Business: Xperi is a technology company that develops software solutions and has the following four main business segments. First, there’s pay-TV, which provides backend software for internet-enabled cable boxes. There is the consumer electronics segment, which delivers audio and media technology for consumer devices at home and on mobile. There is also the connected car unit, which brings high-quality multimedia and personalization to the connected car. Finally, Xperi has an independent media platform that allows Smart TV original equipment manufacturers to brand the experience, retain customer ownership and generate recurring revenues through the company’s TiVo brand.
Activist Commentary: Rubric Capital is a New York-based hedge fund founded by David Rosen. It first got its start as a division of SAC Capital while Rosen was working there. The firm was launched independently in October 2016 by Rosen, who is a managing member. Rubric is a deep value, long/short investor that will become active in situations that require it. The firm has filed five previous 13D’s in its history and gained board representation in three of those situations.
On Jan. 22, Rubric nominated Deborah S. Conrad, former senior vice president and chief marketing officer of Hinge Health, and Thomas A. Lacey, former CEO and director of Xperi’s predecessor company, for election as directors to Xperi’s board at the company’s 2024 annual meeting.
Xperi has mid to high single-digit growth, over $500 million of revenue in 2023 and over 75% gross profit margins. However, the company is only guiding to $35 million of earnings before interest, taxes, depreciation and amortization for 2023. Peer companies with similar gross profit margins generate 25% to 35% EBITDA margins. Meanwhile, Xperi is guiding for 6% to 8%. So, the first opportunity for value creation is cost cutting. Presently the company spends 45% of revenue on selling, general and administrative expenses and 43% on R&D. Together, that is well more than total gross profit. There needs to be a lot more discipline in the company’s spending. Decreasing R&D by just 20% — to 35% of revenue — and SG&A by 5% would increase EBITDA from $35 million to over $95 million. Part of that can be done immediately by divesting or shutting down the Perceive artificial-intelligence chip business. This business has no revenue and burns through $20 million of expenses each year. That would be an immediate bump of EBITDA to $55 million. Moreover, there is value to Perceive, and the company could probably sell it for something.
Another benefit to selling Perceive would be getting back some credibility in the market about management’s strategic decisions after its curious divestiture of AutoSense, its cabin safety business. This is a business that was breaking even and had huge growth potential from regulatory tailwinds mandating additional interior safety precautions. Xperi announced that it would sell the business to the Swedish company Tobii AB for approximately $43 million, of which about $28 million was a promissory note to be paid off over three years starting in 2027, and $15 million was additional payments in aggregate over four years starting in 2028. Moreover, Tobii was a $50 million company, so Xperi transformed itself from an owner of a promising cabin safety and sensor business into the sole creditor of a Swedish micro-cap. As Xperi would need to invest in this business to grow it, this was likely a decision to try to make short-term margin guidance by sacrificing long-term prospects.
But the problem with the company is not a bloated cost structure or poor strategic decisions. Those are just symptoms. The problem is a culture that is not focused on shareholder value. This can clearly be seen through Xperi’s executive compensation policies. The company has approximately 46 million shares outstanding, including approximately 3.6 million of restricted stock units that have been previously granted to management prior to Jan. 1, 2023. In the last nine months, Xperi has granted an additional 4.1 million RSUs to management, which will result in a 12% dilution to shareholders based on a full year. To make matters worse, 75% of these grants are just time based as opposed to performance based, which has resulted in management owning RSUs for 14% of the company – 75% of which are only subject to time vesting during a period when the company’s stock price has declined by 24%, while the S&P 500 has increased by 36%.
While it seems like Xperi has a lot of problems, the good news is that it has great products in excellent markets and a management team that just needs discipline. All of its problems have the same solution: fresh blood on the board that will change the corporate culture, institute discipline and hold management accountable to shareholder value. Accordingly, Rubric Capital nominated Conrad and Lacey for election as directors to the company’s board at Xperi’s 2024 annual meeting. Lacey certainly knows this industry and Xperi well, as he has been a shareholder since he left the company and seems to care about it prospering.
This is a company that is in desperate need of board refreshment; it has only five directors on the board and could easily add two directors while still having a very manageable board of seven. Moreover, three of the incumbent directors received over 12% of against votes at the last annual meeting. While this is not an unusually high number, it is for a company that had only been public for seven months at the time of the annual meeting. With the use of the universal proxy card, we believe Rubric should easily get at least one, and likely two, of its nominees elected if this goes to a proxy fight. But that should not happen. Rubric is being amicable here: looking to work with management, not threaten them. There is a big difference between settling for two additional directors on a seven-person board and replacing two incumbent directors on a five-person board. The company would be unwise to take that risk. While Rubric is the type of investor that would prefer to settle amicably and has never taken a proxy fight to a decision before, the firm once came very close to doing so at UK-based Mereo BioPharma, and it would take this all the way to a decision if forced to.
Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.