Description

Trident Microsystems (TRID) is a freshly minted bankruptcy that should result in a recovery for equity holders. TRID has no debt, no DIP, and filed with $55mm of cash, a $55mm stalking horse bid from Entropic (ENTR) for its set-top box business, a newly announced $16mm non-exclusive licensing deal for its TV SoC platform, among other assets. A preliminary recovery analysis shows non-trivial upside at current prices, and there is a potential for a home run if Trident completes reorganization as a pure IP licensing company.

The docket is available at http://www.kccllc.net/trident

PDF of this write-up w/ tables is available here: http://dl.dropbox.com/u/4775695/Trident%20Microsystems.pdf

Business Description

From the 10-K: “We design, develop and market integrated circuits, or ICs, and related software for processing, displaying and transmitting high quality audio, graphics and images in home consumer electronics applications such as digital TVs (DTV), PC and analog TVs, and set-top boxes. Our product line includes system-on-a-chip, or SoC, semiconductors that provide completely integrated solutions for processing and optimizing video, audio and computer graphic signals to produce high-quality and realistic images and sound. Our products also include frame rate converter, or FRC, demodulator or DRX and audio decoder products, interface devices and media processors. Trident’s customers include many of the world’s leading original equipment manufacturers, or OEMs, of consumer electronics, computer display and set-top box products.”

Liabilities

With any bankruptcy, it’s wise to start with the liabilities because as a wise dude once said: assets may be fleeting, but liabilities are always real.

Pre-Petition Liabilities Subject to Compromise ($87mm)

In his declaration in support of first day pleadings, Trident’s general counsel stated there are $215mm of outstanding unsecured obligations at the petition date. However, $128mm of that are intercompany payables, so the Debtor estimates $87mm of external unsecured obligations, the majority of which are owed to trade vendors.

Post-Petition Liabilities ($35mm)

One would be hard pressed to tell the difference between Trident and a giant pit of fire that consumed cash (and possibly puppies because it’s an evil pit of fire). Through the first 9 months of 2011, operations consumed $38mm of cash. Trident broke out the financials of the STB business in the exhibits to the stalking horse asset purchase agreement (APA). Through the first 9 months of 2011, the operations of the STB business posted negative $30.5mm of EBITDA.

The sale of the STB business is expected to close in Q1 and the remaining operations appear to running at negative $3.5mm of EBITDA/month. Trident has already been cutting costs and I would expect them to continue doing do in bankruptcy. For example, ENTR would take on 385 Trident employees as part of the sale. I am going to unscientifically guess they burn another $20mm before they are able to stop the bleeding.

Bankruptcies cost a lot, so I will estimate costs at $15mm, which will buy Trident 30,000 hours of professional services billed at $500/hour.

Rejection Claims ($15mm)

There is the potential for rejection claims if Trident ends up rejecting leases and other executory contracts. The table from the Q3 2011 10-Q below shows Trident’s contractual obligations. From footnote (1), it appears the operating leases are for office space and thus would be subject to the one year cap or $4.2mm in this case. The bulk of the purchase obligations ($16.2mm) would have already been satisfied at the end of 2011. The remaining obligations sum up to $9.2mm. An estimate of $15mm for rejection claims seems appropriate, but this is probably high because the stalking horse is assuming a number of leases and other contractual obligations.

(1)           At September 30, 2011, we leased office space and has lease commitments, which expire at various dates through August 2019, in North America as well as various locations in Japan, Hong Kong, China, Taiwan, South Korea, Singapore, Germany, The Netherlands, the United Kingdom, Israel and India. Operating lease obligations include future minimum lease payments under non-cancelable operating.

(2)           Purchase obligations primarily represent unconditional purchase order commitments with contract manufacturers and suppliers for wafers and software licensing including engineering software license and maintenance.

Assets

Cash ($55mm)

According to statements at the first day hearing, Trident filed with $55 million of cash, including $20mm from the sale of a China facility and the $7.5mm upfront fee from the RDA Microelectronics license.

RDA Microelectronics License ($8.5mm)

In the same press release announcing the filing, Trident announced a $16mm license with RDA Microelectronics.

“Trident also announced that it has entered into a license agreement with RDA Technologies, Ltd., pursuant to which it granted a non exclusive license to its SX-5 SOC product for the television market. Under the license agreement, Trident has received an upfront fee of $7.5 million and expects to receive an additional $8.5 million in the near term.”

RDA’s press release: “SHANGHAI, China, Jan. 4, 2012 (GLOBE NEWSWIRE) -- RDA Microelectronics (Nasdaq:RDA) ("RDA Microelectronics" or the "Company"), a fabless semiconductor company that designs, develops and markets Radio Frequency (RF) and mixed-signal semiconductors for cellular, connectivity and broadcast applications, today announced that it has signed an IP license and development agreement with Trident Microsystems. According to the terms of the agreement, RDA will pay US$16.0 million in cash to secure a non-exclusive, worldwide, non-transferrable license to develop, manufacture and sell derivative versions of the Trident SX5 Digital TV SoC platform for a period of 10 years.”

Stalking Horse Bid from ENTR ($55mm)

ENTR’s stalking horse bid for Trident’s STB business is $55mm in cash, subject to working capital adjustments. The STB SoC market is a little over $3b annually and dominated by Broadcom, STMicro, Renesas, Trident, and Sigma Design. I imagine Broadcom, STMicro, and Renesas may be interested bidders, especially STMicro. A purchase would help them expand their STB business outside of Europe.

The 363 sale is on a fast timeline. Bids are due no later than 9am EST on Feb. 12, 2012. If there are additional Qualified Bid(s) received, an auction will be held at 10am EST on Feb. 15. The next bid increment is $55m + $1.65mm (breakup fee to ENTR) + ENTR’s reasonable expenses (TBD) + $600K. The sale hearing is scheduled for Feb. 20.

TV Business ($25mm)

Trident also appears to be putting its TV SoC business on the block, either in a separate transaction or together with the STB business. In the motion for management incentive payments during bankruptcy, one of the milestones is the sale of the TV business for at least $20mm. Two more VPs will get payments if the sale is for at least $25mm.

I could rant about the insanity of paying a management team that has run this company into the ground “incentive payments” for simply doing their jobs in bankruptcy, but I won’t (though an objection with the court might be in order). I will note, however, that it is uncommon for management teams to set hurdles they cannot clear, especially when “incentive payments” are involved. For example, the milestone for the sale of the STB business was $45mm.

In addition, STMicro acquired Genesis Microchip in late 2007 for $328mm or 0.8x EV/Sales. Genesis was also very unprofitable at the time. I realize this comp is stale given what has happened to the world since then, but Genesis is a very close comparable to Trident’s TV chip business. Trident ex-STB generated $143mm of revenue through 9 months 2011, nearly all from the TV chip business. Here’s the deck from the STM/GNSS deal: http://library.corporate-ir.net/library/11/111/111941/items/272928/STGenesis1211.pdf

NXP Note Receivable ($21mm)

As part of the acquisition of the STB business from NXP, Trident received notes that could be used for inventory purchases (“gift certificates” would have totally been a better balance sheet line item name). These notes are specifically excluded from the assets sold in the stalking horse APA.

From the Q: “At September 30, 2011, the Company had a note receivable from NXP of $20.9 million related to future inventory purchases from NXP, of which the entire balance was a current asset on the Company’s Condensed Consolidated Balance Sheet.”

The history of these notes from the K: “As of the effective date of the asset acquisition, the Company acquired two inventory notes receivable (the “Note” or “Notes”). The first Note is for $19.1 million and allowed the Company to purchase finished goods inventory on March 22, 2010.

The second Note is for $20.8 million and allows the Company to purchase work-in-process inventory on the readiness of the Company’s enterprise resource planning system which is projected to be implemented in fiscal 2012.”

Preliminary Recovery Model

This recovery model is rough and one can certainly make different assumptions, but I think it hits the major assets and liabilities. My point isn’t to get to an exact recovery number, but to illustrate that there is likely very little downside at current prices and the potential for upside, even in liquidation. However, I do not believe the company will liquidate.

Reorganization as an IP Licensing Company

In court filings Trident states: “The Debtors believe that a rapid sale of the set-top box business will allow them to immediately stop the drain on cash balances and afford them an opportunity to determine which, if any, of the Debtors’ other business lines should be marketed for sale and take such other steps necessary to reorganize their remaining operations into a profitable and sustainable business.”

I believe the Trident’s end game is to sell off its operating businesses and reorganize as a pure IP licensing company. Here are my reasons for thinking so:

1)      The stalking horse APA includes the sale of intellectual property related to the STB business. However, as part of the sale, Entropic will grant Trident a worldwide, irrevocable, fully paid, royalty-free license, including sublicensing rights, to that IP for use in the TV and audio markets (see Exhibit D of the APA).

2)      Trident can continue to enter into new licenses for the IP being sold to ENTR during the bankruptcy provided the license would be permitted by the License Agreement mentioned in #1 above.

3)      The APA specifically excludes Trident’s current IP licenses from the assets to be sold (see Schedule 1.1(g) of APA).

4)      I am not an expert, but apparently Trident has some foundational TV and display patents around motion estimation and motion compensation (MEMC) and frame rate conversion. From the 10-K: “For example, in December 2010, we entered into a license agreement with MStar Semiconductors, Inc. relating to a part of our motion estimation/motion compensation patent portfolio. The licensed patents are directed to the display of high definition and 3D images for high-quality televisions and other video enabled LCD display devices.”

1. This is an interesting article: http://www.eetimes.com/electronics-news/4207198/Trident-fires-opening-salvo-on-frame-rate-conversion-patents

5)      At the first day hearing, Trident stated that it had 1,900 patents that it could look to sell or license.

6)      Over the past two years, Trident has completed a few IP deals:

1. http://www.tridentmicro.com/trident-microsystems-announces-plans-to-license-foundational-memc-patents/
2. http://www.tridentmicro.com/licenses-mstar-semiconductors-memc-patents/
3. http://investors.tridentmicro.com/releasedetail.cfm?ReleaseID=595121
4. http://www.tridentmicro.com/announces-sale-five-patents/

At this point of the bankruptcy, it is impossible to attempt any sort of valuation of a standalone Trident IP business, but here are my thoughts:

1)      Is it possible for current equity holders to maintain ownership of a reorganized business? Yes, given Trident’s assets and lack of debt or DIP, it is likely that unsecured trade claims can be assumed or paid off in full. The key here to make sure equity holders are well represented in the bankruptcy (I will address this later).

2)      At $14mm market cap, if equity holders can maintain ownership of Trident reorganized as a pure IP company, not a lot has to go right for this to go really well. TSRA trades at a 1.4x EV/Sales ratio, RMBS at 2.2x. On the high end, Imagination Technologies is at 13x and ARM at 16.9x. I think Trident’s multiple would be closer to TSRA and RMBS, but if Trident can build up $30mm of licensing revenues, a 2x multiple would most welcome.

Don’t Bring a Knife to a Gunfight

Bankruptcy is a gunfight between many competing parties: management, creditors, equity holders, etc… Not having your interests well represented is a sure way to get screwed. After mulling it over for a few days, I think the reason Trident filed, rather than sell off assets outside of bankruptcy, is that management wants to take a chunk of the reorganized company. There are two things that I believe will help equity holders not get screwed: NXP’s ownership and proactively pushing for an official equity committee.

NXP’s Ownership

As a result of Trident’s STB acquisition from NXP, NXP is both Trident’s largest trade creditor ($15mm) and shareholder (56% of the shares outstanding). NXP also holds 4 shares of Series B preferred stock with a liquidation value of $4, but the right to elect 2 directors. NXP’s counsel filed a notice of appearance in the case and I would expect NXP to protect its interests in the bankruptcy.

Official Equity Committee

I have been in contact with the U.S. Trustee assigned to the Trident case (Juliet Sarkessian 302-573-6008, [email protected]). She is open to hearing arguments for the immediate formation of an equity committee and I have already sent her a letter detailing the arguments for a committee. This case clearly meets the requirements for the appointment of a committee. I encourage other equity holders to contact her as well, as an official equity committee is the best way to ensure the interest of existing equity holders are well protected.

Risks

Trident is unable to quickly sell its operating business and continues to burn prodigious amounts of cash.

The U.S. Trustee declines to appoint an equity committee (the judge can still appoint one).

It’s a bankruptcy, it is guaranteed to take longer than you expect and there are innumerable ways for you to get screwed.

Catalyst

A successful 363 sale of the STB business.

A successful 363 sale of the TV business.

Formation of an equity committee.

Additional license agreements or sale of patents.

Reorganization as a pure IP licensing company.