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Companies, more and more often, outsource operations that are not key components of their core business. Yet it does not mean the outsourced operations are not key. It is simply a way for the company's leadership to maintain managerial focus on its most important issues. Outsourcing allows service-oriented businesses to create income streams by performing specialized business operations for multiple customers.

Industry leaders 3M (NYSE:MMM), Disney (NYSE:DIS), Intel (NASDAQ:INTC), General Electric (NYSE:GE), Microsoft (NASDAQ:MSFT), Boston Scientific (NYSE:BSX), Samsung (OTC:SSNLF), Fujitsu, Exxon Mobil (NYSE:XOM), Xerox (NYSE:XRX) and as many more have found themselves all doing business with Acacia Research Corporation (NASDAQ:ACTG). Acacia is not just staffed with but led by former employees of industry giants like Texas Instruments (NASDAQ:TXN), Oracle (NYSE:ORCL), Price Waterhouse, Boston Scientific, Microsoft, Boeing (NYSE:BA), Broadcom (NASDAQ:BRCM), Rockwell International, Southern Methodist University, Alcatel-Lucent (NYSE:ALU), Exxon Mobil, General Dynamics (NYSE:GD), Sony (NYSE:SNE), Advanced Micro Devices (NYSE:AMD), and Motorola (NYSE:MSI) just to name a dozen or so. It is confounding to browse the list and spot the commonality. Further confusion abounds when adding the factor that the majority of Acacia's partners are actually small companies, individuals, universities and researchers.

What do a surgeon designing medical technologies, a software developer coding a unique interface, an engineer of electric car batteries, and an ahead-of-its-time broadband communications company have in common? The answer is patents. What problems does the same roster have in common? The answers are: difficulty in effectively licensing or commercializing a patent, patent infringements, and a lack of funds to pursue legal action and defend against infringers.

Acacia fills a niche role of partnering with inventors and patent owners to license their patents to corporations. The financial models include arrangements such as:

  • partnering with the patent owner for simple, equal revenue sharing,
  • purchasing the patent outright from the owner, or
  • paying an up-front payment to the patent owner and then modified revenue sharing applies.

As a partner to the patent owner, Acacia is a non-practicing entity (NPE). It can pursue legal action if necessary against infringers as well as license the patent to appropriate corporate users. Historically, Acacia has found itself both settling infringement issues and licensing the patent for future use with the same corporation. The initial stages of the relationship often proved to be quite adversarial.

Acacia, and other businesses like it, has acquired quite a reputation. Too often that reputation is tied to the perceiver's opinion of the ethics of patent protection. On the negative side, Acacia is referred to as a "patent troll" - one who exploits the patents just to engage in lawsuits and who aggressively forces licensing. It is considered artless to hold a patent when there is no intent to manufacture the product or provide the service. Because a patent troll often purchases patents from a bankrupt company or a financially-troubled company forced to sell its assets, it is likened to a vulture.

On the other hand, some believe NPEs simply balance an unfair equation between "the little guy" and "big business." Absent achievable patent protection, big business is free to be "invention thieves." Patent protectors allow inventors to invent and researchers to research. Organizing and managing patents actually facilitates the access to them.

Acacia grew its number of patent portfolios from 57 in 2006 to a current count of 250. It had 20 licensees paying revenues in 2006 and now has 134. Annual revenue in 2006 was $34.8 million. Year-to-date revenue at the end of 2012's third quarter of $184.5 million has already surpassed 2011 annual revenues of $172 million.

Acacia's track record in technology is leading to trust in the medical technology, automotive and industrial technology sectors. Its track record has also led to unexpected but interesting propositions from its licensees. It is calling the resulting transactions "structured deals." A structured deal may have any of the following characteristics:

  • combination of multiple patent portfolios into a single negotiation,
  • protection from patent claims for a specified amount of time, and/or
  • transfer of the licensee's own patents to Acacia for management and licensing.

Because each structured deal is specific to an individual licensee, the deal is unique and time consuming to negotiate. But, it typically offsets lengthy litigation and ill will.

To date, Acacia has run an all-cash business without incurring any debt. When the stock price fell and fell to a 50% decrease between July and November 2012, it was unsettling. Acacia saw no reason for such a fall other than the inconsistency of quarterly production. Acacia's revenues and expenses are not a steady flow from quarter to quarter. The timing of settlements and litigation decisions are typically not predictable. Negotiations, especially as they become more complex, are taking longer to execute. Rather than taking a quarterly view, Acacia management measures four metrics on an annual basis: growth in patent portfolios under management, growth in new licensing programs, growth in revenues and growth in profits. Growth in new patents has been directly correlated to the growth in revenue.

The non-uniformity of Acacia's revenue and expense flow is not the only quirk shareholders and would-be investors must consider. Acacia's employee base is dramatically atypical of most companies. Furthermore, government regulation is significantly instrumental in how Acacia conducts business

Acacia's success in defining the patent licensing industry revolves wholly around its employees' aptitude, skills and deep experience. Acacia has only 55 employees. Besides an executive management team of 3, there are 27 vice presidents. Its employees' histories are rich in patent law, research, product development and engineering, business development, software development, and technology development. This level of professional employee naturally results in employee compensation and related personnel costs that are steep. From 2008 to 2012, headcount increased 34% from 41 to 55. However, in the same time-frame, average compensation-plus per employee increased 46% from $335,976 per employee in 2006 to $489,042 per employee in 2012.

As Acacia's patent portfolios and licensee programs multiply, headcount will increase. Finding qualified applicants may prove challenging. Even if located, Acacia will be challenged with disbursing essential knowledge from the company's history to new personnel. At some volume, growth may stifle the ability for all personnel to stay abreast of the sheer quantity of available patents. All the while, licensee expectations will continue to migrate from individual licenses and transactions to addressing business as a whole. Steeply-inflating personnel costs may also complicate Acacia's ability to maintain its operating margins. In a word, Acacia has not yet truly proven its dynamic business model is scalable. The exact same factors also serve as a significant barrier to entry in the industry for would-be competitors.

As mentioned previously, Acacia is bound by adherence to patent law. In September, 2011, the Americans Invent Act (AIA) also known as the Patent Reform Act, was signed into law after nearly a decade of effort and debate. The act contained the most major changes to patent regulations since 1952. While Acacia continues to prep and braces for the effectual March 2013 date of the major provisions of the bill, there are two areas of consolation. First, any new patent legislation with major change is not likely to speed its way through Congress since the recent legislation took a decade. Second, Acacia is predicting the legislation will drive business toward it rather than away. In July 2012, Acacia's executive chairman, Chip Harris, pointed out:

"The changes to the legal system haven't just made it harder to be an NPE, they've made it harder for every patent owner to realize monetization."

Acacia's role as an NPE began by meeting an unmet need for inventors, researchers, small businesses and universities. It helped right past wrongs and paved pathways to equitable revenues for patent holders. Recently, Acacia's business model expansion is meeting an unmet need for its licensees. By managing and licensing its licensee's patent portfolios, it is not only expanding its patent base but previously adversarial relationships are resolving to partnerships. Acacia has a solid cash position, no debt, a strong and spreading reputation, and a proven history of growth with expectations to continue on the same trajectory. There are quirks in its business but Acacia looks to be steering well through the obstacles and the unknown. For investors with an unmet need of a growth stock in their portfolio, Acacia is a viable candidate. Besides, with Acacia, investors wouldn't be just tracking share price and studying a 10-K; they would be enlightened about American ingenuity with every press release.

Source: Acacia Research Corporation - Meeting Unmet Needs

Additional disclosure: The investment club to which I belong owns shares in INTC, DIS and BA.