Investors searching for value in an expensive market may wish to look at small-cap stocks. After outsized gains in 2016, the Russell 2000 Index is actually slightly negative for 2017.
One small-cap stock you might want to consider is RPX Corporation (NASDAQ: RPXC). The company does something unique: defensive patent aggregation. While the company has only a $600 million market cap, its clients include the biggest names in consumer electronics, PCs, e-commerce, financial services, software, media content and distribution, telecom, networking, and semiconductors.
Unique companies can make for unique investment opportunities. Here are four interesting things to know about RPX Corporation.
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1. It's a niche monopoly
RPX Corporation's patent-risk client network, which spans 348 clients, acts as a powerful self-reinforcing network. Clients pay RPX a subscription fee, then RPX goes and buys up patents before they can be sold to a non-practicing entity (NPE), or patent troll. This lowers costs for client companies, which would otherwise have to purchase patent portfolios themselves, or litigate each of their own defenses. RPX also offers insurance products for smaller companies that can't afford the full subscription, and it acquired a legal discovery services firm, Inventus, in 2016.
As RPX acquires more clients, costs are spread among a greater number of companies. In other words, if another company wanted to compete with RPX, there wouldn't be much incentive for clients to switch from a larger pool to a smaller one. The service works better if everyone is in the same boat, so to speak.
As such, RPX claims its competitors are either the patent-risk management departments of its own clients, or NPEs that compete for patent assets such as Wi-Lan, Acacia Research, and the privately held PanOptis. While RPX is often compared to NPEs, it is a different kind of company, almost like insurance, or an outsourced legal department.
2. It has odd financials, which could be an opportunity
RPX has strange financials, which may confuse investors. For instance, its trailing price-to-earnings ratio is 34, which looks very expensive, but its ratio of EV (enterprise value) to EBITDA (earnings before interest, taxes, depreciation and amortization) is only 2.4, which is extremely cheap.
This is because RPX's biggest cost is the amortization of its patent portfolio. Patents are currently amortized over an average of 41 months, with a typical range of 24 to 50 months, so that means patents that were bought as long as 5 years ago are still being expensed in the current year.
This is important because as the patent market has softened, RPX has bought fewer patents in 2016 than prior years. For instance, in 2016, the cost of revenue was $197 million, which included $171 million in amortization, but 2016 patent spend on the cash flow statement was only $117 million. Therefore, while GAAP (generally accepted accounting principles) operating income was $32 million, the company's preferred measure of operating income -- adjusted EBITDA minus patent spend -- was $108 million. That's a huge difference, and less than six times the company's $600 million market capitalization.
3. It has an activist investor
In March 2016, activist investor Mangrove Partners took a large stake in the company, and currently holds a 7.34% position; as of Dec. 31, 2016, RPX was Mangrove's fifth-largest holding. Mangrove was angered at the $232 million acquisition of Inventus in late 2015, and pushed for board seats as well as a stock buyback. RPX reached a settlement with Mangrove, instituted a buyback -- the company repurchased $60 million in 2016 -- and appointed two directors to RPX's board.RPX also recently named venture investor Magdalena Yesil to the board, though it's unclear if she was nominated by Mangrove.
4. ...and had a recent management shakeup
In February, founder and CEO John Amster resigned. The company claimed it was due to a disagreement over whether to take the company private or not, with Amster wanting to go private, and the board (which includes Mangrove's directors) disagreeing.
RPX named Marty Roberts interim CEO. Roberts had been the company's general counsel since 2010. While a general counsel may seem an odd fit for a CEO fill-in, the company's main business is the legal field, so it does make sense.
Recently, the company announced Roberts would stay on as permanent CEO. It then hired Andy Block, a former executive at Time Warner Cable, and Neal Rubin, a veteran of Cisco, to business-development roles. Since RPX Corporation's core subscription revenue has stagnated the past couple years, the company is hoping these two industry veterans will be able to court and retain new clients.
RPX Corporation offers some intriguing differences: a niche monopoly, financials that underrate its cash flow, and an incentivized activist making changes. Assuming that patent litigation continues to plague tech-related companies, RPX's services should provide value, and investors could be rewarded as well.
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