Vringo Vs. Google: Ongoing Royalty Prediction

| About: FORM Holdings (FH)

I have followed the Vringo (VRNG) vs. Google (NASDAQ:GOOG) patent infringement trial (actually called I/P Engine v AOL et al.) extensively. Previously I provided a preview of the trial, a summary of the opening day of the trial, which I attended in person, updates on the other days of the trial (here, here and here), my prediction for what the jury would decide, a discussion of risks to the jury's verdict, and my opinion that Google flip flopped on the issue of whether the court should award Vringo an ongoing royalty. At various points I have been long VRNG, short VRNG, and had no position in VRNG. I am a trader. I do not fall in love or hate with a stock. I buy when I think it is underpriced and sell when I think it is overpriced. I indeed have done this within a day when the stock price moved dramatically.

As of now, there are two open threads in the case. First, both sides have filed appeals with the Court of Appeals for the Federal Circuit, which is the exclusive Court of Appeals for patent cases. Vringo is appealing the District Court judge's decisions to not allow a new trial on damages and to limit Vringo's damages period under laches. Google is appealing the judge's claim construction, certain evidentiary rulings, and refusal to overturn the jury's verdict of infringement, validity, and damages. The opening appeal brief is due from Google on July 22, and then there will be a couple of rounds of briefs, followed by an oral argument before any decision is issued. In short, that process is still in its early stages.

The second open thread is the lone remaining issue for the District Court judge, Judge Raymond Jackson, to decide, which is what, if any, royalty to require Google to pay for continuing to infringe Vringo's patents after the jury's verdict. That issue was fully briefed by the parties as of May 24, and the judge has not indicated he wants to have a hearing on it. So, he could issue his decision any day.

Parties' Positions: I reviewed the briefs submitted by the parties and have come to a conclusion regarding how I predict Judge Jackson will rule on the issue. Before I provide my prediction, I first want to summarize the parties' positions.

Vringo argues in its briefs (here and here) that Judge Jackson should:

[E]nter an Order requiring that, for the period from November 20, 2012 through April 4, 2016, Defendants pay I/P Engine ongoing royalties computed on a base of 20.9% of Defendants' U.S. AdWords revenues, at a running royalty rate of 7% of that base for Defendants' continued willful infringement.

FYI, the November 20, 2012, date is the date Judge Jackson entered Judgment on Vringo's behalf after the jury verdict, which was issued on November 7. The April 4, 2016 date is the date Vringo's patents will expire.

Google, on the other hand, argues in its brief that Judge Jackson should deny Vringo's request for any post-judgment royalty in its entirety. Google makes this argument because it says it no longer infringes Vringo's patents, due to a change it says it recently made to its systems, and also because Vringo is only entitled to a lump sum payment, which is covered by the jury's damages award for past infringement.

ActiveVideo: In forming my opinion, I also reviewed his ruling on post-verdict royalty in another case he presided over called ActiveVideo v Verizon. As an aside, in that case Judge Jackson noted, "[t]he parties have provided the Court vastly dissimilar submissions regarding the appropriate royalty rate." So, the vast difference between Vringo's and Google's arguments is not unusual for the judge.

In the ActiveVideo case, the jury awarded the patent holder a royalty for past infringement of $1.13 per subscriber, while Judge Jackson awarded the patent holder a post-verdict ongoing royalty of $2.74 per subscriber, more than double the jury verdict. The patentee had proposed $3.40 per subscriber, a tripling of the jury's verdict, while the infringer had proposed only $0.17 per subscriber. In his analysis coming to the $2.74 figure, Judge Jackson said:

[I]t would have been reasonable for the parties to make an agreement whereby Verizon would receive 60% of the profits and ActiveVideo would receive 40% of the profits from the FiOS TV system.

I conclude from this that Judge Jackson is not uncomfortable with awarding a patentee a very large percentage of the profits derived by an infringer from continued infringement. Nor is Judge Jackson uncomfortable with awarding post-verdict royalties that are more than double what the jury awarded for past damages. Further, Judge Jackson can feel confident in issuing such a decision because the Court of Appeals blessed his ActiveVideo analysis, saying "we see no error in its post-verdict royalty calculation."

My Opinion: I believe it is more likely than not that the Judge will grant Vringo an ongoing royalty against Google's continued patent infringement and that he will set a royalty rate of between 5 and 6% applied against a base of 20.9% of Google's AdWords revenues. I explain how I came to this opinion below.

First, Google has, for better or worse, given the judge an all or nothing proposition, which is exactly what they did at trial, where Google presented no evidence of a different royalty base or royalty rate than what Vringo proposed. Both at trial and again now in the post-trial royalty briefing, Google has maintained its position that the proper award is a one-time lump-sum amount. That is a very bold, but very dangerous litigation strategy, because the fact that it didn't work at trial means it is unlikely the judge will adopt it in the post-trial motion. As such, I expect the judge will reject completely Google's argument that Vringo is not entitled to an ongoing royalty. (I wrote previously about Google flip-flopping on this issue, which it seems to have done now yet again. If Judge Jackson is anything like me, at this point he likely gives Google very little credibility on the issue.)

Royalty Rate: The next question is what royalty will he award. This involves two parts. The judge must determine a royalty rate and a royalty base. The royalty rate is the percentage to be paid to Vringo and the royalty base is the revenues of Google against which the royalty rate is to be applied. Vringo argues the rate should be 7% and the base should be 20.9% of Google's U.S. AdWords revenues. Google, after arguing there should be no royalty whatsoever, argues the rate, if any, should be less than 3.5% and the base should be no greater than 2.8%.

It is my opinion that Vringo is correct when it points out in its briefs that the case law supports post-judgment royalties being higher than the royalty awarded at trial both because the patent holder is in a stronger bargaining position and because the infringer is now fairly considered to be willfully infringing. In this case, the jury found that an appropriate royalty rate for past damages would have been 3.5%. Thus, the royalty rate I expect the judge to award for post-verdict infringement will be higher than that.

Vringo's argument that it should be double (7%) seems reasonable and well within the judge's discretion to award, especially given his decision in ActiveVideo. However, because Google has appealed the issues of infringement and validity, I do not think it is appropriate to over penalize them for willfulness, at least not unless and until the Court of Appeals affirms that they are infringing valid patents. For that reason, I expect the Judge will award a royalty rate that is higher than the 3.5% found by the jury, but not as high as 7% as Vringo proposes. I expect he will award a royalty rate of between 5 and 6%. Google's argument that it should be less than 3.5% is a non-starter.

Royalty Base: Once the judge determines the proper royalty rate, he must also determine the proper royalty base against which to apply that rate. On this issue, the jury was not asked to provide its determination, so it's uncertain what they used to calculate the damages awarded to Vringo at trial. Google argues the royalty base must be much lower than 20.9%, because the total jury verdict against Google of approximately $16M does not work out mathematically. Specifically, Google suggests that if you take the $16M total amount of damages awarded against them and apply a 3.5% royalty rate to Google's U.S. AdWords revenues for the relevant pre-verdict time frame, the algebra indicates the jury applied a 3.5% royalty rate against only 2.8% of Google's U.S. AdWords revenues, not the 20.9% royalty base Vringo argued to the jury during trial and now argues to Judge Jackson in the ongoing royalty motion.

There is no conclusive proof of what the jury believed was an appropriate royalty base. Unlike the royalty rate they were expressly asked to determine, the jury was not asked to say in its verdict what royalty base it found was appropriate. Therefore, it isn't possible to know for sure whether the jury rejected Vringo's 20.9% royalty base argument or not. Given the options of a 20.9% royalty base, which Vringo presented at trial, and a 2.8% royalty base, which Google argues can be inferred from the jury verdict, but which it did not argue at trial, it is my opinion that the judge will adopt the 20.9% royalty base of U.S. AdWords revenues. This is because it's the better choice between the two being presented to him, and there's no evidence for him to rely on to say some other royalty base is appropriate. He'd literally have to make one up out of thin air and I don't see him doing that.

Google's Purported Design Around: It is important to note that Google told the judge in its brief that it has implemented a change to its systems such that it is no longer infringing Vringo's patents. If this is true, then no matter what ongoing royalty the judge imposes, Google will not have to pay any money to Vringo as of the date Google stops (or stopped) infringing Vringo's patents.

However, in my opinion, Vringo is correct when it argues that the currently pending motion for an ongoing royalty is not the appropriate time to deal with that issue. If/when the issue of Google's purported non-infringing alternative is before the court, I hope to have time to analyze it then. For now, I (and I assume Judge Jackson as well) will withhold having an opinion on that issue, while keeping in mind that Google argued its previous system also did not infringe the patents (and it maintains that argument in its appeal), and yet the jury disagreed.

Timing of Decision: Lastly, on when we can expect a decision from Judge Jackson, as I said above, the ongoing royalty motion was fully briefed as of May 24. I generally expect district court judges to rule on motions within two months, and Judge Jackson does not appear to me to be outside of the normal range. In fact, in the ActiveVideo case, the judge made his ruling just eight days after the ongoing royalty issue was fully briefed.

In this case, Judge Jackson ruled on four other post-verdict motions made by the parties in little over six weeks. Therefore, I fully expect Judge Jackson will rule on the ongoing royalty motion anytime between now and mid July at the latest. I indeed wouldn't be surprised if he ruled by the end of June.

Risk Factor: I am human, and therefore might be completely wrong with my opinions and predictions. Therefore, before making any investment decision based on what I have written here, please spend some time evaluating the situation on your own, and also please evaluate my credibility. Without question, I can be and have been wrong many times. For example, in January 2011, I predicted Rambus (RMBS) would win two appeals in its patent cases, but that didn't exactly happen. I was long RMBS based on my prediction, but the stock went down more than 20% when things didn't go as I predicted.

Even in this case, I've made mistakes. For example, in my December 13 article, I said:

The judge will decide whether the claims are invalid for obviousness, although the jury did find several preliminary factual questions for the judge to consider on that issue in Vringo's favor... Vringo must have the judge rule the patents are not obvious.

However, the judge had already ruled on the issue of obviousness in Vringo's favor. I unfortunately missed that in my review of the docket, which was a mistake, and I immediately apologized in the comments of the article once it was brought to my attention. I had, however, assumed in the article that the judge would rule in Vringo's favor on obviousness, so even if I had known about the judge's decision, it wouldn't have materially changed the opinions I expressed in that article. But, regardless, it was a mistake, and I could very well make such mistakes again. I am human. This is why you must review what I've said for yourself to make sure I haven't made a mistake.

As another example of my being incorrect, in January I wrote an article saying Google's request to postpone Vringo's ongoing royalty motion had been ignored, which was disproven a few hours later when the judge granted the motion, quite to my surprise and embarrassment.

Warning: Finally, even though I firmly believe in what I've said here, I also strongly discourage anyone from investing in VRNG, or any other volatile stock, with money they can't afford to lose. I really do not want the guilt of people losing their savings because of my prediction, since it is extremely possible that I could be completely wrong. I strongly encourage investors to consult with their own patent attorney on these issues to get a second (and possibly different) opinion.

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.

Additional disclosure: This content was originally published as a Ravicher Report on June 13, 2013. It is now being made available for free to the public for the first time here. While I am long VRNG as of the submission of this article for publication to the Seeking Alpha editors, VRNG is, in my opinion, highly volatile, as is the litigation process in which it is involved, and therefore I may change my position in VRNG at any moment for any reason or no reason at all. I have been asked by the Seeking Alpha editors to state the price at which I would change my position in VRNG. At the precise moment that I am submitting this article to the Seeking Alpha editors I would be willing to close my long position in VRNG if it reached $3.50-3.75. In stating these prices, I am not providing any investment advice or making any buy or sell recommendation. I am merely saying what prices I would at the moment of submission of this article I would be willing to close my long position. My opinion on this may very well change, rapidly. Also, when asked, I have given my opinions about VRNG to private parties, some of whom had positions in VRNG at the time I gave my opinions to them. Sometimes I gave my opinions in exchange for a fee and I may very well continue to do so.