Overview

Following a disappointing 2013, Wi-Lan's (WILN) Board of Directors embarked on a strategic alternatives review. With the setbacks that Wi-Lan was experiencing, its Board of Directors believed that alternatives should be examined. The plan was to look at any and all options, including a sale of the company, in an effort to maximize value for shareholders.

During the review period, Wi-Lan generated a good amount of positive news. In both Q4 2013 and Q1 2014, Wi-Lan had strong revenue and positive GAAP earnings. It expanded the breadth of its patent portfolio and signed many new licensing deals. The company also received good news in ongoing disputes with Apple (AAPL).

On May 14th, the company announced the conclusion of its strategic review. The company plans to make significant changes that are expected to add value going forward. The market reaction was overwhelmingly negative. An overview of its announcement can be found here, and more details can be heard on its most recent conference call.

Announced Changes

• Portfolio Transitions

In a major departure, Wi-Lan has decided to change the way its customers license patents. The company will now license specific portions of its patent portfolio, as opposed to requiring customers pay for the entire portfolio. This change was inevitable given the expanding scope of Wi-Lan's portfolio. This makes sense for Wi-Lan, because its customers are presumably interested in paying only for patents they plan to use. Management believes this will drive revenue growth by increasing the number and frequency of license signings.Wi-Lan should be able to generate new business, as companies that were unwilling to pay for the entire portfolio may be interested in paying only for relevant portions. This change will also make it easier for Wi-Lan to divest unneeded patents. With customers paying only for specific patents, it will be readily apparent which patents add no value to the company. These patents can then be sold to reduce expenses.

In a related move, Wi-Lan has announced that it will be focusing on a small number of high-quality patents when adding to its portfolio in the future. The company is looking to take on only patents that have strong licensing potential. Since future licensing revenue will come from the specific patents that customers pay to use, it makes little sense for Wi-Lan to own patents that offer no value to its customers. A smaller portfolio will also help reduceWi-Lan's maintenance costs, which will be discussed later. Through a combination of changes in licensing, a focus on quality, and divestitures, Wi-Lan hopes to be left with a smaller, but higher-quality portfolio.

• Use of Partnerships

In the past, Wi-Lan would purchase desirable patents and then license them to its customers. Recently, Wi-Lan has expanded its use of partnerships as an alternative to the outright purchase of patents. In its recent announcement, the company has confirmed that it is looking to focus on partnerships and that it plans to purchase fewer patents in the future. In its partnerships, Wi-Lan receives a percentage of the revenue it can generate from the patent, but the original patent holder maintains ownership. As an added bonus, these partnerships often do not require an upfront payment byWi-Lan. Since fewer patents will be purchased, Wi-Lan should see an immediate reduction in its capital expenditures. Over time, as acquisitions decrease, the company should see a decline in its amortization expense. Amortization was Wi-Lan's largest expense over the past two quarters, so this could have a noticeable impact on net income down the line.

• Reducing Expenses

Legal expenses have been a thorn in Wi-Lan's side for years. Recently, the company has made progress in reducing these costs. The graph below shows the decrease in the amount of Wi-Lan's litigation expense over the past year. In the past two quarters, Wi-Lan began sharing risk with its legal counsel. Under this arrangement, Wi-Lan's lawyers receive a base payment, and are able to earn additional money following successful litigation or when licenses are signed. Management has stated that its legal counsel will make most of its money through these contingency fees. This new agreement is likely to reduce the amount of litigation that Wi-Lan pursues. Less litigation will obviously limit litigation expense. This risk-sharing deal ensures that the incentives of Wi-Lan's legal team are aligned with the best interests of company.

Wi-Lan also plans to reduce patent maintenance expenses. Management believes that Wi-Lan owns a number of patents that add no value to the company, while increasing patent maintenance costs. In an effort to reduce expenses, management is considering the sale of as many as 2000 non-core patents. Maintenance costs grew over 27% to almost $6.5 million in 2013. Considering that Wi-Lan had just under $90 million in revenue over this same period, lower maintenance expenses could have a noticeable impact on the company's bottom line. Management has said that it is tough to estimate the amount of money it will generate when selling these non-core patents. Divestitures will help Wi-Lan generate cash and reduce maintenance expenses. NEXT >>>>>>