Finally! It's over. The binary event of a win versus loss against Google (GOOG) is now over. And Vringo (VRNG) won. So what should Vringo be worth right now? Now that they were the complete winner. Let's clear up all the misinformation.
For instance, many articles make this erroneous quote: "Vringo won a $30 million settlement from Google." I was sort of hoping that the weak hands in Vringo would all dump VRNG into the $1s and maybe I would then buy up the entire company. Or something like that.
But unfortunately there are a few smart people who are preventing that from happening, so I might as well correct the mistakes.
Let's just break it down. I'm going to do the worst-case scenario, the middle-case scenario, and the best-case scenario of what I think VRNG is worth. I personally think VRNG is worth the best-case. But you can decide what you want.
Let's do a sum of the parts.
A) Cash in the bank: $60 million.
B) Cash awarded to them from Google: $30 million (see why I do not think it's less than that below). By the way, this is where the news reports discuss "VRNG won $30 million." Because $30 million is the "damages."
C) 3.5% royalty rate. The royalty runs from September for the next 4 years, until the patent runs out. Worst case, it's $30mm (equivalent to the damages). I say "worst case" because the jury sort of picked out that $30mm arbitrarily and it's actually much larger than that number as documented here and here. But forget those articles for a second. Let's just assume that it's $30 million per year. That's $120 million.
Most news reports have failed to report a number here. I am giving the worst possible scenario here. It's so unbelievably "worst case" that it's barely worth mentioning but I mention it in order to show the risk versus reward.
E) Vringo successfully sued Google. Now I'm assuming they would do what any other patent holder will do and sue Microsoft (MSFT), Yahoo (YHOO), and all of Google's customers. I'm taking the worst-case: let's say that's worth ZERO. Unlikely, but we're all about risk versus reward here.
F) Let's also assume Vringo never does meaningful with its pitiful life ever again. And just collects their money, dividends it all out to shareholders, and then everyone retires to the beach.
Worst-case scenario sum of the parts: $410mm. That's a share price of about $3.80. Maybe a little higher than where we are now. That's what I view as the cash value of the stock, worst-case. You have to discount that back a little bit since they don't get all the Google and Nokia money at once, but you can decide what you want that discount to be.
"A" and "B" from above remain the same.
"C" is changed to $120 million a year for four years. See here for a good explanation as to why. Essentially, it's a 3.5% royalty on 20% of Google's US revenues. So "C" now is $480 million.
If you want more evidence for that number, look at documents filed by both Google and Vringo during the court case. Essentially you want the part of Google's US revenues that their smart ads are applicable to. Here is one document describing it as 20% of Google's revenues: (go to slide 8)
"D" remains the same. I'm going to stay conservative on the $200 million. Why not? It's only upside and I care more about losing money than making money.
"E" What will they make from Microsoft, Yahoo, and all of Google's customers. I have no idea. MSFT + YHOO + the revenues of all GOOG customers is probably about half of Google's US revenues when all added together. There will be some litigation costs, but it will be minimal. Many will settle and Vringo, as investors who have done their research know, did not spend a lot on this litigation (about $5 million total). So we can take the $510 million number ("B" and "C" from above) and divide it in half. But let's even be more conservative. Let's divide it in half again. I like to be safe.
So that's $130 million.
"F" we will still assume is nothing. Assume those Vringo guys are a bunch of lazy bastards eating donuts and suing Google and that's about it.
So what's our medium case sum-of-the-parts: $700 million or about $6.40 a share. Almost double form here.
"A" through "E" is about the same as above. You can be a bit more aggressive on "D" and "E" if you want, but I like to be conservative.
"F" is interesting and somewhat subjective. Let's look at the two actions VRNG has done since changing management a few months ago.
They bought the Lycos patents for $3 million, spent about $5 million on litigation and won about $510 million (so far. They will win more, as mentioned in "E" above). So about a 60x return on their cash. Probably more like an 80x return when all is done. But let's be conservative.
On the NOK portfolio, they structured a deal that was cheap for them ($22 million) to buy a portfolio by which they will have about 10x benefit. Why did NOK sell for so cheap? For reasons already explained, Nokia benefits by having Vringo own the portfolio rather than Nokia. So Nokia wins huge in this deal, as does Vringo.
So we've established that Vringo knows what they are doing when it comes to patents. Plus they have Don Stout on the team. David Cohen, who was Nokia's chief litigator in the US, is the chief litigator for Vringo, and a technologist like Ken Lang to pick through the patents and see where the value is. Now that they won this case, my guess is they are being pitched non-stop by patent companies and they will have their pick of the litter on who to buy.
So the question is: what is the value of the $700 million in cash they will eventually have in the bank. It's clearly not $700 million, based on how successfully they've been able to put their cash to work. Is it 60x? Probably not. The Google outcome is probably an extreme. Is it 10x. That's probably more likely.
Do I think VRNG is a $7 billion company in the making? That seems too unrealistic at this point. Too many unknowns. So let's discount that down 70%. Instead of putting a 10x multiplier on their cash (which, by the way, the market put a 10x multiplier on patent company VirnetX's (VHC) cash) let's just put a 3x multiplier on it.
Or about $18 per share. Discount that back however you want. I was already being pretty conservative.
I think the ultimate risk-reward on the stock is between the medium case scenario above and the best-case scenario. Or about $6.50 to $18. You can even take the worst-case scenario above and you still have almost no risk on shares at this point.
So, some basic Q&A:
- Why did the shares go down? I called several retail investors who owned the stock right before the verdict. I asked them, "Are you going to buy more on a positive verdict?" 100% of them said they were going to sell. They all wanted to sell "the pop."
In other words, everyone who was an investor for the court case, had ALREADY BOUGHT their shares and were waiting to sell. It was a classic "sell the news."
Now the shares are trading hands and going in the hands of long-term shareholders. How do I know? Because when I look at the $45 million they raised before the verdict, I see it was an institutional round and not a retail secondary. Institutions were buying this at higher prices while retail was selling it at lower prices. The weak hands are getting out and the stronger hands are getting in now.
- What if Google appeals? If Google appeals, then Google might have a problem. Vringo can appeal the laches rulings (which limited the past damages) and Vringo can appeal the jury verdict, which it now appears was a mathematical error that won't be corrected. (More on the laches rulings here). Meanwhile, the cost to Vringo on any appeal is close to zero. Some people have said that "Google can appeal this for years…" And my response: change that to "year." That's the law. Look it up. The Supreme Court won't take this, so there's only one court to send this to.
- Is there any other upside? Yes, huge. If VRNG sues MSFT, YHOO, etc., the laches which limit damages no longer applies. Damages can go all the way back to 2001. And if we avoid any mathematical errors, the numbers can be much larger. In the above, even in the best-case scenario, I took a very conservative estimate. It might not be so conservative in the real world. But better safe than sorry.
When I first wrote about this stock, it was about $1.80. Now it's $3.67. It's been as high as $5.75. People played this with various strategies. I hope people made a lot of money. But, now we are here and we have to decide what to do. I like the risk-reward a lot. I think there is very little downside now.
We are past the binary event of a jury verdict. It's over. Vringo won. And it wasn't a $30 million settlement. It was more like a $500 million verdict. Figure out the exact cash Vringo is going to have. Figure out what they will continue to make. Compare with the current market cap.
Good luck investing.
Disclosure: I am long VRNG.