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If you've read the headlines about Rambus (RMBS
) and its legal woes lately, you probably haven't been thinking about buying shares in the memory-chip maker. After all, its stock chart looks something like an Olympic downhill slope.
But in the midst of the company's legal turmoil, investors may have forgotten one crucial fact: Rambus' products still have appeal to a broad and lucrative market. Maybe its dreams of domination of the memory-chip market have been dashed by its defeats in the courtroom, and Rambus will never join the ranks of Microsoft (MSFT
), Intel (INTC
), and Cisco Systems (CSCO
). But it still has superior technology that, if produced and marketed well, has the potential to create a profitable niche in an industry worth some $200 billion a year.
BARGAIN? And Rambus' stock fall has a positive side: It's cheaper now than it has been since its 1997 initial public offering. Rambus stock can be had for under $12 a share, which looks pretty good when you consider its all-time high was $127 in June, 2000. Its price-to-sales ratio stands at 17.5. That's high when compared to the broader market multiple of about 5. But for a company that's still expected to increase sales at 50% a year or more for the next few years, it's a relative bargain.
Robert Morse, who manages Wall Street Fund (WALLX
), invested heavily in Rambus three years ago and sold off most of his holdings when it went over $100 a share. But he's thinking of getting back into it. "Now that there's some resolution to the court battle and the price is so low, it's hard not to think about buying again," says Morse.
It's also hard to feel anything but optimistic about the potential growth of Rambus' primary product, Rambus dynamic random access memory (RDRAM). Intel has maximized its new Pentium 4 chip to work with Rambus memory chips. Samsung Electronics, the No. 1 producer of memory chips in the world, continues to support Rambus as nearly a third of its chips are based on the Rambus design. And the new generation of Sony Playstation 2 devices use Rambus chips. For a company that has been written off as a loser, it has lots of momentum.
SMALL PREMIUM. An even more important kind of momentum has to do with the pricing differential between RDRAM and its chief competitor in chips, double data rate DRAM (DDR DRAM). Executives at Samsung, which produces both Rambus and rival chips, predict that their plants will be able to lower the manufacturing cost of Rambus' RDRAM chips enough so that by yearend 2002, they'll be only 10% more expensive than rival chips.
That's a pittance when you consider that future versions of RDRAM should be able to provide as much as twice the competition's performance power. "Performance sells," says Rambus Chief Executive Officer Geoff Tate. "As long as the price premium is minimal, we'll always be the first choice of any device manufacturer."
Unfortunately for Tate, Rambus isn't the only choice. And while some customers will be willing to pay 10% more for performance, many will choose to go the cheaper route. Of course, figuring out what to do about pesky competitors is what got Rambus into legal trouble in the first place.
LEGAL ASSAULT. Soon after Rambus appeared with its original design for memory chips, a competitor emerged. Called synchronous DRAM (SDRAM), it proved to be cheaper than RDRAM while providing a substantial increase in efficiency and speed over traditional DRAM. The newest version of SDRAM, DDR (double data rate) SDRAM literally doubles the speed of SDRAM, although it's still well behind high-end RDRAM's speed.
However, rather than beating the competition through superior design and marketing, Rambus decided to claim in court that its patents also covered the SDRAM and DDR DRAM designs. At first, the strategy seemed like a winner. The legal assault on competitors convinced some DRAM makers to pay royalties to Rambus for chips made using those designs, most notably Samsung Electronics, the world's largest DRAM producer.
Other key players, though, including Micron Technology (MU
), Infineon (IFX
), and Hyundai Electronics, balked at paying the royalties. Rambus quickly filed lawsuits, and countersuits followed. Rambus' "fatal flaw was to take what should have been its top customers and turn them into adversaries in the courtroom," says Manoj Nadkarni, a money manager who edits Chipinvestor.com.
BACKFIRE. At the time, Wall Street didn't see it that way. As the company's revenue mix changed to where almost half of it was coming from royalties, investors expected limitless opportunities for total dominance of the DRAM industry. And that's from a company with no capital costs and only about 200 employees. The stock soared, the future looked bright.
As Rambus shareholders soon found out, however, the strategy backfired. On May 4, a federal judge in Virginia ruled that not only did Rambus' patents not cover its competitors' chips but the Los Altos (Calif.)-based company had committed fraud many years earlier by not revealing its full patent portfolio during meetings of a standards policy body. The judge then ordered Rambus to pay Infineon $3.5 million in damages.
Rambus plans to appeal the verdict, and at this stage, the outcome is impossible to predict. Also, several other cases are pending, including one in Delaware against Micron that should start in October, and another against Infineon in Germany that has already begun hearings. But the Virginia loss was a catastrophe on many fronts.
For one thing, this was the most important of the trials. "Rambus chose the venue for this trial," says Morgan Stanley analyst Mark Edelstone. "Management...tried to put its best foot forward and [took] its best shot to prove the validity of the non-Rambus patents in this case." The Virginia case will set a precedent that the others will examine closely. And it turned the tables on Rambus.
FINISHED FAIRY TALE. Rather than being portrayed as a victim of intellectual-property theft, this judgment puts Rambus in an unfavorable light. "The company's long-term earnings power may be significantly lower than previously expected," Edelstone said when he lowered his rating on the company from strong buy to hold on the day of the court ruling.
So is the Rambus story over? The fairy-tale chapter is certainly finished. SDRAM and DDR SDRAM are going to be significant competitors to RDRAM, and Rambus may never get royalties from chips produced by competitors. "There is going to be market segmentation, and it will be very hard for one standard to completely dominate another," says Chipinvestor.com's Nadkarni.
Rambus can continue to sell its RDRAM chips profitably. For now, it appears that the company took its intellectual-property strategy one step too far and tried to litigate its way to profitability. But despite the setback, Rambus has a good product that customers want. And the stock is selling at a very low price. That's a combination that could spark the interest of smart investors.
Jaffe writes about the markets for BusinessWeek Online in our daily Street Wise column
Questions or comments? Please visit our Ask Sam Jaffe interactive forum Edited by Beth Belton
Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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