Though the recent history of new patent focused stock Document Security Systems, Inc. (DSS) has been anything but negative, the stock still offers tremendous upside potential. Considering the well-documented success of VirnetX Holding Corp. (VHC) and recent success of Vringo Inc. (VRNG), investors might be surprised by the lack of initial success of those patent firms.
The first article, Document Security Systems Has Significant Patent Monetization Plans, offered a glimpse at the potential in the stock. A big key for the stock will be the execution of those plans highlighted in Important Dates For Document Security Systems. This article will attempt to compare the different patent stocks to provide a glimpse into the potential of DSS.
DSS is a leading developer and integrator of cloud computing data security, Radio Frequency Identification (RFID) systems and security printing technologies that prevent counterfeiting and brand fraud.
With the stock crashing to 52-week lows around $2.15 due to a disappointing Motion to Transfer ruling, investors now have the opportunity to purchase the stock significantly below the merger and private placements levels. While the company hasn't executed on target dates whether with the patent case or possibly the merger, the question remains whether it has taken any different path than the likes of VirnetX or Vringo?
Disappointing Transfer Outcome
DSS reported that the federal judge in the Eastern District of Virginia ruled that the case would be transferred to the Northern District of California. The company had hoped that the lawsuits against Facebook, Inc (FB), LinkedIn Corp. (LNKD), Novell Inc. (NOVL), Jive Software Inc. (JIVE) and BroadVision, Inc. (BVSN) would proceed in the 'rocket docket' court of the Eastern District of Virginia.
While this outcome probably has minimal impact on the substance of the case, it clearly could have a major outcome on the timing of the case. Management originally estimated that a move to California could delay the case by at least 9 months.
This company is the poster child for the success and possibly creation of the patent stocks hype. The stock soared from around $1.5 in mid-2009 to as high as $41.77 in only two years. Those types of gains attract investors hoping for a major score in other patent stocks. Was VirnetX the exception or the rule?
The company is an Internet security software and technology firm with patented technology for secure communications including 4G LTE security. It has a limited revenue base with only $1.2M expected in 2012. The company has a patent portfolio of 20 U.S. and 26 international patents and over 100 pending applications.
Back in early 2008, VirnetX teamed up with ipCapital Group to derive the potential value of the technology and patents owned by VirnetX. ipCapital Group, a leading intellectual property (IP) strategy consulting and licensing firm, concluded that VirnetX had a portfolio worth in the multi-billion dollar range.
In February 2009, the company completed a public offering at $1.50 per share plus warrants. At that time, the company had 37.4M shares outstanding.
In June 2009 after a couple of years of limited success on a patent infringement case against Microsoft (MSFT), the company hired McKool Smith to lead the ongoing litigation efforts in June 2009. In July, the company obtained a positive ruling in the Markman Order in this case.
The stock had languished mostly under the $1.50 offering price until this ruling. Several years after the initial lawsuit and a massive IP valuation, the stock appreciated. It wasn't until a positive ruling occurred that the stock finally gained traction and quickly doubled to $3.
In December 2009, the company claimed that it owned the patents for LTE and 4G wireless security standards. It believed to hold the majority of the Series 33 specifications that define the security standards for the technology.
Finally in March 2010, the jury awarded VirnetX a $105.75M judgment against Microsoft for willful infringing on two patents owned by the company. Then in May, the companies settled the dispute with Microsoft agreeing to a licensing deal and a one-time payment of $200M.
Another interesting side note for investors interested in the jackpot like winnings of a large settlement or judgment, VirnetX only reported $115M in income from operations off the $200M settlement with Microsoft. A huge royalty expense of $60M and over $20M in additional administration expenses above the previous year took a significant bite out of the cash collected. The company also paid $34M in income taxes that will vary based on company specific accumulated tax losses. In the end, the company reported net income of only $81M on 47M shares outstanding. Note how the share count increased 10M in the nearly 18 months since the public offering.
Off the success of the Microsoft victory, the stock soared to $20 and the company filed a lawsuit against Apple (AAPL), Cisco Systems (CSCO), NEC, and Aastra (AATSF.PK). The company followed up with a suit against Siemens (SI) and Mitel Networks (MITL) in early 2011.
The company announced in early April that the iPad 2 was now included in the lawsuit against Apple. The suit now includes the iPhone, iPhone 3G, iPhone 3GS, iPhone 4, iPod Touch, iPad, and iPad 2.
By July 2011, VirnetX was granted two more security patents for the 4G mobile market to notch the total for the year to eight. The stock was stretching to all-time highs near $42, a level to only slightly be surpassed in July 2012. It eventually received several more patents during the year.
The stock eventually plunged to $11 by October after Cisco Systems and Apple obtained reexamination decisions by the U.S. Patent and Trademark Office (PTO) on Patent 6,502,135. That turned out to be an ideal time to repurchase the stock as it eventually soared back to just above the all-time high after a positive Markman Order in the infringement case against Apple, Cisco, NEC, and Aastra in April 2012.
The process took nearly 18 months from the original suit filing in October 2010 and the stock only appreciated about 20-30% in that time period. Beginning in May, the company began signing license agreements with the defendants starting with Aastra and followed by Mitel.
Eventually the company went to trial with Apple that led to a $368M verdict in November 2012. On top of that, the company asked for damages based on the iPhone 5, iPod Touch 5th Generation, iPad 4th Generation, iPad mini, and the latest Macintosh computers. Apple is to provide sales data on these products in January.
Based on the same 40% net profit, the company would report net income of about $150M off this initial award.
The company will go to trial with Cisco and the remaining defendants in March 2013.
Based on these results, the stock now sits at $30 with a market cap around $1.5B. Since the peak in July 2011, the stock had become a good trading vehicle, though not necessarily a long-term investing vehicle.
The important takeaway is that the company had significant IP that was eventually monetized. The stock though struggled until years after the initial lawsuit. The chart below shows the 3-year chart:
The company well known for recent success with suing Google Inc. (GOOG) went public back in June 2010 at $4.60 per unit. The offering of 2.4M shares consisted of one share and two five-year warrants. The company received proceeds of $9.4M.
At unit separation in July, the stock initially traded above $2.50 and quickly traded down below $1.50 by August. The company didn't receive its first patent until that July when the PTO approved Patent No. 7,761,816 covering aspects of its video ringforward technology. The second patent wasn't issued until January 2011. It covered the technology for distributing personalized mobile apps. At the time, the company had another 21 patent applications pending around the world. The stock though plunged throughout 2011 and ended up in the pennies in early 2012.
The company didn't obtain its third patent until October 2011. The first international patent was issued around that time as well.
While the stock jumped back above $1 at the end of January either due to the iPhone app or other various speculations, the stock really jumped after the deal to merge with Innovate/Protect. That company was the owner of patent assets acquired from Lycos, one of the largest search engine websites in the mid-late 1990s, with technologies that remain critical to current search platforms.
Innovate/Protect is a company that maximizes the economic benefits of intellectual property assets and at the time had a patent infringement lawsuit in the Eastern District of Virginia against Google, AOL, Inc. (AOL), IAC/InterActiveCorp (IACI), and Target Corporation (TGT). The Markman claim construction hearing was scheduled for June 4, 2012 with a trial scheduled to begin in October.
The stock surged in April apparently on the hopes of the litigation with the likes of Google and AOL. It eventually hit new highs of $4.5 prior and right after the Markman hearing.
Shortly after finalizing the Innovate/Protect merger, the company agreed to acquire over 500 patents from Nokia (NOK). The portfolio encompasses a broad range of technologies relating to cellular infrastructure, including communication management, data and signal transmission, mobility management, radio resources management and services.
In November, the company won a verdict against Google and the others, but the jury only awarded $30M in damages whereas the market expected upwards of $500M. The stock that initially jumped over $5.5 in early October based on a lawsuit filed against ZTE and expectations of a large award, eventually plunged to around $1.75 after announcing the Court ruled that damages should be calculated beginning from September 15, 2011 instead of September 15, 2005.
At the end of the day, the stock trades around $3. Not far from the original trading price even though the company has won a judgment against Google. Along the way several common stock offerings were exercised to dilute existing shareholders that haven't benefited from any financially significant awards.
The company is still pursuing ongoing royalties with Google at upwards of 5-7% rates based on the willful violation of patents proven to be valid. The ZTE litigation continues moving forward as well.
In a lot of ways, the company has a similar history to DSS. Both were small public companies with small revenue bases and intellectual property. Both merged with IP monetization firms that brought along recently started litigation cases against major firms.
So far Vringo has chosen to raise cash and make a significant purchase of IP assets to expand the patent portfolio. Any investors buying at the right time made some decent gains especially for the ones not caught up in the initial hype. The signal exists for investors to keep DSS on a watch list until more data is available on the patent cases.
Vringo only has a market cap of $222M, so the stock has some potential upside as well based on the potential for royalties in the Google case. The below chart shows the volatile history of the stock:
LTG Merger Remains On Track
One of the original concerns with investing in DSS surrounded the timing of the merger with LTG. Did any possible negative outcome exist if a positive outcome from the Bascom Research lawsuits occurred before the merger finalized? After all, DSS didn't have ownership of the LTG assets yet leaving some risk that an extremely positive court decision or royalty agreement could cause the owners to drop the merger and take all the winnings for itself.
The decision to move the trial to Northern California and likely delay any outcomes by up to a year, likely ensures that the merger will progress without any hesitation.
The merger though appears slightly delayed from the original expectation of a March close. The company announced that the updated expectation is for a close in first half of 2013. While not specifically stating the merger is delayed from a Q1 close, the press release suggests a slight delay into April or May.
As mentioned in detail in the previous article, DSS has several major catalysts that could push the stock up starting with the Bascom Research patent case through to the merger. Other potential catalysts include the Coupons.com trademark lawsuit and the IPNav license program.
Clearly the major catalyst remains the Bascom Research litigation against Facebook, LinkedIn, and the others. It now isn't likely to have a significant start prior to when the merger with LTG will be finalized.
The stock hit new 52-week lows since the last article in early December, as the original timelines have not been met. As the below chart shows, the stock has been very weak since announcing the merger and patent monetization plans in early October.
6-Month Chart - Document Security Systems
With the lack of a bounce off the $2.50 level, it wasn't a huge surprise that the stock was unable to hold support at that level. The inability of the stock to move above the 20ema suggested the market was more concerned about the transfer than the management of DSS.
The stock remains a huge risk/reward situation even with the negative outcome in the transfer motion hearing on the 7th. Though the movement to the Northern District of California might leave the stock off the radar for a while now.
The past histories of both VirnetX and Vringo suggest that the original weakness was an ideal time to purchase the stocks. In both situations the stocks had long periods of limited gains after the initial lawsuits were filed. The patient investor tended to make the most money.
All three firms will own significant and interesting patent portfolios that are in the process of being monetized. Even a patent expert would have a difficult time forecasting the eventual judgments so a wise investor might want to trade the extremes. Buy as investors dismiss the potential lawsuits' ability to win and sell as the stock soars on any positive verdicts or speculation of unmitigated success on those lawsuits.
Right now investors don't appear that positive that the Bascom Research lawsuit has any merit making the stock very enticing as the case opens up in California.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Please consult your financial advisor before making any investment decisions.