Can You Get Rich from “Mobile Royalties?”

By Travis Johnson, Stock Gumshoe, November 29, 2010

This latest teaser ad is all about owning a “piece of an idea” — owning something valuable that gets you royalty payments, or payment for the “rental” of that idea. It’s a little bit similar to the old “Mainz Income” royalties, which were teased as a way to get recurring income that (we were told) was kind of like the income Barack Obama and Bill Clinton pull in (theirs being book royalties, while the teased ones were natural gas royalties … but still, you get the idea).

Patrick Cox, who has previously teased us many times about high tech and biotech stocks, most recently with a recurring teaser that focuses on stem cell companies. But he says that “nothing is more exciting than the mobile royalties” he’s telling us about now. And the tease this time is for his newer investment newsletter, Technology Profits Confidential (his older mostly biotech-y teasers were for his Breakthrough Technology Report).

And alas, the Agora mothership didn’t see fit to supply us with a text version of this “presentation” teaser ad, so I had to listen to Patrick’s voice for God knows how long — one of my kids was climbing on me at the same time (thanks, random school holiday!) so I didn’t quite keep track of the ticks and the tocks.

I don’t wish to imply that Mr. Cox’s voice is anything less than mellifluous, you understand, just that I wouldn’t generally have the patience to sit through an entire sales pitch if it weren’t in service to my favorite people (that’s you!)

But anyway, this newsletter is a “mass market” letter that looks at the “safer” and more blue-chippy stocks that aren’t sexy enough for his Breakthrough Technology Alert (that’s my read on the situation, though he implied as much in the presentation). And as such, it’s far less expensive and doesn’t include the little pink sheet-listed stocks … heck, in this letter he might even pick some companies that make a profit, which would probably get you drummed out of the biotech investment newsletter editor’s club.

So what’s the stock he’s pitching today? He calls this a “mobile royalty cash pool” and says it’s just getting started.

Apparently there are more than 5 billion cell phone subscriptions out there now, and this company has the valuable idea that all the cell phone companies can’t do without. Cox says that 98% of cell phones use the idea he’s teasing us about and have to pay cash royalties to the owner of the idea.

And it gets better — it’s not just mobile phones, but theyr’e also levered to get higher earnings from smart phones. The smarter the phones get, the more they depend on this “valuable idea” and have to pay more money into the pool (we’re told that they earn about about 6X more mobile royalty income from smart phones than from regular cell phones).

And Cox tells us that we can get rich just by owning the patent rights, we don’t have to own the company that makes or sells the product or develops the best factory.

This company that he’s teasing apparently pulls in hundreds of millions of dollars in royalty fees every year from Blackberries, Digital cable boxes, “smart brakes” (that one’s new to me), color laser printers, wireless speakers, flat screen TV, media devices, video game players.

And he does some quick name dropping of the clients that this company works with:

Vizio
Samsumg
Palm
Nokia
Nintendo
Casio
Amazon.com
Nokia

And says that we can claim a stake in all of it, “more easily than you might imagine.”

And that buying this stock is “like owning the pick and shovel play at the start of the California gold rush.”

And the big three are customers: Apple pays royalties on ipods, ipads, iphones and even their laptops. Google is also committed to paying the mobile royalties for a long time to come, as is Microsoft with the tablet version of Windows 7, though “most of these deals happen behind the scenes.”

Then he gets our imagination cooking to seal the deal: “What if you discovered Intel at the beginning?” He says this mobile royalty play is similar.

He’s pitching a subscription, of course, but he says this special report is “free” (with subscription, naturally) — the special report is called “How to collect a “Mobile Royalty” on Nearly Every Smart Phone Sold (Plus Millions of Laptops and More).

So what is he talking about?

Well, there aren’t that many real powerhouse intellectual property licensing firms in the world — there’s one that arguably stands head and shoulders above the rest, Qualcomm (QCOM) but they also manufacture chips and they aren’t in 98% of phones … so the one he’s teasing now is probably (not enough clues to be 100% certain this time around) …

Arm Holdings (ARMH)

This is the darling of the British tech industry, and they do have a strong portfolio of patents and intellectual property that bring in big licensing and royalty revenue on pretty much all kinds of mobile computing. They have developed a core processor design (an efficient, low energy use RISC processor) that’s licensed by hundreds of different semiconductor manufacturers to be the basic foundation of thousands of different products.

I have no idea what their royalty level is — it would make sense that they’d have more opportunity to get more of their products into smarter devices that use many different chips, and royalties and licensing fees on their newer designs are more expensive than on their legacy products, but I don’t know precisely what they earn. I do know that as of the last couple years there were claims that ARM chips were in 98 percent of cell phones, and that they are a royalty and licensing company.

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ARM has a long history with Apple, they developed chips in partnership for many years back when ARM was called Acorn (one of their designs was in the Newton, the long-ago predecessor of the Palm and the iPhone — and I think a newer one is also in the iPad, though I don’t know if that’s been confirmed) and was trying to compete with IBM for the basic processor core architecture used in personal computers. Acorn even built it’s own computers, a UK competitor to Apple’s personal computers decades ago — since then, ARM’s simpler and more efficient design has evolved as the winner in the mobile world, particularly thanks to the mobile developers’ constant demand for lower power consumption, and they have a pretty overwhelming ownership of this RISC processor design (some reports I’ve seen are that they get royalties on 90% of RISC processors, though for some simpler, older designs it may just be a penny or two per device, or less). They’re also, like Qualcomm, signing licensing deals like crazy in China, which leads me to think that they’re either not copyable enough or too easily identified as copies to be widely pirated.

There have been lots of rumors that someone might take over ARM, though Intel probably can’t (due to competitive concerns) and Apple, the most oft-rumored suitor, probably wouldn’t in my opinion (why would they want to bother if they can just pay a small royalty for basic processor designs? Apple management, for whatever reason, has shown no interest in large or complex acquisitions — or, really, in using their cash hoard at all).

And if no one takes them over at a premium valuation, it’s certainly reasonable for a thoughtful investor to look at ARMH right now and say it’s really freakin’ expensive. The shares go for more than 40X next year’s estimated earnings, which is steep even if you are growing rapidly and have a low cost base with possibilities for boosting margins and significantly leveraging any revenue growth.

If the analysts are correct about next year’s earnings (and they might easily not be, ARMH has blown away estimates the last couple quarters), then ARM Holdings is only expected to grow earnings at about 10% a year … which means paying 40X earnings is perhaps a bit much. Of course, if ARM’s new processor designs take off and the analysts are just being cautious, then they may grow far faster — I have no idea, they’re still relatively small compared to the giants like Intel (which is also desperately trying to get into mobile chips) or Qualcomm (ARMH has a market cap of about $8 billion, Qualcomm is roughly 10X larger).

And while royalties may well be a great way to generate recurring revenue for decades to come based on a few key ideas, they’re not necessarily a way for investors to generate income — ARMH does have a policy of paying dividends, but they’re frightfully small and have grown very slowly over the years. Current income yield is about one half of one percent, so performance of ARMH in your portfolio would depend a lot more on the price going higher, probably either through an even loftier valuation, higher earnings, or something like a takeover. Growth and momentum traders like Louis Navellier have been talking up ARMH in recent months, too, so it should come as no surprise that the stock is near it’s 52-week highs — and, if you ignore the brief and glorious apex of the internet bubble, just shy of it’s all-time highs.

And, like I noted above, the clues were not terribly specific for this one so it’s always possible that I got this teaser solution wrong — though if you can find another royalty- and licensing-based company that’s been in 98% of cell phones recently and it’s not ARMH, I’ll be pretty surprised. If you’ve a better way to get rich from our increasingly mobile world, or some wisdom to share on Arm Holdings, feel free to let ‘er rip with a comment below.

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