says that ENTR will grant TRID a “worldwide, irrevocable, royalty free, fully paid license”. That will allow TRID to still be able to sublicense that IP even after the sale.

The Players

TRID management- The current CEO, Bami Bastani, came on in June 2011 and is holding worthless stock options while other executive management only owns about 700,000 shares. So they are not particularly motivated to save the current equity holders. I think their motivation here is to reorganize the company and get a large equity stake. It is not so clear why TRID felt they could not restructure outside of Chapter 11 as they had no debt burdens and they were not quite on their last legs in terms of liquidity. One possible reason might be that management felt that if they were going to reorganize the company they wanted a larger equity cut, which is more likely to be granted to them in a formal reorganization.

Unsecured creditors- The unsecured creditors claims should easily be paid in full. Additionally, these are all trade claims with the largest non-related party claim at $9 million. While the unsecured creditors will certainly make their presence felt I don’t think they will cause too much trouble as long as the assets are sold off in a timely fashion and they can be sure they will be paid.

NXP- Maybe the most interesting aspect of this bankruptcy is NXP’s situation. NXP is the largest creditor, largest shareholder (58% of the stock), and they control two seats on TRID’s board. There doesn’t appear to be much risk of NXP’s unsecured claim not getting paid, so I think their primary motivation here will be to maximize value for the equity. They should prove to be an important advocate for equity holders.

Equity committee- An equity committee has not been formed yet, but given the likelihood of recovery for the equity an equity committee seems strongly warranted in this case.

Despite the recent run up, TRIDQ still might be attractive in the 14-15 cent range. You still have decent upside to a conservative liquidation value, and there is further potential upside in either a liquidation or reorganization. Of course this is a bankruptcy and things can go wrong, but I like the odds here.

Disclosure: I own shares of TRIDQ.

Elie Rosenberg runs a value investing research website at valueslant.com. Sign up here to get his free value investing ideas and analysis by email and get his free ebook, "16 Ways to Find Undervalued Stocks."

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Comments

jhodges72
Jhodges72 - 2 years ago
Good analysis, even if I disagree with it. Assuming you're correct, the current market price doesn't allow for a large enough margin of safety to minimize risk.

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