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Investors who have followed the stories of Vringo (NASDAQ:VRNG) and VirnetX (NYSEMKT:VHC) understand that there is plenty of money to be made following high-stakes litigation, but there is also plenty of money to be lost. Investors who belatedly discovered James Altucher's darling Vringo when it was trading in the $5s and manically chased its unsustainable rally have lost over $150 million in market capitalization to date. In fact, Vringo's market capitalization at one point exceeded what most expected it would ultimately receive. In much the same way, VirnetX had its day in the sun while its market capitalization exceeded the total patent reward it was seeking, as well. The time has come to look for alternatives to über-popular patent stocks like Vringo and VirnetX and look for undervalued alternatives.

It should not surprise investors to learn that there are dozens of stocks (not 2!) in the patent sector. Just to mention a few, Acacia (NASDAQ:ACTG), Rambus (NASDAQ:RMBS) and RPX Corp (NASDAQ:RPXC) have been litigating patents for years. Many companies in this sector have just as much eye-boggling potential as Vringo or VirnetX.

As an example, I would like to analyze one company that is trading near cash value and a mere 5% the market capitalization as Vringo, yet pursuing patent rewards of an equivalent amount ($2 billion). Although the companies are litigating in different industries, they are pursuing identical amounts of money. I choose this example simply to illustrate the mania of crowds that prefer a company trading at $250 million (Vringo) versus an equally legitimate company trading at $13 million when both are pursuing $2 billion in patent awards.

MGT Capital Investments (NYSEMKT:MGT) has a market capitalization of $13 million. It has $7 million in cash (yes, over 50% of the market capitalization is pure cash), no debt, and a cash burn rate around $1 million per year. It is pursuing over $2 billion from lawsuits against five casino companies. It is valued at less than 1% of its desired $2 billion, while Vringo is valued at 13%.

This is an important point to make, so let me be very clear. James Altucher just wrote that Vringo could be worth $2 billion in a best-case scenario. We already know that MGT could also be worth $2 billion. So, Vringo is valued at $250 million and MGT is valued at just $13 million. Given this reality, if you are invested in Vringo, you are paying a massive "popularity premium."

In making this comparison, I acknowledge that Vringo has already won some milestone payments (e.g. it expects $30 million and hopes to receive an ongoing royalty from Google), so it deserves a slightly higher market capitalization than MGT. However, the difference in valuation is so enormous ($250 million to $13 million) that even if Vringo's risk-adjusted rewards were backed out of its $250 million, it would still be valued hundreds of percentage points over MGT's $13 million ($7 million of which is cash, by the way).

Morale of the Story: Do Your Own Homework

What is the morale of this simple exercise? If you enjoy investing in the patent sector, there are far cheaper stocks in which to invest than Vringo. Specifically, MGT has 1/20th the valuation of Vringo, even though both companies are pursuing the exact same $2 billion of patent rewards.

Loyal Vringo investors might respond, "Well, but Vringo could license its patent, or sue Microsoft, or subcontract extra law firms, or..." In essence, Vringo could pursue additional opportunities to exceed Altucher's (self-admitted best-case scenario) forecast of $2 billion. In response to this argument, investors must realize that this argument conceptually applies to every company in the intellectual property sector. The possibilities for monetizing patents are always enormous. Like Vringo, MGT could also sue additional casinos (WYNN, LVS, IGT, or BYI). Like Vringo, MGT could subcontract a licensing firm and earn residual revenue. Like Vringo, MGT could pursue additional usage violations, or any number of other lucrative possibilities.

The reality is that MGT's market capitalization relative to its desired legal settlement pales in comparison to the value of stocks like Vringo or VirnetX because of an alarmingly simple reason: popularity. Dozens of patent-focused companies simply pursue their litigation quietly, without fanfare or CNBC appearances or James Altucher blogs, and receive their reward in a sudden strike of a judge's gavel. They quickly rally hundreds or thousands or percentage points on a single press release as investors languish over missed opportunities (or, colloquially, "not doing homework").

These days, some investors are too busy dissecting every scrap of news regarding Vringo's trial against Google, and many invested while it was valued over $400 million and are still underwater. MGT, in contrast, has never rallied over $20 million and has always been trading at less than 1% of its desired reward. Many other companies offer the same risk-averse opportunity.

The outcome of any lawsuit is inherently uncertain. Small companies like the ones discussed in this article are volatile. Nevertheless, if you want to manage risk as a investor, why not pick a company at 1/20th the valuation versus going with an expensive, popular stock?

Source: MGT Capital A Better Bet Than Vringo At 1/20th Its Valuation