The Intellectual Property Litigation space is quite confusing and highly volatile. It seems that almost during the course of a single day, stocks operating in the space see large moves either higher or lower, and on very little news. Such volatility can be surmised due to these companies not being typical, as they exist in an industry that creates revenue by acquiring and owning IPs and then suing those that infringe on the technology. Hence, participants in the space shouldn't simply be viewed as traditional public companies, but rather public law firms that have tremendous upside, pending a successful suit.
The "Erin Brockovich" of the Stock Market
I'm sure that most people have seen the movie "Erin Brockovich", a movie released in the year 2000 that highlights a legal clerk's instrumental role in winning the largest settlement ever paid in a direct action lawsuit. The case involved the southern California town, Hinkley, and a claim that Pacific Gas and Electric Company contaminated drinking water with hexavalent chromium. To make a long story short, Hinkley won, and the small law firm, Masry & Vititoe, had both the nerve and patience to fight toe-to-toe with the massive energy company. If the firm would have lost then it most likely would have seen bankruptcy, but instead it won and received more than $130 million from the $333 million settlement. Following this large win, as the firm went from small to large, it sought other high-profile cases, winning the "Kettleman suit" in 2006 for $335 million. Currently, Brockovich is working on several other high- profile litigation cases with her name striking fear into those companies responsible for environmental harm to people.
With the Hinkley case being so large and so public, most people are very familiar with the story. However, it was a huge financial risk for the firm to pursue PG&E. So how does this compare to the market or any one industry in particular? Well, I think it's wise to think of those companies in IP infringement like the law firm of Masry & Vititoe, and less like a technology company. When it's all said and done, these companies are in the business of litigation and identifying companies that are using patents in an erroneous manner (much like a law firm). By viewing these companies like publically traded law firms, you can better understand the risk-reward ratio, and in my opinion, there are three stages in the space.
Stage 1: Research, Development, & the Smoking Gun
There's wild potential in "Stage 1" and absolutely zero expectations. In the IP infringement space, these are companies that have acquired and own patents that are allegedly being used by larger companies. Thus, sticking with my Erin Brockovich comparison, this is the point when Masry & Vititoe saw the smoking gun and decided to pursue litigation against the massive PG&E.
A good example from this stage is Marathon Patent Group (NASDAQ:MARA), a company that focuses solely on the acquisition of IP to seek litigation, acting almost precisely like a law firm. In total, Marathon Patent Group has 14 U.S. and 27 international patents, all of which the company has acquired or owns with the belief of each being infringed. The company's most promising patents include those in biotechnology, US 6,772,229, with 54 total claims including IBM and Microsoft; US 6,161,149, with 32 total claims including AT&T and Cisco; and US 8,015,495, with 25 total claims also including AT&T, Facebook, and IBM.
What's encouraging about Marathon in particular is the diversification and the presence of research in its patent infringement suits. According to its press release on April 19 following the recent acquisition of US 5,331,637, there are 254 citations of this one patent alone. Hence, the potential upside is great if the company can capitalize. Personally, I think this Stage 1 company will be interesting to follow as it's attracting a lot of interest. It recently completed a strategic relationship with IP Navigation Group, a company that has created more than $600 million using a similar business strategy.
If we compare it to Masry & Vititoe, then Marathon is at the point when the firm was first exploring PG&E and had just approached the energy company about its wrongdoings. Actually, Marathon is slightly ahead, as it recently filed suit in Texas against Sony Computer Entertainment America, Siemens Energy, Juniper, and Dell among others. However, there is still a lot of work ahead, as we still don't know the company's initial direction. What we do know is, if you look at its phosphate linkage, microarrays, and labeling patents alone, then we're talking about many billions in annual revenue with the largest of companies. Hence, with a royalty rate of just 3% you can see how great revenue could become.
Stage 2: The Court Drama
There's nothing worse than long and drawn out court or litigation proceedings. From the movie "Erin Brockovich", I remember one line in particular where Masry's character says, "They could bury us in mountains of paperwork and it could take years to see any money". This is the problem that small IP infringement companies face when battling the largest of corporations. It is the battle of companies with endless resources versus those with limited resources. Yet at this stage in the game, the battle is on and, in many cases, working in favor of those seeking royalties and past monies.
Vringo (NASDAQ:VRNG) is the most noticeable name in this "stage", as its returned gains of 225% from Stage 1 until its current point in the middle of Stage 2. The company is in the middle of an ugly dispute with Google (NASDAQ:GOOG), having already received $30 million, related to the company's advertising services, and reportedly in settlement talks with Microsoft (NASDAQ:MSFT) to settle a similar suit where Vringo alleged that Microsoft infringed upon its patents. Much like Marathon, Vringo is using patents that it owns to seek past damages and future royalties on IP that is being used by large companies, on a daily basis. However, unlike Marathon, Vringo is further in the process having already been awarded for past damages, hence putting it in Stage 2.
The problem with these suits is that it creates mass volatility, as rumors, speculation, and every word spoken is taken in a very literal manner. While investors are happy with the $30 million that Vringo won, most seek larger back pay and want bigger royalties. As I mentioned, the success that Vringo has seen in its dispute with Google (although still occurring) has led to settlement talks with Microsoft and the pursuit of the telecom company ZTE in a global lawsuit (practically). The money earned from Google is giving Vringo flexibility and is allowing the company to explore lawsuits that could be even larger and return higher royalties. When you combine all of these potential suits, the feed of royalties and one-time back payments become large, and allow the company to then seek other companies that may be infringing on its technology.
When you stop to think about the actions of Vringo, how can you not identify and relate the company to a law firm? It is seeking other lawsuits and settlements for IP infringements, which is the bulk of its day-to-day operations, hence making the company a law firm of sorts. In many ways, Vringo's point in the case against Google and its pursuit of other tech companies reminds me of the part in Erin Brokovich when Masry brought in a partner who agreed to take on all the legal costs after the research had been done and the case had been built. It gave Masry some flexibility (which is what we're seeing with Vringo) and also signaled that the case against PG&E was near its end, or that light was at the end of the tunnel. In respect to Vringo, I think the same can be said for its case against Google.
Stage 3: Looking for Someone to Sue
After receiving $30 million and future royalties, Vringo is starting to cross over to the level where it's simply looking for trouble in the courtroom, almost daring larger companies to test them. However, it hasn't yet closed its $300 million PG&E case… not yet. We're looking for the jackpot, and the company that produces consistent growth having created a powerhouse from its approach. In a sense, we're looking for Sullivan & Cromwell, although we want firms that don't partner with large corporations, but rather sue them for IP infringements.
During my conversation of Stage 1, I mentioned that Marathon had entered a strategic relationship with IP Navigation Group, which is probably the clear leader with $600 million in annual revenue. However, it is a patent monetization company, generating much of its revenue from licenses, settlements, and damage awards-- meaning all companies in the space should strive to be like IP Navigation Group. With that said, there really isn't a large dominating presence in the market as a traded company. The closest thing is Acacia Research Corp (NASDAQ:ACTG), a $1.20 billion company that is on the verge of crossing into this "stage".
Acacia is a company that has seen three years with growth of more than 30%, having control of 250 IP portfolios-- not patents, but rather portfolios. The company has technology in virtually every industry and has reached a point where most of its infringement suits are settled through licensing agreements, which means that as a company its margins have risen drastically with lower court costs. Now, with full-year revenue of $250 million and countless royalties and pending infringements, the company is the closest thing to the Procter & Gamble of IP infringement that this space has to offer.
From an investment point-of-view, Acacia is the perfect example of what can happen as a company goes from Stage 1 to Stage 3, and also the volatility that occurs. Since the end of 2008, Acacia has seen its market cap increase from $100 million to its current $1.2 billion cap, although it should be noted that in 2011 its valuation peaked at $2.30 billion. This means that in three years the stock increased from $2.50 to almost $50.00, and has since seen a pullback. In many ways this is reminiscent of a biotechnology company, one that presents good data and sees a successful product launch push its stock drastically higher. However, in the IP infringement space, the number of companies and the level of investor interest are much smaller, which then creates great opportunity for those who are early to invest.
Masry & Vititoe, as a firm, had all the odds stacked against it when the company chose to pursue PG&E. Yet, with thorough research the firm won and instantly became a powerhouse, then was able to pursue other suits. For IP infringement companies, there are a lot of similarities; but I'd argue that, in the IP space, a company has a better chance of success because of volume. IPs are in the millions and, if a company dedicates all of its energy to finding operations that infringe on one of its unknown patents, then it will most likely have some success in the pursuit. On the other side, there is risk of loss. And in that case, there exists potential bankruptcy or fear that a large company will change its practices to no longer infringe on the IP in question. To conclude, I assume that this interesting industry will remain volatile for some time to come, but lucrative nonetheless.