Every day I meet a new legal expert online with a brilliant new calculation of Vringo's (VRNG) expected courtroom payout. It is so fashionable to guess how much money Vringo will win that I feel like Josh Brown at the Jamba Juice (NASDAQ:JMBA) conference in 2007.
I have never owned a share of Vringo, yet these at-home analysts mesmerize me with their breathless calculations and play-by-play commentary. My favorite is the blogger with no background in law who attempted to diagram valuation models with worst case scenarios starting at double-digit upside... followed by a decline of 37% the following month.
As I have written before, my thesis is that Vringo is so popular that investors are deliriously overlooking identical opportunities at fractions of the cost. Vringo carries an enormous popularity premium- tens of millions of dollars in extra market capitalization that shareholders do not receive in underlying value but instead forfeit as admission to the party.
Vringo boasts $260 million in market capitalization, despite a 48% decline in revenues last year to a paltry $369,000. This means that almost its entire market capitalization is based on hopeful payments. For example, Lake Street Capital calculates the NPV of Google's future, multi-year payments at $250 million. Now, a few tens of millions is justified, but getting into the hundreds of millions is just being optimistic. These extra tens of millions are what I call Vringo's popularity premium- the result of shared optimism and incessant headlines about Vringo.
The reality is that none of us (aside from a few attorneys) understands how to estimate the likelihood of legal victory nor the size of payouts. We do not understand contingency fees, laches, prior art or the discovery process. (Researching prior art alone requires hundreds if not thousands of hours.) We are simply investors who are trying to earn risk-adjusted returns on our capital, and many of us were attracted to the glittering dollar signs of Vringo. We saw it mentioned on CNBC, we heard about Mark Cuban, we read James Altucher's blog or we saw a headline on Yahoo. We heard something about billions of dollars and dove in.
I find myself in sparse company when I admit that I have no idea how much the courts will order Google, Microsoft or ZTE to pay Vringo. All I can do is look at a stock and ask myself, "What is my upside, what is my downside, and what is the likelihood of getting the upside versus the downside?"
That final question about likelihood is where the hysteria is happening with Vringo. I would be delusional if I thought I could predict the likelihood of Vringo winning its lawsuits better than millions of other legal professionals with brokerage accounts who could buy or sell short Vringo if it was mispriced. I defer to their opinion.
Right now, the market is giving Vringo a very generous market capitalization -- including hundreds of millions of dollars worth of expected future revenue from lawsuit defendants -- and for all I care, that prediction is far better than anyone else's calculation. The market's current prediction could be too low or high, but it is probably right (the market usually is).
For my part, I prefer a stock like MGT Capital (NYSEMKT:MGT) that offers only $5.5 million of downside (half of MGT's $11 million debt-free market capitalization is cash) in the event of a total loss, with equivalent "billions" of upside potential from its ongoing lawsuit. This is unquestionably lower risk than Vringo's tens of millions that could vaporize if its payouts disappoint.
MGT is suing the casino industry for infringing on its patented method of linking slot machines with LCD screens and bonus round gameplay. Defendants have plenty of cash, and MGT hopes to receive billions in damages and royalties. I have no idea if it will win, of course. I do know, however, that its market capitalization is just $11 million, giving it that same eye-boggling allure as Vringo, but again, with only $5.5 million of downside versus Vringo's tens of millions of downside.
It is for this reason that I claim that there is hysteria in the market for Vringo. It is an expensive, en vogue stock spawning overnight analysts and valuation claims based on blogs and zero legal training. It is time to ask, "Is Vringo more attractive than other stocks?"
To be clear, the question is not "How much is Vringo worth?" There is a new blog answering that question every day. The question is: "Relative to other stocks, is Vringo more attractive?"
I would rather not pay popularity premiums of over $200 million and make guesses on legal outcomes that would take full-time law firms months to analyze. I would rather be an investor, look at my company's management critically, and say, as I do with MGT, "OK, you have personal savings at stake here, you believe in this enough to transition your full-time career to this, your law firm only gets paid if they win, your inventor has spent the last 12 years of his life trying to assert his rights on this patent, and the entire risk is $5.5 million if we get an apocalyptic disappointment. OK. That is a risk I am willing to take with a small portion of my portfolio."
Such is the case with MGT. Investing in patent litigation is risky anyway. I would rather not compound risks by buying a company with big market capitalizations like Vringo, despite how fun the small talk is. Whether MGT is something you might like or any of the other patent trolls (ACTG, VHC, RPXC, UPIP, SPEX, IDCC, MARA, WDDD, WILN), I encourage readers to consider just how much downside they are facing in Vringo versus these other opportunities.
None of us knows how much any of these companies' defendants will ultimately pay. The only thing we can do is take care of our risk- and there are far lower risks out there than Vringo.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.