Vringo's Catalyst Is Finally At Hand, Or Is It?

| About: FORM Holdings (FH)

Last February, I wrote an article entitled "Can the NTP Lawsuit Provide Insight Into Vringo's Ongoing Battle With Google?" outlining the similarities between Vringo's (VRNG) case against Google (NASDAQ:GOOG) and the NTP vs. BlackBerry (NASDAQ:BBRY) case. Chief amongst these similarities, I pointed out that a ruling on the long awaited running royalty rate in the I/P vs. Google et al. case may come somewhere in the April/May time frame.

With Vringo's May 20th response for an Award of Post-Judgment Royalties now in the books, Judge Jackson is free to rule at any time on the royalty issue. In effect, it looks like the May time frame has an excellent chance of holding up, showing that the similarities between these two cases are only growing stronger. At worst, the ruling should come within the first week of June.

In case you haven't been following closely, the issue at hand is whether Vringo's is entitled to the $31 M jury award plus an enhanced 7% of 20.9% of Google's Adwords revenues, or a lump sum payment of $3.5 M (Google's argument based on hypothetical licensing negotiations) (see hyperlink above). While Google's lump sum argument appears DOA as it's been rejected multiple times at this point, the enhanced royalty rate is expected to be a major catalyst for the stock going forward. Regardless, any ruling on the running royalty rate is going to have a major effect on VRNG shares.

So what can investors expect? If we lean on the NTP example again, I expect Judge Jackson to indeed increase the running royalty rate above the initial 3.5% due to continued willful infringement by Google. As other authors have pointed out, the supposed "workaround" by Google is little more than a red herring, and is immaterial at this time. That said, I doubt he is going to assign the maximum 7%, given that he does appear to be sympathetic towards Google. To be frank, there is no other way to explain why he has allowed Google to repeatedly waste court resources and time throughout the duration of this case. The surprise laches ruling, that significantly truncated the jury award, also suggests a sympathetic view of the defendants in this case. In essence, investors should expect an enhanced running royalty rate based on legal precedent, but not the maximum Vringo is seeking. Personally, I think this number will come in somewhere around 5-6%, which is little more than pure speculation.

Sounds great, right? If we turn back to our NTP road map, however, the answer becomes unclear. Based on this prior case, I would expect Google to appeal any positive district court decision on the royalty rate to the U.S. Court of Appeals, further tying up this case for perhaps as long as another 15-18 months, or perhaps for just under a year (see hyperlink above). In effect, a final, final conclusion on this case is possibly over two years away.

The question thus becomes, how should investors play the running royalty catalyst? To my mind, there are two ways to think about this trade. One can consider it in isolation, or in combination with the potential for a Microsoft settlement (NASDAQ:MSFT) this week. To refresh readers' collective memories, the Microsoft case was postponed to June based on settlement talks between the two companies.

Considering the trade in isolation, I believe VRNG becomes a "play the pop" stock. There is going to be strong momentum carrying VRNG perhaps into the $4-$5 range based on a positive running royalty rate decision, and speculators are sure to join in the rally. However, the rally will more than likely be short-lived given that Google will turn around and appeal the decision.

By contrast, the potential for a Microsoft settlement makes this trade much more difficult to judge proper entry and exit points. Based on the timeline of the Microsoft postponement, I suspect they are awaiting a ruling on the running royalty rate in the Google case in order make an official offer. Simply put, the running royalty assigned in the Google case is likely to be used as a basis for the negotiations in any potential Microsoft settlement. If that is the case, or whether Microsoft was simply stalling, will soon be known. Nevertheless, a settlement by Microsoft, combined with a positive running royalty rate in the Google case, would undoubtedly make shares of VRNG fly. How high is anyone's guess, but such a scenario should at least double or triple the company's current cash position of roughly $49 M.

The downside risk for traders looking for a synergy between these two catalysts is that they end up holding into what could be a rapid decline due to Google's imminent appeal.

Without a settlement by Microsoft, I see no reason VRNG shares won't sink back to pre-ruling levels ($2.80-$3.20), where it is trading at roughly 5X cash on hand. Indeed, there isn't a catalyst in the ZTE case until at least the 4th Quarter of this year, and Google is likely to throw every conceivable roadblock up to paying VRNG one red cent of their award. My personal plan is to hedge this trade by selling half of my VRNG holdings the first day after the ruling (assuming it favors VRNG). The other half I plan on holding to take advantage of not only a possible Microsoft settlement, but for the eventual conclusion of the Google case in the distant future. Eventually, I believe VRNG will be a $30 stock, and I am willing to wait 5 years if it takes that long. Patience is key.

Disclosure: I am long VRNG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.