This article provides a unique discussion of broad economic conditions in software, energy, human labor, and patents. The discussion highlights upside and downside characteristics in the patent space, and argues software patents are overvalued relative to other industries. The article then provides an investment conclusion of selling Vringo (VRNG) shares and buying Lightbridge (LTBR) shares.
To bypass the macro discussion, scroll down to the bold heading containing the text "Dump Vringo"
Software is hot.
Investors are concerned about bubble-like conditions. Inside this bubble float software patents, gaseous substances which have been reified as solids in public perception. A crescendo of such reification is scored by the America Invents Act, which introduced "first to file" priority, overturning the "first to invent" principle which has been around forever. Instead of inventions, patents themselves are now the property; in a classic sense of reification, words have stolen the identities of the ideas they describe.
We are taking the word "property" far too literally, as if the government had announced a race for land, as if patents were a hard asset like real estate. Fiat currency is a far more appropriate analogy. Patents are inflated and deflated at the whims of politicians, and frequently counterfeited by artistic lawyers in a game of litigation shakedowns. A land run among investors in this now-crowded space occurs atop thin ice.
Nuclear is ice cold.
Although energy leaders like Elon Musk still see it playing a substantial role, they are outnumbered by financiers fixated on natural gas. The economics of carbon emissions and dollars place nuclear among the most attractive forms of energy in geographically appropriate regions developing new programs. And, a principle of sunk costs makes it unlikely that existing reactors will be shut down any time soon.
Nuclear is part of energy. Institutional investors love the future in this overall space. We are unlikely to curb our accelerating consumption of energy; thus we need to increase our production. The demand for nuclear is not a problem.
Here is the real problem. Investors in an era of software wealth inherited unrealistic expectations for the pace of nuclear adoption, and have abandoned the space in disillusionment.
Marx vs. Nietzsche: The Case For IP Investment
Information (technology) is replacing humans. All relevant economists understand this. Marx described himself as an economist in books based on this idea, and the trend has only accelerated since.
Workforce participation has been declining all the more quickly since companies like Google (GOOG) began replacing human intelligence with computer intelligence. Thus, economists should acknowledge that workforce participation is no longer a crucial metric. But they are blind to this, as political expediency favors the illusion of a sustainable, working middle class. With IP business models, investors have an opportunity to get ahead of flawed economic thinking by betting against the value of human labor.
A recent article in Discover Magazine quotes Nietzsche to discuss robots replacing humans. "Man is a rope, tied between beast and overman[computer]--a rope over an abyss. What is great in man is that he is a bridge[to robots] and not an end." I feel this raises a distinction between the early-redemption-seeking philosophies of Nietzsche and Marx. "While Marx places salvation in the embrace of collective humanity, Nietzsche finds it in high solitude, far from the madding crowd."
For better or for worse, I think society has chosen Nietzsche's redemption model as the winner, and the economic power created by technology will not be collectively distributed. This reduces the relative value of human labor and establishes intellectual property as an attractive asset class.
Vringo is a small-cap software patent company. Its business model is acquiring patent rights and suing businesses for infringement. It has an enterprise valuation of several hundred million dollars and some tens of million in cash. It has been relentlessly hyped. The hype is starting to wear off as investors realize: the lawsuit against Google will bear less fruits than expected, and even these fruits will not be forthcoming.
Software patents are an inflated currency; Vringo's software patents may be proven a counterfeit currency! Patent law insider Dan Ravicher writes the following:
Thus, as with the original expectation of $700M and then $493M in trial damages, which resulted in a verdict of only $31M, and may soon be shrunk even further, expectations that Vringo will receive hundreds of millions of dollars in future royalties are also, in my opinion, very unlikely to materialize.
I have been warning Vringo investors about this for half a year now. It's time for Vringo to "pay the piper". There is talk about their partnership with Nokia (NOK) to litigate mobile patents, but that is future talk and will occur in a less friendly court. I don't think a long-term battle for uncertain profits appeals to Vringo's shareholder demographic, which is why shares have been selling off.
Let It Ride On Lightbridge
Lightbridge is an energy patent company. It has about 1/10th the valuation of Vringo. It is developing lucrative patents in nuclear power. Unlike biotech, which becomes more risky with each stage of approval, Lightbridge becomes less risky as it progresses through stages of testing and validation. Recent publication in American Nuclear Society's journal, and a study from Siemens company Pace Global confirm the economic potential of these patents. The final step is testing in government model reactors, which will take the rest of this decade but should see licensing revenues sooner from future customers purchasing "options".
Remember, energy innovation takes decades. Lightbridge has been working on this stuff for decades although these patents in particular are a newer discovery. The patents are for a modular upgrade on nuclear fuel rods which will generate 10%-30% improvements on fixed costs, or 200+% ROI for plant operators. Like Vringo's patents for search engine filtering, Lightbridge patents are based on laws of nature. Unlike Vringo's patents, Lightbridge patents are extremely valuable.
Being an investor in either Lightbridge or Vringo will require patience. I would prefer to patiently wait for a company to generate hundreds of millions in licensing revenue from operating partners, rather than patiently waiting through a patent troll's burning of investor cash on failed lawsuits.
But being an investor in Lightbridge right now doesn't require too much patience. The company is likely to report an uptick in revenue next quarter from renewal of consulting work in Abu Dhabi. There is a smaller but still substantial possibility they will report new consulting contracts.
Lightbridge: A Better Trade And A Better Investment
Lightbridge has no long-term debt and never has, however cash reserve is low and the market has been concerned about dilution. I believe last quarter's conference marked a "kitchen sink quarter" and that shares will never see these lows again. Although I have never suggested Lightbridge as a short-term trade, I am suggesting it now--and as a long-term investment with huge upside.
The company does not need to promote its share price, because it funds its patent development from revenues generated by consulting countries and businesses on nuclear power. When is the last time a country paid Vringo to consult them on software? Why would you want to invest in one of the most popular speculations around--wouldn't you rather find something under the radar?
Lightbridge is led by an experienced international lawyer focused on generating revenues from patents in America and Eurasia. It is also led by a former buyer at nuclear utility Exelon (EXC), and such buyers are Lightbridge's future customers. Lightbridge is staffed with a who's who list of leaders in international politics, nuclear design, and nuclear commerce. You can take their projections very seriously.
Contrast this with the Hawaii family law attorney, Steve Kim, who was most actively providing "expert" bullish advice to Vringo investors as shares went euphorically high.
With their conservative assumption of 20% penetration in Lightbridge's target market, the company expects licensing revenues between $200-300mm which is roughly the same size as Vringo's valuation as a company. The 20% figure is quite conservative considering the offering to potential customers of 200-300% ROI. Around the world, nuclear stakeholders understand that Lightbridge could further enhance the comparative advantage of nuclear power relative to other energy sources.
Looking at licensing revenues for 15 years ending around 2035, I personally see a more healthy market penetration around 50%, expect Lightbridge to generate $600-800mm per year, and thus value potential of the patents at $10BB. This is a high-margin IP business model so revenue is virtually the same thing as cash flow. Discounting 90% for risk, I value Lightbridge at $1BB which presents 50x upside from current levels. If Lightbridge simply reverts to the range established prior to Fukushima--before its patents reached their current level of promise--the stock price will triple on this revenue stream alone, and I expect this to occur over one to two years as consulting revenue trickles back in. As I have said recently, I would not even begin to think seriously about buying Vringo stock for more than $2. Don't like the immediate upside in Tesla (TSLA)? Lightbridge is a more dynamic bet on electricity.
Disclosure: I am long LTBR.
Additional disclosure: Lightbridge purchased reprint rights in a standard procedure facilitated by the Copyright department at Seeking Alpha for which I received nominal compensation. This does not constitute an ad-hoc relationship in any form. I began writing without any expectation of reprint fees. I have an established record of writing candidly on all stocks, and I am not concealing any conflict of interest in sharing my unbiased opinion on this company.