MGT Capital Investments (NYSEMKT:MGT) has been pursuing damages and royalties that could be worth many multiples of its fully-diluted market capitalization from five casino industry companies since November 2012. A judge uploaded a favorable memorandum on Wednesday using the court's information portal, yet there are only two paragraphs of information about this memorandum accessible to most investors. This article explains the judge's comments and my outlook for common stock that is backed by plenty of cash, assets, insider support and unrelated business operations. Although MGT has not won its lawsuit yet and is prone to volatility, it has improved its chances of success and prevented many months delays with Wednesday's memorandum.
Judge Carlton W. Reeves of the Jackson Division of the U.S. District Court for the Southern District of Mississippi issued several orders on October 23 regarding MGT's lawsuit against Scientific Games' (NASDAQ:SGMS) recently acquired WMS Gaming (NYSE:WMS-OLD), Caesars Entertainment (NASDAQ:CZR), MGM Resorts (NYSE:MGM), Penn National Gaming (NASDAQ:PENN) and Aruze Gaming America, a privately-held company.
- The court denied summary dismissal of the lawsuit.
- The court denied motions to change venue.
- The court denied the motion to sever claims against Aruze and Penn.
- The court denied the motion to dismiss claim of direct infringement.
The court issued only minor rulings in favor of MGT's defendants.
- The court granted defendants' motion to dismiss contributory and induced infringement claims.
- The court granted the motion to sever the action against WMS, Caesars and MGM.
- The court granted defendants' motion to pause proceedings against MGM, Caesars and Penn.
I do not know the exact time on Wednesday that the court released this order publicly, but I assume that it posted it to PACER after the market closed, as MGT's stock did not move significantly on Wednesday. MGT rallied 11% on Thursday, and by 3:47pm ET, MGT had issued a short press release that various news agencies soon rebroadcasted.
MGT is a debt-free business operating several online gaming websites, including the #5 daily fantasy sports website, FanThrowdown.com. It has no preferred stock, high insider ownership, a fully-diluted market capitalization below $40 million and years of cash reserves in the bank.
MGT also owns 55% of a patent that is the basis of a lawsuit against five casino industry companies. It is a 20-year patent No. 7,892,088 entitled "Gaming Device Having a Second Separate Bonusing Event." The '088 patent covers the process of intermittent bonus rounds on an overhead screen with nearby slot machine players (see my previous article for pictures). MGT alleges that five companies manufacture or operate slot machines that infringe on its patent. The five defendants are grouped according to their allegedly infringing operations.
- Slot machine manufacturers: WMS and Aruze
- Slot machine operators: MGM, Caesars and Penn
I will explain why Wednesday's rulings are positive for MGT's shareholders who hope to receive settlement or legal award. I should disclose that for my own portfolio, I am a long-term MGT investor solely because it is the only stock within the daily fantasy sports sector, and I agree with a billion dollar fund manager's prediction that daily fantasy sports will grow 2,000% by 2020. Nevertheless, a payout from MGT's lawsuit would be a pleasant dessert in addition to my meat and potatoes investment (based solely on MGT's daily fantasy sports business). Regardless of my own opinion, other MGT investors certainly seem pleased with Wednesday's ruling based on the market reaction.
Because I have already explained MGT's daily fantasy sports division, I will focus entirely on the lawsuit news for this brief article. My goal is to succinctly explain the court's opinion on each ruling.
(Before I begin, a brief note on terminology. WMS was MGT's largest defendant by market capitalization and scope of alleged infringement at the time the lawsuit was announced on November 2, 2012. On May 10, 2013, shareholders of WMS Industries approved a takeover bid from Scientific Games. On October 18, 2013, this $1.5 billion merger finalized. Because the Mississippian court has officially updated the lawsuit as recently as October 23 using the name "WMS," I maintain the use of this term in this article. I assume that if MGT settles with or prevails against "WMS" in this lawsuit, Scientific Games will be the entity that pays.)
Rulings in Favor of MGT
1. The court denied summary dismissal of the lawsuit.
The court did not dismiss the lawsuit altogether. MGT survived the first round, a small yet encouraging sign of strength.
2. The court denied motions to change venue.
MGT's lawsuit will stay in Mississippi. WMS and Aruze failed to demonstrate that the Northern District of Illinois and the District of Nevada, respectively, were "clearly more convenient" than the Southern District of Mississippi. The court ruled that it would not have been appropriate under 28 U.S.C. § 1404(a) to transfer the claims against WMS to the Northern District of Illinois nor the claims against Aruze to the District of Nevada.
Staying in Mississippi is positive for MGT because it accelerates the trial considerably. Avoiding relocation delays speeds up settlement discussions and avoids months of delays in scheduling a new Markman Hearing and jury trial, if necessary. Ultimately, this ruling means that MGT investors can expect a Markman Hearing next summer, unless WMS or Aruze derail the lawsuit sooner or settle with MGT outright.
3. The court denied the motion to sever claims against Aruze and Penn.
A minor, positive victory for MGT is that its arguments satisfied the requirements of 35 U.S.C. § Section 299 for joinder of Aruze and Penn. The court ruled that severing MGT's infringement claims against Aruze and Penn into two lawsuits "would not promote judicial economy or reduce expenses." Instead, it would have created "two separate but similar infringement actions with the potential for inconsistent outcomes." MGT's claims can therefore proceed with simultaneous legal action against Aruze and Penn.
4. The court denied the motion to dismiss claim of direct infringement.
Perhaps the biggest victory is the court's ruling that MGT's claim of direct patent infringement cannot be dismissed. MGT met the legal standard for pleading direct infringement of its patent infringement, and the court upheld MGT's right to claim direct infringement. Obviously, the vast majority of MGT's potential reward depends on this claim, so it is positive to see the court uphold MGT's right to pursue legal action on this claim.
Rulings in Favor of the Defendants
1. The court granted defendants' motion to dismiss contributory and induced infringement claims.
MGT lost its contributory and induced infringement claims, but these were minor claims in comparison to its claims of direct patent infringement, which the court upheld in this ruling (see earlier discussion). Per 35 U.S.C. § 271(b), the court dismissed claims for induced and contributory infringement without prejudice. It lost both contributory and induced claims because of technicalities. For example, it attached a declaration to its response to defendants' motions, yet per the precedent of Streit v. Bushnell, it is improper for courts consider an affidavit attached to a response to a motion to dismiss.
I expect that this tiny mistake will be the worst oversight of MGT's law firm, Nixon & Vanderhye. The firm is, after all, a 37 member patent law firm in the Legal 500 and ranked Tier 1 among 10,000 firms in a 2013 edition of U.S. News & World Report. I would guess that the top partners at the firm are not even working on this lawsuit until it advances beyond formalities, anyway, so this might have been a mistake by a junior level employee.
2. The court granted the motion to sever the action against WMS, Caesars and MGM.
Although it seemed to me like a faster and more efficient option to consolidate all defendants into a single lawsuit, the court ruled that consolidating the defendants in this lawsuit "may circumvent the purpose of the newly enacted joinder restrictions" per 35 U.S.C. § Section 299. These new joinder restrictions stipulate that plaintiffs may not join unrelated defendants in a single action based solely on an allegation that they infringe the same patent. Ultimately, the court ruled that legal actions will start with the manufacturers, WMS and Aruze, and continue later to the casino operators, MGM, Caesars and Penn (see next ruling).
3. The court granted defendants' motion to pause proceedings against MGM, Caesars and Penn.
The court temporarily paused proceedings against the slot machine operators, MGM, Caesars and Penn, because they direct competitors and cannot be easily joined in legal actions. Moreover, the court views these operators as "retailers" that did not necessarily have knowledge about the intricacies of each slot machine they operated. The court ruled that, regardless, patent infringement truly begins at the design and manufacturing stages, so it makes sense to start with the manufacturers, WMS and Aruze. "The Casino Defendants would only incur liability for using the infringing products if the Court finds that the manufacturer infringed MGT's patent."
This makes intuitive sense. To summarize, MGT's lawsuit will progress initially against the manufacturers, WMS and Aruze. If MGT prevails against the manufacturers, only then will the lawsuit progress to the slot machine operators, MGM, Caesars and Penn.
With MGT up 11% in one day since the court posted these rulings, investors seem pleased with MGT's initial progress in its lawsuit. I hope this article explains the reason for this enthusiasm. As investors await a payday, the court at least affirms MGT's right to pursue its claims of direct patent infringement against WMS and Aruze. In the meantime, I cannot evaluate MGT's skill in negotiating settlement, nor can I predict the likelihood of MGT winning this lawsuit. If it does settle or win, I explained the formula for calculating its payout in a previous article.
If MGT receives a settlement or wins the lawsuit outright, the formula for calculating its payout is: [total amount] - [approximately 30% to Nixon & Vanderhye, the law firm working on contingency] - [45% of the remaining 70% to J&S Gaming]. Note that the exact fee schedule for Nixon & Vanderhye is confidential, so 30% is a very rough estimate and will vary based on the dollar amount. Also note that MGT Capital Investments has $18.7 million in federal tax loss carry-forwards and $2.3 million in state tax loss carry-forwards, so up to $21 million of its take-home winnings will be tax-free. After $21 million, normal taxes will be assessed.
Because I am a long-term investor in MGT's daily fantasy sports business alone, the lawsuit could flop completely yet my investment thesis would remain intact. The risk of total failure in this lawsuit is not very daunting to me when I consider MGT's $0 in debt, millions in cash, no preferred stock, negligible warrant and options overhang, high insider ownership, and unrelated operations in the daily fantasy sports business sector. Of course, there are innumerable legal complications in lawsuits that are beyond most investors' ability to assess, including my own. Nevertheless, as I have said before, "MGT's lawsuit provides a jackpot opportunity for shareholders, and it costs nothing to maintain that opportunity aside from minor, out-of-pocket expenses to the law firm, Nixon & Vanderhye. I wish them the best, and I am happy owning shares, regardless."