Acacia's stock has recently dropped over 15% despite a blowout Q4 earnings report and a very bullish earnings call commentary, here. The stock started to fall following news of a pending Congressional bill called the Shield Act. The purpose of this article is to articulate why this bill should not materially affect Acacia's business.
As background, the Shield Bill proposes that any NPE (non-practicing entity) that sues for infringement and loses in court would have to reimburse the defendant's legal fees. This is an attempt to dissuade any frivolous lawsuits by obviously changing the expected returns. Below are my reasons why this will not impact Acacia negatively and as a result the recent shaving of close to 300 million in market capitalization presents a tremendous opportunity.
1) Acacia's suits rarely make it all the way to court. It has become a real licensing company with an increasing amount of signed deals occurring with no legislation whatsoever. For example, in 2012 Acacia didn't have any trials.
2) The threat of having to pay legal fees will not change the calculus whatsoever on either Acacia's side or the defendant's side. Acacia is generally seeking large amounts in the order of $50 million or more. Having to pay approximately $3 million in defendant's fees would be meaningless in the overall scheme of things. Moreover, such a prospect shouldn't act to empower any defendant into not settling early; the numbers are just too small to matter.
3) This bill is really intended to stymie "frivolous" lawsuits and rightfully so. Acacia doesn't take on or buy any "frivolous" patents in the first place; it's track record of success certainty proves that. Acacia expects to extract significant revenue from each patent portfolio and is generally successful. In the rare event that a case actually makes it all the way to trial, Acacia's expected return will dramatically dwarf any legal fees that would have to be paid in the case of a loss.
4) It's no sure thing this bill passes. Assuming it does and were to take effect this year (again no sure thing), any IP that Acacia assumes now wouldn't make it to trial for at least 2 years. By then, based on my estimates, Acacia should be generating close to $400 million of revenue and significant cash flow.
5) Even assuming 4 trials per year and a 50% win rate, and assumed legal bills of $5 million each, Acacia's exposure would be $10 million. This is on back of the stock having lost close to $300 million in market capitalization.
6) Any smaller players could have a higher incentive to partner with Acacia thus driving more business to Acacia. We certainly have seen this following the America Reinvents Act, (last iteration of patent reform).
In conclusion, I believe this is a gross over reaction in the stock. As a reminder, the company is sitting on $6.38 per share in cash and short-term investments and over $500 million worth of purchased IP in the past 2 years (approximately $10 per share). Revenue and cash flow should grow significantly over the upcoming years especially given the fundamental drivers articulated by management. The company also has a $100 million buyback in place so any more weakness could activate more company repurchases. Lastly, the upcoming April trial versus Apple could prove to be a significant catalyst for the stock should the outcome be favorable.
Admittedly, the business is very lumpy and as a result quarter performance is volatile. So one needs to maintain a long-term perspective on this business.