Here are Keys to Finding the Next Big Plays in Licensing
Investors are always on the hunt for high growth companies that are capable of generating strong cash flows for reinvestment, regular dividends, or share buybacks. For instance, Visa (NYSE:V) maintains 80 percent gross margins by essentially licensing its name to banks and merchants; Dolby Laboratories (NYSE:DLB) maintains 90 percent margins by licensing its audio technology to audio equipment makers; and Immersion Corporation (NASDAQ:IMMR) maintains 97 percent margins by licensing its haptic technology to consumer electronics and automotive firms.
In this article, we will take a look at why licensing stocks are attractive to investors and explore one company that is transitioning from a product model to a licensing model.
Product Vs. Licensing Margins
The companies mentioned in the examples above all license their technology or brand to various end markets. Since they do not have to physically manufacture any substantial products, they have very little cost of goods sold (“COGS”) and high gross margins. Many times, these high gross margins translate to high net margins over time, as licensing revenues grow to overcome fixed costs (like selling, general and administrative expenses or interest expense). It is this high net margin that ultimately drives significant shareholder value.
High net margins generally equate to a greater amount of cash generated from operations, which can be used to reinvest in growth or redistributed to shareholders via dividends, buybacks or similar events. For instance, Visa has continuously upped its dividend yield over time, while Dolby Laboratories offered investors a special dividend in late-2012. High net margins can also justify higher P/E multiples and valuations relative to lower-margin peers, as seen in Figure 1 below, as long as the high margins are accompanied by strong top-line growth rates.