Seeking Alpha
Research analyst, oil & gas, tech, mid-cap
Profile| Send Message|
( followers)

Intellectual Property is an important aspect of a technology company because this provides an important source for revenue generation and a competitive advantage over competitors. Vringo (VRNG) develops and acquires technology patents for internet search. The company generates revenue by patenting and licensing the technologies it develops. Thus, safeguarding these technologies is as important as developing them. In the past and in recent times, Vringo has sued a number of companies for using its technologies for infringement issues, leading to legal lawsuits.

The story so far

In 2012, Vringo sued [[AOL]], Google (GOOG), IAC Search & Media (IACI), Gannett Company (GCI), and Target Corporation (TGT) for patents infringement. Those patents are known as U.S. Patent Nos. 6,314,420 and 6,775,664 referred to as "420″ and "664″ patents respectively.

The final hearing happened on November 20, 2012, and the ruling was in favor of Vringo. The jury awarded Vringo Engine a total of approximately $30.5 million as a compensation for the revenue lost due to infringement. Google paid $15.8 million, AOL $7.9 million, IAC $6.6 million, Target $98,000, and Gannett paid $4,000. A running royalty rate of 3.5% was also awarded to Vringo in November of last year. A running royalty rate signifies that the percentage of revenue Vringo will receive as a royalty from the companies on the assumption that they continue to use Vringo's technology to generate revenue.

After the judgment in November, only Google has appealed for re-examination of the asserted patents at the United States Patent and Trademark Office, or USPTO, one request against the "420" patent and two requests against the '664 patent. The outcome of Google's appeal has the potential to affect the revenue rate of all the involved companies, because if it comes out in Vringo's favor the company can reinforce its claim of 7%, which might force Google, as well as the other companies to negotiate the royalty rate. The court ruled that, if the companies are not able to settle among themselves, then parties will have to schedule a different settlement conference with the U.S. Magistrate Judge by December 2013.

The Views

Patent "664" helps a search engine user find relevant advertisements. It uses a feedback system that screens information from users. The feedback works by matching the information of previous searches to anticipate a future search query from the same person.

This is done by screening the words that a user types into a search engine. The search system also measures the amount of time a person requires to find a particular advertisement. Thus, this search system combines previous information along with the time spent by the users to find an advertisement. Then, by applying weights to the amount of relevant information, and to the time spent by the user, the algorithm can rank or give score to the advertisement in comparison to other advertisements. Through this, the advertiser understands the relevancy of the words in their advertisements and can gain important insights about the advertisement content. This helps optimize a user's search for advertisement.

Google also has its own advertising systems that use their own filtering process. Some of Google's advertising products are Google AdWords and Google AdSense, which help filter advertisements. Google AdSense is a product that helps advertisers know the relevancy of their advertisement to users by ranking and scoring advertisements. Vringo claims that the algorithm of Google's AdSense is same or similar to that in the patented algorithm of "664".

The above comparison of the basic structure of the search engine products makes us believe that Vringo has a higher chance of success in the re-examination of patent "664". It filed patent "664" in 2001, and Google launched AdSense in 2003. If the re-examination results of the patent "664" come out positive, and in our opinion, this will most likely be the case, than it would give Vringo a major thrust to negotiate a royalty rate with Google.

Going Forward

Vringo may receive around $125 million per year from the companies for five years at the royalty rate of 3.5% per year. Also, it has appealed to the court for an increase in royalty rate to 7%, if the infringement is willful. We also consider a third scenario with a revenue running rate of 5% on the assumption that a negotiation takes place between Vringo and other companies for an out of court settlement for the running rate. Here we calculated the future revenue for a period of four years since one year has already passed.

A study published on lawsuit costs finds that a patent litigation costs around 20% of the patent value if the total value of patents exceeds $25 million. This cost refers to all costs related to the litigation. Here we are considering 20% legal cost for our calculation.

Here are the 3 scenarios we discussed with the revenue potential of each:

Scenario 1

Scenario 2

Scenario 3

Running Royalty Rate

3.50%

7.00%

5.00%

Royalty revenue for four years

$500

$1000

$714

Less: Legal Cost at 20%

$100

$200

$142

Less: Tax at 35%

$140

$280

$200

Royalty Revenues receipts from Google and other companies

$260

$520

$372

(All amounts in millions)

This shows that Vringo has significant upside potential if it can prove a willful infringement on its patent by Google.

Google is one of the main stakeholders in the lawsuit. Google earns huge revenue from the advertising business. In the last fiscal year, Google earned total revenue of around $50 billion. Out of this total revenue, 95% is earned from advertisements. This rate has been fairly consistent; it earned 96% of its total revenue from advertisement in 2011. According to the original complaint, Vringo would seek compensation from the period of infringement from 2005 to the date of expiration of the patent in 2016. This accounts for a significant amount from Google.

The outcome of the Google lawsuit settlement also has another benefit relating to receipt of royalty payment from Microsoft (MSFT). In May this year, Microsoft settled a patent lawsuit with Vringo for $1 million for infringing the above mentioned patents. Apart from the $1 million payment, this settlement also contains another clause, stating that Microsoft will pay 5% of the total amount that Google will pay to Vringo. In our analysis, we found that Google is at a disadvantageous position in the lawsuit. So, we believe that the Google lawsuit also provides an additional benefit to Vringo. A similar scenario analysis is done in the following table for Microsoft:

(Google paid around 51.8% in the $30.5 million dollar settlement. Assuming that Google pays the same percentage in the above discussed scenario we calculate the following)

Scenario

Royalty Receipts (in million)

Vringo royalty receipt at 5%, if the revenue running rate is 3.5% with Google

$6.73

Vringo royalty receipt at 5% if the revenue running rate is 5% with Google

$9.64

Vringo royalty receipt at 5% if the revenue running rate is 7% with Google

$13.47

What to expect

As we have discussed earlier in the research, this legal tussle with Google is important for Vringo from a revenue generation point of view. Additionally, we believe that Vringo holds a more favorable position compared to Google in the re-examination of patent "664". As discussed, the outcome of the re-examination will affect the revenue running rate that Google and the other companies pay. The outcome of this re-examination will also influence the revenue opportunity from Microsoft. Being on the more positive side of the lawsuit, Vringo has a good probability to get a favorable decision from the USPTO, which could provide a further tailwind for the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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: Fusion Research is a team of equity analysts. This article was written by Rohit Gupta, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article