Could This Tech Dividend Disappear?

Apple (NASDAQ: AAPL  ) rewrote the history books this summer when a California jury awarded Cupertino $1.05 billion in lawsuit damages. The landmark decision was the largest patent infringement award in history. Samsung is busy asking for lower damages, mistrial, or appeals. But the enormous damage total was a benchmark in the world of patent enforcement.

Until this week, that is. Chip designer Marvell Semiconductor (NASDAQ: MRVL  ) just broke the record when a Pittsburgh jury found the company guilty of infringing on two Carnegie Mellon patents. Pending appeals and post-trial motions, the university could collect $1.2 billion in damages. Both Samsung and Marvell might end up tripling their legal bills if the judges find their infringement willful.

What did Marvell do wrong?
According to the verdict, Carnegie Mellon held exclusive patents for methods of cleaning up noisy signals when reading data off a hard drive. Marvell collects about half of its revenue on selling hard drive controllers (the rest comes from networking chips and mobile system processors
), and may have used some of Carnegie Mellon's technology to produce competitive products.

It's a highly concentrated market on both the supplier and end-product sides, so the potential value of any business edge can be enormous. Both Seagate (NASDAQ: STX  ) and Western Digital (NASDAQ: WDC  ) use Marvell's controller chips, and the only serious competition comes from LSI (NYSE: LSI). If Marvell gets knocked out of contention for new contracts in the hard drive market, LSI stands to win big, while the hard drive makers could end up paying more for the controller chips they need.

And that's not an entirely unreasonable outcome here. If Carnegie Mellon's big paycheck survives appeals, with or without willful tripling of the damages, Marvell would be hard pressed to come up with the cash.

That's ridiculous! Marvell is flush with cash!
The company does have a cool $2 billion of debt-free cash reserves -- surely enough to cover at least the original $1.2 billion jury award. Break it up into installment payments to allow Marvell some operating breathing room, wait for the generally positive cash flows to refill the drained coffers, and all will be well.

Unfortunately, it ain't that easy. You see, most of Marvell's cash is held outside U.S. borders, and would not be easily moved to Carnegie Mellon's bank accounts in Pennsylvania.

Customers in Asia account for some 80% of Marvell's sales. A staggering 95% of operational income flows through overseas operations. The company cares a lot about tax-efficient accounting and holds very large cash reserves outside American borders for this very reason. Marvell's real headquarters may be in Santa Clara, Calif., but the company was incorporated in Bermuda for tax reasons. The effective tax rate? 0.6%. Blink and you'll miss it.

Marvell isn't particularly eager to tell us how and where every penny is actually stored. But only $770 million of the company's short-term investments are held in the form of definitely American securities. All the rest is up for debate, and given the heavy foreign component of Marvell's bottom-line income, it's a fair bet that most of it sits somewhere else.

What's next, then?
I'd estimate that at least $1 billion of Marvell's cash equivalents would be subject to a 30% tax hit the moment it crossed U.S. borders. Paying down a $1.2 billion Carnegie Mellon bill would most certainly trigger that unfortunate event, even if the domestic reserves were nearly bled dry first.

And that's where investors throw up their hands and back away slowly. The company recently kicked off a dividend plan that pays $0.06 per share, per quarter. That's a fairly generous 3.4% yield today. Marvell would have to turn off that spigot in order to satisfy Carnegie Mellon's demands. The court hasn't actually ordered this (yet), but I can see Marvell on the hook for a permanent technology license on top of the one-time damage payments. Those royalties alone could reduce the cash available for dividend payments to zero.

Investors hate shrinking or unreliable payouts. And that's exactly what we're getting from Marvell unless the jury verdict is overturned somehow. Our Foolish watchlist feature will help you keep a close eye on the proceedings.

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Comments from our Foolish Readers

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  • Report this Comment On December 28, 2012, at 8:29 PM, rsinj wrote:

    There is a good probability that the verdict will be modified in some way.

    Let's begin with the venue for the trial - Pittsburgh? How is any defendant going to get a fair trial in the backyard of the plaintiff? And the amount of the damages/award - likely way too high (thanks again to hometown advantage) and will be modified somehow. There are quite a few stories/articles questioning how valid the patent is, that it's old, that other drive controllers/manufacturers utilize it...just numerous questions surrounding how valid the claim is to begin with. And that this patent was funded by a US government (taxpayer) grant in the first place.

    The likely outcome, as we've seen in other instances, will be a major reduction in the award, and then some type of royalty arrangement put in place going forward.

    I don't pretend to be a lawyer or have specific knowledge of the technologies involved or anything regarding the trial. I assume it is likely the same for the author and most folks not directly associated with the proceedings. What I do know is that there is precedent in other cases (not Apple/Samsung), Carnegie Mellon is not a commercial entity and was not harmed by Marvell's use of the (supposedly valid) patent, they aren't looking to put any company out of business, and if they really are looking to monetize the IP then they'll look for a workable/amenable resolution should the verdict stand. They want people successfully using the IP and paying for its use.

    I believe that at the current stock price MRVL shares are undervalued. The company has $2 billion cash, no debt and is still quite profitable. I took a small position today and would be happy to buy more should the weakness continue and the stock head lower.

    It will be interesting to see how it all plays out over the coming months. Might be good for a follow-up story once it's all wrapped up.

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