The recent legal battle between Apple (AAPL) and Samsung (SSNLF.PK) is just one well known example of an industry that could see increasing interest over the next few years. Intellectual property companies are in business to acquire, develop, and enforce patented technologies. The costs that these companies face to litigate can be high but the rewards can be even higher. Below are a few industry highlights and companies that seem to have potential.
Public Spotlight Legal Battle
The legal case between Apple and Samsung can illustrate what's at stake, the potential rewards, and why investors should care. In 2011, Apple sued Samsung, alleging that Samsung's Android phones and tablets infringed on Apple's intellectual property: its patents, trademarks, user interface and style. Initially, Apple won the trial and was awarded a settlement of $1.05 billion. However, on March 3, 2013, U.S. District Judge Lucy Koh wiped out $450 million from the verdict and ordered a new trial to reconsider damages related to 14 Samsung products. Now while $1 billion may not be a lot of money to a company like Apple that carries a market cap of almost $430 million, it shows the potential sums of money that are at stake. Let's turn our attention to another case that shows how seriously companies can be damaged when they lose.
Rambus vs. Micron
Back in 2010 and 2011, Rambus (RMBS) was involved in a major $4 billion lawsuit against Micron Technology (MU). Rambus had accused Micron and Hynix of price-fixing in an attempt to keep Rambus' RDRAM memory technology from gaining popularity. Rambus briefly was engaged in a partnership with Intel (INTC) however, that relationship didn't last long. Rambus argued that Micron and Hynix conspired to make sure that Rambus memory would be a more expensive option and thus less appealing to OEMs.
However, Micron and Hynix claimed that it was "design flaws, higher manufacturing costs and other drawbacks associaetd with RDRAM along with Rambus' business practices" that caused RDRAM to fail. In the end, the jury sided with the defendants and Rambus was dealt a major blow. As the chart below shows, Rambus has steadily fallen in market cap since the beginning of 2010 when it was embroiled in legal battles.
Rambus also suffered another intellectual property defeat when the U.S. Patent and Trademark office declared that two of Rambus' patents (known as the Barth I patents) were invalid. Previous to this, the company was able to generate royalty revenues from Nvidia (NVDA), Hewlett-Packard (HP), and other companies.
As the chart shows, Rambus has been in a perpetual decline and is now a sub $1 billion market cap company. This case shows the importance of being able to defend patents/intellectual property and the potential value involved.
Importance of Intellectual Property
Recently, investors have been more closely associating a company's value with its IP portfolio. An example is Yahoo's (YHOO) lawsuit against Facebook (FB) when Yahoo claimed patent infringement. Facebook executives actually made the decision to include this information in its initial public offering filing to warn potential investors that the lawsuit could have an impact on the company going forward.
Another example of the importance of intellectual property is InterDigital (IDCC). The company's share price soared in late 2010 on rumors that the company was seeking a potential buyer for its intellectual property portfolio. The stock actually reached the high 70s before eventually selling off once a deal couldn't be reached. Still, the stock trades much higher than its levels in late 2010.
Clearly investors are starting to understand the importance of intellectual property. Below are a few small companies that appear to have a lot going for them in this space.
Intellectual Property Companies
Marathon Patent Group (OTC:MARA) engages in the acquisition, development, and monetization of intellectual property through the defense and licensing of its patent portfolio. Its IP services team devises strategies that allow clients to maximize the value of their IP assets. Marathon is able to generate revenue in a variety of ways including IP consulting engagements and partnership with inventors and patent owners in order to monetize patent portfolios through IP licensing campaigns.
Marathon Patent Group is led by Doug Croxall, who was previously employed at KPMG and Motorola. He has tremendous experience in the patent protection space, including a six-year term at Firepond, in which he was able to get the company a cash tender offer. From 2004 to 2009, Firepond was able to generate approximately $90 million in licensing revenues.
The company has been gaining a lot of momentum, including several positive press releases during the past few weeks. Since the company generates its revenue through both consulting agreements and patent acquisition, it's important to look at the revenue streams that these patents have the ability to generate. On May 1, 2013, Marathon Patent Group announced that its wholly owned subsidiary, TCP Acquisition Corp., had acquired U.S. Patent 5,412,730. This particular patent is a data encryption patent that has generated 97 settlements and licensing agreements, and $39 million in recoveries. Marathon agreed to pay $6 million dollars and issue 7 million shares of stock in exchange for the patent. Besides this patent acquisition, a few of Marathon's wholly owned subsidiaries have filed patent infringement lawsuits. On May 6, 2013, Sampo IP, a Marathon subsidiary, filed a patent infringement lawsuit against Starbucks (SBUX), E*Trade Financial (ETFC), and Hewlett-Packard. Sampo is seeking damages for patent infringement against U.S. Patent numbers 6,161,149, 6,772,229, and 8,015,495. Also on the same day, another one of Marathon's wholly owned subsidiaries, Relay IP, filed a patent infringement lawsuit against Sprint (S), Juniper Networks (JNPR), and Cisco Systems (CSCO). Relay claims that these companies infringed on U.S. Patent number 5,331,637, entitled "Multicast Routing Using Core Based Trees."
Clearly Marathon has been extremely busy lately, in a positive way. It's always encouraging to see positive press releases coming out that can have a material impact on the business. Now while the press releases only seek to strengthen the future, the present looks quite positive as well. Marathon filed its recent annual statement on March 26, 2013, for the year ended December 31, 2012. The company was able to grow its cash position from $129,152 to just over $2.35 million. Another thing that I really like is the company only has current liabilities of $87,822 and no long-term debt on the books. While the company did incur a net loss of $6.9 million, I believe that with the recent patent acquisition and an increasing amount of lawsuits to defend its existing portfolio, this loss will be narrowed in the future.
Now of course, the company is not without risk. It does trade on the bulletin board, which is known for having large price swings, limited trading volume, and the potential for market manipulation. However, given that the stock trades over 140,000 shares per day on average, limited trading volume shouldn't be a major concern. In fact, Marathon traded over 600,000 shares a few days ago, a sign of surging volume due to its recent news announcements. Additionally, intellectual property companies are known for wild price swings and high levels of volatility.
A few other intellectual property companies that I really like are InterDigital and Acacia Research Corporation (ACTG). I mentioned InterDigital earlier as being a hot stock back in the first half of 2011 on takeout rumors. However, even putting that aside, I like the company on its own merits. The company engages in the design and development of technologies that enable and enhance wireless communications in the United States, Korea, Canada, Europe, and Asia. Its patented technologies are used in various products, including mobile devices, such as cellular phones, tablets, and notebook computers. As of December 31, 2012, the company held a portfolio of 19,000 patents and patent applications related to the fundamental technologies that enable wireless communications.
The company had a wild three months of trading, having sunk lower and then recently rebounding. However, over the past year, the stock is up roughly 65%.
Besides the recent 52-week performance, the company has generated impressive financial statements, especially its most recent annual report. According to the balance sheet, InterDigital increased its current assets from $768.9 million to $814.3 million. At the same time, the company's long-term debt only increased by about $8 million from $192.5 million to $200.4 million. The income statement is what really caught my attention. The company's total revenue more than doubled, from $301.7 million to $663.1 million. Also, the company's net income soared from $89.5 million to $271.8 million.
My main concern about InterDigital is the volatility. This is not an investment for the faint of heart and investors need to be willing to accept unusually large price swings. A retail strategy that could be used is to sell covered calls against a long stock position in order to generate monthly income.
Another one of my favorite IP plays is Acacia Research Corp. Much like Marathon Patent Group and InterDigital, Acacia generates its revenue through the enforcement and licensing of its patent portfolio. The company owns or controls the rights to approximately 250 patent portfolios, which include the U.S. patents and foreign counterparts covering technologies used in various industries.
Now unlike InterDigital, Acacia's chart isn't as appealing. It fell hard on its last quarterly earnings report and the two-year trend is fairly ugly.
The company is trading right at its two-year low and although I don't tend to recommend buying companies with this kind of trend, I now consider Acacia a value play with its deep portfolio of valuable patents. Although the company fell on its last earnings report, I still like what I see on the annual report. The balance sheet shows that a company has no long-term debt on the books and reduced its accounts payable while maintaining almost the same amount of current assets at $325 million. On the income side, the company increased its year-over-year revenue from $172.3 million to $250.7 million. It also grew both its annual operating income and net income. In fact the company's net income was almost double the amount it generated in 2011.
The growth expectations also appear to be fairly strong. For this current year, analyst are expecting revenue growth of 11.4% and 21.2% in 2014.
My concerns with Acacia are similar to that of InterDigital. The volatility is even higher with Acacia, due mostly to its recent trading. With the stock trading at a near two-year low, investors are probably wondering what's next. The short term is uncertain but the long term appears bright.
The intellectual property industry is an interesting space right now. With all of the new technological innovation occurring in today's economy, the ability to defend and protect patents is more important than ever before. As we've seen with Marathon Patent Group, InterDigital, and Acacia, companies can generate substantial revenues and profits from enforcing patent portfolios and I expect that growth to accelerate going forward.