FOOL ON THE HILL
Court Victory! Stock on Sale?

In a rare instance, a court's decision actually awarded a clear-cut benefit to a company. A federal appeals court yesterday gave Rambus shareholders every reason to believe their company may now own a few percentage points of Infineon's computer memory output. Rambus stock is now selling at a substantial discount to intrinsic value.

	Email this page Format for printing Reuse/Reprint
	Related Links The Motley Fool Select The Quiet Tech Risk
	Discussion Boards Fool on the Hill Rambus

By Tom Jacobs (TMF Tom9)
January 30, 2003

It's not often that you own a stock that jumps 57% in a day to head the Nasdaq gainers. So, go ahead and crow if you hold shares of chip designer Rambus (Nasdaq: RMBS). Shares vaulted $4.25 yesterday to close at $11.69 -- a finish not seen since October 2001, and then only briefly since June of that year.

The cause? A startlingly clear victory in Rambus' federal patent-infringement appeal against chip maker and Siemens (NYSE: SI) spinoff Infineon (NYSE: IFX) may finally lead to what Rambus investors have long dreamed of: millions of dollars in royalties on all the consumer PC memory produced.

Here's the page-turning story of the court decision and its importance (whether Rambus is a buy, sell, or hold today). You should know I own shares; though at an average price of $19.00, I'm not buying Mumm's and Beluga caviar. I promise to save most (but not all) unseemly crowing and gloating for our Rambus discussion board. But permit me one out, loud and proud, "Go Rambus!"

That felt good.  

Navigating the royalty stream
In 2000, Rambus sued Infineon in federal court seeking royalties on the chip maker's sale of two of today's three dominant computer memories -- SDRAM (synchronous dynamic random access memory) and DDR (double data rate) DRAM. Rambus alleged that its patents covered those memories, and that Infineon infringed on them by making and selling them without a license or royalty agreement -- agreements Rambus had or would obtain from other memory makers Samsung, Toshiba, Hitachi (NYSE: HIT), and NEC (Nasdaq: NIPNY), but not Infineon, South Korea's soon-to-be-ailing Hynix, or the last U.S.-based DRAM maker, Micron Technology (NYSE: MU).

The money was big. Infineon was one of the top 10 DRAM makers in a market worth over $30 billion in 2000. Even after that number more than halved in 2001, royalties of 1% or 2% add up fast, are very high margin, and for profitable companies, can convert to free cash flow at giddy rates. So, like any other intellectual property company that lives or dies on licensing and royalties, Rambus went for what it believed was its rightful share. 

The same month that Rambus sued Infineon, Micron sued Rambus to preempt the scrappy upstart from pulling an Infineon. Unlike Infineon, which at least made RDRAM and paid royalties, Micron bet the company on DDR SDRAM, and apparently decided to fight Rambus to the death rather than deal.

Short-lived humor
Rambus investors enjoyed referring to Infineon as "Infringeon," but that became gallows humor when the trial court judge and jury hanged Rambus on all points in 2001, finding the company guilty of fraud and making it pay Infineon's attorneys' fees. Rambus stock, which in early 2000 jumped 600% in weeks into the split-adjusted $100s, fell from the $40s to the single digits.

Along the way, writers -- including Jack Robertson of the electronics industry newsweekly EBN --appeared determined to reveal their ignorance of law and business with uninformed personal attacks against Rambus couched as journalism. Robertson should have just switched to commentary, and he could've been as uninformed as I am.      

Rambus was the company everyone loved to hate. Except its investors.

Darkest before the dawn
In June 2002, the specialized federal appeals court heard the parties' oral arguments. It was fabulous theater. Infineon's appellate lawyer, Ken Starr (known more for years of Supreme Court appeals than for his technical patent law expertise), entered with a train of private firm attendants and the time clock running. Rambus had made the prosaic decision to hire a top patent appeal lawyer.  

Where the gallery usually echoes, it was standing room only. Robertson grinned front and center, while I sat a few rows back, waiting in vain for Fool fans to ask for autographs. I had to hand it to Starr. He argued a tough case with rhetorical brilliance, while the other guy stuck calmly to mind-numbing details. Of the three judges, the two experienced ones and authors of many major opinions asked penetrating questions, while the newest appointee sat mum.

But two weeks later, any happy handicapping of the appeals court gave way to further gloom when the Federal Trade Commission (FTC) voted unanimously to sue Rambus for anticompetitive conduct -- conduct underlying the jury's fraud verdict in the Infineon case.    

Sticking to knitting
Meanwhile, Rambus' business developed. Yes, RDRAM appeared to lose to DDR SDRAM to become the consumer PC's next-generation memory, but it found a solid niche in performance workstations. Sony (NYSE: SNE) put RDRAM in the best-selling PlayStation2, and it appears set for the PlayStation3. In a semiconductor depression, with average selling prices of DRAMs below many makers' costs, Hynix is on a deathwatch, and Micron is in critical condition. Only more diversified Samsung appears healthy.

Yet all the time, Rambus generated free cash flow, developed and patented new advanced technologies, obtained its first licensee for one of them, and signed a favorable five-year, $200 million licensing deal with Intel (Nasdaq: INTC). If Rambus didn't have to spend those pesky legal fees, it would've performed even better.

Of course, if your business is licensing and royalties, and you don't defend your patents, you die.    

That was then; this is now
But now the sun is shining. Yesterday, the two experienced judges on the appeal panel issued the majority decision reversing all of the trial court's decisions against Rambus, affirmed all decisions in its favor, and sent the case back to trial court. It even vacated the judge's award of attorneys' fees to Infineon. The newer judge dissented.   

By reversing the jury's verdict that Rambus committed fraud in dealing with the industry standards-setting body, the court weakened -- some would say flattened -- Micron's pending case against the company and the FTC's suit (though the FTC felt compelled today to issue a press release strongly to the contrary). But for investors, the key was the court's decision reversing the trial court judge's interpretation of certain language in Rambus' patents. 

The court has reinstated Rambus' case against Infineon and armed it with almost foolproof offensive weapons.

Where to?
We shouldn't count Infineon royalties too soon, though. The company is free to ask for a rehearing by all the judges on the court. It must do this as a prerequisite to any request that the Supreme Court hear the case. I'll make some predictions.

First, it costs less to pay lawyers than tens of millions in back and future royalties, so while I'll bet Infineon is today exploring a settlement with Rambus, it may choose the reasonable business decision to continue its few legal options... in vain. Why in vain? 

1. The appeals court won't grant a rehearing. Two of its most experienced and knowledgeable judges -- the ones the others look to -- issued the majority decision, and a newcomer dissented. Not going to happen.  
   
   
2. Should Infineon ask, the Supreme Court won't take the case. There's no constitutional issue or split among the circuit courts requiring a referee.
   
   
3. Infineon and Rambus will settle the case quickly, within 90 days and certainly within six months. 
   
   
4. Micron will eat its own young before it settles its case, but Rambus might well win a motion for summary judgment (decision without a trial). The trial judge in Micron's case has stayed proceedings pending the appeals court decision. While Micron has behaved like a company that would sooner go bankrupt than agree to pay Rambus one farthing, its financial position has worsened considerably. I won't predict a settlement because this company appears hell-bent on going out of business. It's the headstrong youthful execs running the company, no doubt. 
   
   
5. Despite the FTC's position today, its anticompetition case against Rambus will wither and die or at least become a bothersome fly. The government has recently moved for a decision without a trial, but the appeals court appears to have decided several crucial issues common to the FTC case in Rambus' favor, and they would likely carry weight.

I could be wrong about all of these. There are no guarantees.

Buy, sell, or hold? 
It doesn't get much more exciting than this, but emotion must give way to valuation. If Infineon settles quickly and starts paying royalties a quarter later, I estimate that Rambus' intrinsic value today (using a discounted cash flow model) rises from the high single digits to somewhere between $20 and $30 -- assuming a discount rate of 11%, low single-digit dilution from stock options (Rambus has a bad history to overcome), and double-digit growth rates. Some may estimate higher, but I'm not adding anything for a possible Micron settlement. Given Micron's health, that might be like getting blood from a stone.  

As long as the appeals court decision leads to Infineon royalties sometime in 2003, Rambus stock at yesterday's $11.65 close is selling for anywhere from 45% to 60% under intrinsic value. Now there's a margin of safety.

Some fun, eh? Have a Foolish weekend, and for more Rambus fun, you can learn the history of the company and its legal wranglings from The Motley Fool's Fabulous World of Rambus:

FTC Sues Rambus, June 2002 
The Quiet Tech Risk, June 2002 (watching the appeal oral argument)
Rambus Loses Round One, May 2001 (trial court bad news)
Legal Fees Sap Rambus Earnings, April 2001 
Rambus Under Siege, March 2001
Is Rambus' Advantage Sustainable? Jan. 2001 (the business, part deux)
Is Rambus a Rule Breaker?   Nov. 2000 (the business)
Rambus Captures Samsung, Nov. 2000 (the key license and royalty deal)
Rambus, Intel on the Outs? Oct. 2000 (Intel's support crucial)
Rambus Scores NEC Deal, Sept. 2000
Micron Sues Rambus, Aug. 2000
Dueling Fools on Rambus, Aug. 2000 (what a Bull I was!)
Rambus is King of the Hill, July 2000
Rambus Rides Again, June 2000 (Toshiba and Hitachi agreements)
Do You Believe in Rambus? April 2000

Tom Jacobs (TMF Tom9) was a lawyer for 12 years and wouldn't have lasted two seconds against the big guns in the Rambus case. Catch his in-depth stock analysis in The Motley Fool Select (if you subscribe today, you get our Stocks 2003 free!). Hear Tom with Bill Mann (TMF Otter) this evening on Online Tonight with David Lawrence (to listen to this or earlier shows, choose the first hour, segment three). You can view his stock holdings, which include Rambus, in his profile. The Motley Fool sports a disclosure policy.