MGT Capital Investments (MGT) is suing the following five companies for patent infringement: MGM Resorts International (MGM), Caesars Entertainment Corporation (CZR), Penn National Gaming (PENN), WMS Industries (WMS-OLD), and Aruze Gaming. Potential settlements exceed $4 billion, a big number considering that MGT is only valued at $16 million.
Given the huge increase in MGT's recent trading volume, I'm speculating that settlement negotiations are occurring with one of the defendants, WMS Industries. If that is true, MGT's share price could double within the next couple of weeks.
Something's brewing with MGT
MGT's share price has been languishing in the low $3 range, but last week, something happened that caught my attention. MGT's volume increased to 341,000 shares as compared to the previous week where just 44,000 shares traded. Last Monday 674,000 shares were traded and the stock was up over 20%.
I called the company in order to gain some clarity, but I received a message which basically said "no comment." I actually take that as a good sign because in my experience, when patent litigation companies won't speak to me, there is often something going on.
Why I think settlement negotiations are taking place
WMS Industries recently received a buyout offer from Scientific Games (SGMS). The offer was for $1.5 billion, a 59% premium. This was a significant price, at 7 times EBITDA earnings which is higher than rivals IGT's (IGT) multiple of 5.3 and Bally's (BYI) multiple of 6.6 EBITDA earnings.
Would Scientific Games offer WMS a 59% premium if the MGT lawsuit was not going to be settled before the deal was finalized? In my opinion, no. I don't believe Scientific Games would take on the risk of a potential $1 billion lawsuit while paying such a large premium for WMS. From my perspective, it appears that WMS and MGT will need to negotiate a settlement before the Scientific Games/WMS deal can be concluded.
The WMS/Scientific Games deal is supposed to be finalized before the end of this year, and in my opinion, one of the first items that need to be dealt with would be the MGT lawsuit.
The next question becomes, how much could MGT expect to receive from WMS? First let's take a look at the entire group of defendants, and what the potential settlements could generate for MGT.
A total victory for MGT would be mind-boggling for shareholders
If MGT prevails over all defendants, the numbers are huge. According to a MGT investor presentation, the company estimates the present value of the royalties over the life of the patent to range between $330 million and $4.5 billion. Even a minor victory would translate into major share price appreciation for MGT shareholders.
For example, take a look at the numbers, based on MGT's lowest settlement estimate, $330 million. With MGT's 55% interest in the IP, the company would retain $181.5 million. After paying legal fees of approximately 30%, this would leave MGT with $127 million. The company has $21 million in carry forward tax losses, which would make the taxable amount, $106 million. At a 30% tax rate, MGT's liability would be $31.8 million. With a $330 million settlement, MGT should walk away with $95.2 million. If all warrants and preferred shares were converted to common shares, the fully diluted share count would be 8.6 million, which would give MGT $11 per share in cash. If MGT were to win settlements approaching the $4.5 billion estimate, MGT's cash value per share becomes astronomical compared to today's share price.
What makes these numbers so high is MGT's incredibly low fully converted share count of just 8.6 million shares. As a point of reference, Vringo (VRNG), has over 100 million shares outstanding, and VirnetX (VHC), has over 50 million shares.
MGT is seeking treble damages
All of my calculations have intentionally left out an important component, which is the fact that MGT stated in a press release that it is seeking treble damages. What's significant here is not so much whether or not MGT will actually get treble damages, but that this added element could make the defendants more willing to settle. Treble damages implies willful infringement, and in my opinion, this puts even more pressure on WMS to settle with MGT. I cannot imagine Scientific Games taking on the additional risk of treble damages.
How much is the WMS lawsuit worth?
MGT names six slot machines in its lawsuit. WMS manufactures five.
- Battleship - WMS
- Clue - WMS
- Pirate Battle - WMS
- Reel'em In Compete to Win - WMS
- Great and Powerful Oz - WMS
- Paradise fishing - Aruze
From this perspective, it appears WMS is by far the largest defendant and could ultimately provide MGT with up to 50% of the total settlement fees received from all defendants. If we take the median settlement number of $2.4 billion and apply 50% to WMS, that puts the potential WMS liability at $1.2 billion, close to the Scientific Games buyout price.
But let's say I am wrong, and WMS would only be responsible for 15% of the median settlement fee, that could still give MGT a WMS settlement of $360 million. That is not a figure that Scientific Games can ignore.
MGT should have bargaining power
If I am correct, and WMS needs to settle with MGT before the Scientific Games deal can be completed, MGT is in a very strong bargaining position. I assume WMS doesn't want to walk away from a $1.5 billion offer, so the company should be highly motivated to negotiate with MGT, and possibly with terms very favorable to MGT.
How much will the WMS settlement add to the MGT shareprice?
It won't take much of a settlement to significantly move the MGT share price given its low market capitalization. Even though WMS could potentially be on the hook for over $1 billion, for my estimates, I am going to keep the settlement figures extremely low.
- Scenario number 1: $20 million net. This would equal $2.32 in cash, based on 8.6 million fully diluted shares. Shareprice estimate: $6-$10.
- Scenario number 2: $50 million net. This would equal $5.81 in cash. Shareprice estimate: $10-$15.
- Scenario Number 3: $100 million net. This would equal $11.62 in cash. Shareprice estimate: $15-$20.
While these figures are relatively low compared to the potential of a full-blown court trial, any of these settlement figures would benefit both companies. MGT would benefit because a settlement would make it easier to prosecute the other defendants. If WMS needs a MGT settlement in order to complete the Scientific Games deal, a settlement will be extremely important.
When you consider that the WMS/Scientific Games deal is worth $1.5 billion, even a $100 million settlement would be a mere drop in the bucket for WMS. No matter how you look at it, the Scientific Games deal provides more liquidity for WMS, which in turn should help MGT receive a healthy settlement.
Patent validation should more than double MGT shareprice
In many settlement cases, patent validation is as important as a large cash infusion. Once the patent has been validated as a result of a settlement, other companies become more willing to settle because it becomes less likely they can continue to use the patent for free. Also, future settlement value often increases because the patent holder now has real negotiation power. Remember, VirnetX was trading at $1 a share until it had its patent validated in the Microsoft case which caused the shares to run up to $40.
What is MGT worth today?
MGT is tremendously undervalued right now, which significantly limits the short-term risk. This is a $16 million company with $5 million in cash, that could potentially receive $4.5 billion in settlements. In my opinion, MGT should currently be valued at over $30 million, in line with Internet Patents Corporation (PTNT), and Worlds Incorporated (OTCQB:WDDD) $30 million valuations.
What's the risk?
The long-term risk is that MGT goes to trial and loses against all defendants. While I don't think that will happen, it is a possibility. The most likely scenario is that MGT wins some of the cases, and loses others which still should translate into significant MGT share price appreciation.
In my opinion, a settlement between WMS and MGT appears inevitable. Given the recent increase in volume, it's possible that settlement talks are going on right now. But if I'm wrong, and another catalyst (Markman date, new patent acquisition, settlement with one of the other defendants) is bringing in buyers, a WMS settlement still appears likely within the next couple of months. Remember, the WMS/Scientific Games deal is supposed to be concluded this year.
But perhaps the most important part of a settlement with WMS would be patent validation which should lead to more lucrative settlements with the other defendants. If MGT is able to obtain reasonable settlements from the other defendants, MGT shares could be trading well above $40. I have been aggressively buying at these levels in anticipation of a potential short-term 2X return.
For complete disclaimer and disclosure information please click here.