Although few people sense the urgency to buy shares now, I expect MGT Capital (MGT) to provide double- or triple-digit returns this year, even if it ultimately loses its high-profile lawsuit against the casino industry. Just as biotech companies rally before major FDA decisions regardless of the outcome, MGT has defined catalysts in 2013 that will provide similar motivation for a speculative rally regardless of the outcome. In this article, I will explain the numerous reasons for a significant rally in MGT's share price during 2013, as well as the risks associated with this company.
MGT is one of the simplest stocks on Wall Street. In a nutshell, it turns patents into money. Specifically, it owns patents that it is selling ($6.8 million) and one patent that it is using to sue the casino industry (announced). It has no debt, fully million in cash, $6.8 million in stockholders' equity on its balance sheet, and minimal operating expenses. It used to be a medical company, but that business failed and was all but terminated in 2012. The company let almost all of those employees and contractors go, sold equipment, terminated leases, and recorded one-time losses to its books. It is now a pure investment vehicle for investors who want exposure to its patent portfolio.
It was this simplicity that originally attracted me to MGT. As I researched the company, I became impressed by how it acknowledged its mistakes, shut down a bound-for-zero business venture, and recapitalized to avoid bankruptcy. I also became impressed with CEO Robert Ladd who quite literally saved the company's life through his involvement as a value investor. I had been following his Laddcap Value Advisors due to his success at Delcath Systems (DCTH), and when he became involved with MGT--first as an investor and then as its CEO--I watched him save the company from self-destruction. Now that MGT has wound down its medical division, it has stabilized into a low-risk opportunity for investors.
Multiple Catalysts for a Massive Rally
Let me explain what I mean when I claim that MGT will rally this year even if it ultimately fails in the courtroom. As all MGT investors know, the company's primary focus is an ongoing lawsuit against five companies in the casino sector for patent infringement: Caesars Entertainment (CZR), MGM Resorts (MGM), WMS Gaming (WMS), Penn National (PENN), and Aruze Gaming America. MGT has a 55% stake in a patent that covers bonus round play in linked slot machines, and it claims that these companies willfully infringed on its patent.
The lawsuit has been announced, and all companies are awaiting the legal proceedings that will determine any monetary outcomes. MGT hopes to win estimates. The defendants hope the courts throw the case out. Simple. If I taught an introductory corporate finance course at a college, I would pick MGT for one of my students' first homework assignments.
For the remaining months of 2013, there are defined milestones that I believe will be cause enough for MGT stock to provide double- or triple-digit returns on pure speculation, regardless of the final outcome of its '088 patent lawsuit.
- Markman hearing
Preceded by several months of discovery, this hearing will determine the scope and final definition of the '088 patent. I have read the patent (very simple to understand) and noted its 10 years of clarification by the U.S. Patent and Trademark Office before it was issued. The '088 patent cites an extensive list of patents and inventions that pre-date its issuance and, again, was inspected for over 10 years. If this hearing is favorable towards MGT, as I expect given this level of precision in the '088 patent, defendants would be highly motivated to settle with MGT quickly. This hearing would also provide fodder for all kinds of press releases, patent analyses, and speculative chatter that could easily attract traders to MGT.
- Final hearing
The jury trial for this lawsuit could be scheduled as early as this winter. As I have explained, even if MGT loses, the run-up in share price prior to this hearing could represent a double- or triple-digit return from today's $3 per share. Recall that MGT was trading at $7.46 just three months ago, so even a double from here would not re-test 52-week highs.
- Scientific Games' (SGMS) buyout offer of WMS Industries
This catalyst has already been fully explained, so I will simply quote a summary here and encourage readers to visit the hyperlinked explanations for more detail.
WMS agreeing to a $26 per share sale to Scientific Games is big news for MGT. Because the deal is so important for both Scientific Games and WMS, we believe pressure to settle the MGT case will mount...
...We think the Markman hearing in MGT's lawsuit could be scheduled for sometime in 2H13, just when the proposed WMS-SGMS deal is garnering intense scrutiny. Such timing would be consistent with that of other recent patent infringement suits...
...Overall, the importance of this deal combined with the pending timeline suggests mounting pressure on WMS / SGMS to settle the case before it goes to the next level, in our view. A WMS / SGMS settlement could also create something of a domino effect that pressures the other defendants to settle, as well.
-Zacks Investment Research
I will only further note that there is no urgency for WMS or SGMS shareholders to acquire MGT shares as risk mitigation until later this year (after the Markman hearing). The slow realization of this risk and its associated buying could easily attract millions of dollars to MGT's tiny market capitalization.
Like analysts at fully, I expect MGT to save its $5.5M in cash for litigation costs this year, as it has proven its desire to only acquire cheap patent portfolios (sub $200,000). If MGT were to spend any money acquiring intellectual property this year, I would expect all purchases to total less than $300,000. I also expect the company's burn rate to fall dramatically from last year's burn rate due to the dwindling need to record one-time losses associated with the wind-down of MedicSight. I personally estimate that MGT will burn approximately $1.7M for its minimal operating costs in 2013, and so I expect it to end 2013 with $3.5M in cash plus (+) any settlement rewards and less (-) any out-of-pocket legal expenses (travel, etc.).
Law firm Nixon & Vanderhye is working on MGT's lawsuit on contingency, meaning that it is not being paid for hourly services and, aside from out-of-pocket expenses, will receive no money unless it wins the lawsuit. MGT has agreed to give Nixon & Vanderhye a larger percentage of the payout in consideration, but I do not mind because the cost before the outcome is so remarkably low. Indeed, MGT estimates the present value of its '088 patent at $330M to $4.5B, and it is able to pursue this lawsuit for free aside from minor, out-of-pocket expenses? This is an ideal situation for shareholders.
CEO as Value Investor
Robert Ladd did not originally come to MGT as CEO. At the time, he was running Laddcap Value Advisors and had been doing quite well for himself after his career at Neuberger Berman. Ladd made a name for himself at Delcath Systems as "an early champion of the potential of chemosaturation therapy" (not to mention that time when his firm started aggressively buying shares in the low $4s just weeks before the stock went to the $6s). Anyway, Ladd started allocating investment funds towards MGT in investing as its medical division was failing, and it was partly due to his leadership that MGT decided to terminate this division- a choice that would end up saving the company from bankruptcy.
As MGT was failing in its medical endeavors, Ladd was proactively investing more money every time the share price dropped deeper into his value zone. By 2011, as the company recognized his foresight, it elected him CEO to lead the post-medical phase of its corporate life.
Over the past two years, Ladd has cleaned up all debt and slashed everything except core infrastructure. MGT has finally stabilized and now offers a legitimate opportunity for common shareholders. I like that the basic tenets of value investing are reflected not only in MGT but also in its CEO.
|cheap share price trading close to liquidation value||$3 per share, of which $2.09 is stockholders' equity ($1.69 in cash)|
|full acknowledgement of mistakes||MedicSight patents "do not fit with MGT's current business model" -CEO Robert Ladd|
|low dilution concerns||sufficient cash to last 1-2 years|
|defined plan to turn the company around||MedicSight divestiture and '088 patent lawsuit|
|executives committed to shareholder value||CEO Robert Ladd|
|near-term catalysts to propel shares toward value||Markman hearing, jury trial and SGMS' buyout of WMS|
Of course, MGT has risks like any small company, though it benefits from a strong cash position. Small companies tend to fluctuate in price by larger percentages in shorter periods of time, as less capital is involved in their valuation. MGT is particularly prone to volatility because of its small float of just 3.2 million common shares outstanding plus 1.4 million one-for-one preferred shares. MGT is also risky because of the company's heavy reliance on a single revenue source: patent litigation. Finally, any setbacks in the '088 patent lawsuit would require MGT to use its cash reserves to pursue alternative business opportunities, thereby weakening the company's balance sheet.
Almost a Free Business
Quiet periods with no news are precisely the situations that offer cheap shares to patient investors. Nothing "exciting" is happening at MGT. It will be a few weeks before any significant news is announced regarding its lawsuit, and it is still months away from its Markman trial. I am bidding for my entry. Too much lower in price ($2.09 per share) and I will be buying shares 100% backed by equity with an entire business thrown in for free. Regardless, within 10 months, I expect shares to double from current prices as we approach the summer and fall.
- If the Markman hearing is positive, shares could easily gap up overnight.
- Speculative buying ahead of the jury trial could send shares up by triple-digit percentages without even nearing 52-week highs of $7.46 per share.
- As awareness spreads about the MGT's risk for SGMS and WMS shareholders, hedging could add millions MGT's share price.
- BONUS: The company's CEO first took his job as an institutional value investor.