If you want to invest in intellectual property (IP), I suggest you hawk Hudson Bay Capital Management. It is making a killing in IP. I have set real-time reminders for all of its SEC filings, and I am consistently amazed by its activism in this burgeoning sector. Although it typically invests alongside institutional co-investors in private placements, even common shares graph a remarkable history of double- and triple-digit returns.
The IP sector is one of the fastest growing sectors on Wall Street. According to the World Intellectual Property Organization, the market for global IP licensing alone grew over 500% in the past two decades to over $180 billion. And that's just licensing. Corporations spend another $20 billion per year transferring IP assets between themselves, and then they sue each other in billion-dollar patent wars à la Samsung (SSNLF.PK) v. Apple (AAPL). Funds like Hudson Bay smell easy money in this smorgasbord of business activity and are inviting themselves to dinner.
This article examines the IP sector and the broader knowledge-based economy that has enabled funds like Hudson Bay to earn outsized profits during the past few months. I recount Hudson Bay's recent IP winners -- Vringo (VRNG), Spherix (SPEX) and Worlds (OTC:WDDD) -- and some of its current IP holdings like Marathon Patent Group (OTC:MARA).
Outrageous Profits in IP
Never before has IP been so valuable, and never before have so many world class companies been opening their checkbooks to acquire it. The valuation being placed on IP is approaching, dare I say, obscene levels. I have already written about a company trading around $3 per share with price targets as comical as $18 and $100 per share. Sometimes dreams come true, however: investors watched VirnetX (VHC) go from $1 to $40 per share solely on the basis of IP (the company had just 11 employees while topping $2 billion in market capitalization). Likewise, AOL (AOL) rallied over 40% when it sold its patents to Microsoft (MSFT).
You might have heard of a few of these monster IP transactions.
- Samsung lost a patent lawsuit against Apple for $1.05 billion
- Microsoft (MSFT) bought 800 patents from AOL for $1.06 billion
- Google (GOOG) bought 24,500 patents from Motorola Mobility (MMI) for $12.5 billion
- InterDigital (IDCC) sold 1,700 patents to Intel (INTC) for $375 million
- Sterling Partners acquired IP giant MOSAID for $590 million
- IP monetization firm RPX Corp. (RPXC) completed an IPO of $184 million
- Nortel (NRTLQ.PK, a defunct company!) sold patents to Rockstar Bidco for $4.5 billion
- Facebook (FB) bought 650 patents from Microsoft for $550 million
- Patent troll Acacia Research (ACTG) raised financing of $225 million
- Apple and Google bought 550 patents from Kodak (EKDKQ.PK) for $527 million
Profiting from the Knowledge Economy
Hudson Bay understands that this type of deal flow underpins its IP investments with real cash liquidity. After all, the new U.S. economy is based on ideas - not things - and idea monetization is becoming the country's biggest economic activity.
Manufacturing has been declining as a percentage of U.S. GDP for decades. In 1981, manufacturing was responsible for 22%; by 2010, that share had dropped to 13%.
Over the same period, the services industry - including information services and other IP sectors - has made up for those losses in spades.
Ocean Tomo, an IP valuation and services firm, estimates that tangible assets (factories, offices, and inventory) accounted for more than 80% of the value of S&P 500 companies. By 2010, intangible assets (brand goodwill and intellectual property) had become 80% of the value of S&P 500 companies.
The U.S. Department of Commerce estimates that IP-intensive business is directly responsible for 27.1 million jobs as of 2010, with another 12.9 million jobs indirectly reliant on patents and intellectual property. Taken together, IP-intensive sectors are responsible for 27.7% of all jobs in the U.S. economy.
Overall, the U.S. Department of Commerce estimates that the IP value-added impact on GDP was $5.06 trillion, or 34.8% of GDP in 2010.
Investing for Big Returns
Today, Hudson Bay is one of the most active capital funds in the IP sector. It knows that tiny companies can quickly become overnight celebrities. With just two patents, VirnetX (VHC) was able to secure licensing agreements with Microsoft and quintuple its share price within one year. InterDigital sold $375 million in patents to Intel while gaining billions more in market capitalization amid rumors of a takeover by Apple or Google.
Hudson Bay also knows that Wall Street stalwarts are resorting to IP to stave off declining revenue growth, not to mention paying tons of cash outright for patents (see bullet points above). I was surprised to learn, for example, that 56% of 2011 revenue for old-timer Qualcomm (QCOM) was IP licensing.
Why would companies license their IP rather than use it to create new products and services? Two words: easy margins. In 2011, not only did Qualcomm's licensing revenue grow 48% YoY, but that revenue had a dumbfounding profit margin of 87%. Plus, residual revenue from licensing requires almost no additional work, making IP the most desirable profit generator on the planet.
Hudson Bay Earns Its Reputation
Hudson Bay gained popularity after its massive victory in Vringo. Although many investors heard about Vringo in the $4-5 per share range, Hudson Bay was one of its earliest investors- from the pennies per share. Specifically, Hudson Bay was the largest shareholder in Innovate/Protect, which was the private entity that merged its patent portfolio into Vringo. These patents would ultimately be responsible for Vringo's rally from $1 to $5 per share and legal victory against Google. This makes Hudson Bay an original institutional investor in the IP assets that secured Vringo's victory, not to mention the au courant attention of James Altucher and Mark Cuban.
Hudson Bay is also earning hefty profits in Spherix. On February 13, it disclosed a 7.47% ownership stake. Within two months, Spherix had announced an IP transaction involving wireless communication patents and its share price had doubled.
Triple-digit returns might be the new normal for Hudson Bay. This spring, Hudson Bay bought $1.1 million of corporate debt from Worlds Inc. and was involved in several prior financings. The stock has tripled this year.
Currently, Hudson Bay owns over 3.5 million shares of Marathon Patent Group, which is led by former Firepond CEO Doug Croxall. Croxall has personally secured tens of millions in courtroom IP rulings, and he hopes to find the same success in Marathon Patent Group's current lawsuit against Sony (SNE), Siemens (SI), Winn-Dixie (WINN), Juniper (JNPR), Dell (DELL) and Blue Cross Blue Shield.
Hudson Bay likes Marathon Patent Group not only for its patents but also for its business model. The company is a pure IP company with no debt, current revenues (CyberFone), over $2 million in cash, low burn (approximately $150,000 per month) and executives who have won over $100 million in past IP lawsuits. Marathon Patent Group combines the blue sky potential of IP lawsuits with more established revenue sources like licensing and consulting. Croxall's shareholder letter reflects the invigoration that Hudson Bay evidently imparts to its team. If Croxall maintains this energy, Hudson Bay will likely add another star to its triple-digit portfolio.
If I want my money to be positioned in the hottest sector, IP is my sector. A new billion-dollar lawsuit announcement arrives daily. Untold fortunes are being made and lost in private companies and USPTO application battles. Courts are overwhelmed, and statisticians barely comprehend the sector's growth rate.
I have admittedly simplified Hudson Bay's investments for readability (its investments are not just common stock but rather a combination of notes, rights, warrants and convertible preferred), but the historical reality is that Hudson Bay is one of the best-performing financiers of small IP companies. I welcome readers to look at its SEC filings and even contact the fund's managers directly for tough questioning.
Estimating the value of IP is staggeringly complicated, and I prefer to not estimate it at all. No matter how enchanting the story, I do not understand prior art, laches, re-exam, four-pronged venue tests nor other legal mumbo jumbo. I invest in stocks that have spectacular risk:reward ratios and spectacular insiders. If these stocks happen to underlie IP companies, fine, but the stock itself must offer me a low-risk opportunity.
I suspect that many readers are in the same boat as me.
My search for spectacular insiders leads me to outperforming funds like Hudson Bay and companies that have not rallied too far from original price levels, such as Marathon Patent Group. Any of Hudson Bay's SEC filings automatically warrant my attention. Then, after I analyze its stocks and evaluate risk:reward ratios, I make a personal decision. I suggest that you do the same- preferably with the help of a financial advisor and the co-investment of an outperforming fund like Hudson Bay.