Earlier this year I wrote an article that looked at the rise of the daily fantasy sports industry and, as part of the article, I pointed out a number of possible investment opportunities this growth industry presented. One of the companies I mentioned was MGT Capital Investments (MGT). At the time of writing, MGT Capital, through its subsidiary MGT Gaming, had just acquired a 65% stake in stake in FanTD, owner of the daily fantasy sports website fanthrowdown.com. This acquisition offered investors arguably the only pure play in the daily fantasy sports industry. Since then, the site's user base has expanded through a combination of organic new registrations and the acquisition of members from two other sites, Daily Joust and Fantasy Day Sports. MGT remains a pure play in the expanding daily fantasy sports industry, but is also getting attention from investors for an entirely different reason: patent litigation.
On November 2 last year, MGT Capital announced that, through MGT Gaming, it had filed a lawsuit claiming patent infringement against multiple companies believed to be in violation of the company's Patent No. 7,892,088 ('088). Entitled "Gaming Device Having a Second Separate Bonusing Event," '088 covers the addition of a second game linked to, and activated by, a series of triggers in a first game. The lawsuit involves five defendant companies. Two of these are manufacturers of casino gaming machines, WMS Gaming, now part of Scientific Games (SGMS) and Aruze. The other three are casino operators, Caesars Entertainment (CZR), MGM Resorts (MGM) and Penn National Gaming (PENN). For the purposes of this article and, as per the legal documentation associated with the suit, I will refer to WMS, MGM and Caesars as the "WMS defendants," and Aruze and Penn as the "Aruze defendants."
In response to the infringement claim, the defendants filed a number of motions and, last Thursday, MGT announced it had received an update from U.S. District Court for the Southern District of Mississippi concerning outcome of these motions.
Motion to dismiss
The first motion I will address is the motion to dismiss. There are three separate types of claims a plaintiff can bring in front of a court where patent infringement is concerned. These are direct, induced and contributory. To simplify, the US Judicial System considers induced and contributory to be indirect. Both the WMS defendants and the Aruze defendants filed a motion to dismiss direct infringement allegations arguing that MGT did not give sufficient notice of both defendants' alleged infringements. The conclusion of the direct infringement element of this first motion was that dismissal of MGT's direct infringement claim was unwarranted and, in turn, denied. The conclusion of the indirect motion was, as a result of MGT's acknowledgement that it did not have "necessary facts to establish a claim for contributory infringement," the removal of the indirect infringement allegations, until these necessary facts become addressable. This translates as motion granted, until further notice.
While the granting of the indirect infringement motion favors the defendants, the potential gains MGT stands to receive from these allegations are much smaller than the direct infringement allegations, which the court denied. The vast majority of any damages-based payout would be based upon the direct infringement claims, and so this first motion concluded favorably for MGT.
Motion to sever
The second motion concerns the defendants' movements to sever the claims against them for improper joinder. After the dismissal motion, this motion has what will probably be the most far reaching effects on how the trial plays out, and in turn the financial ramifications for MGT if successful. As a result, it is worth considering it in some detail.
To address this motion, the court acknowledged two distinct relationships between the defendants. The first being the relationship between the manufacturers WMS and Aruze. The second being the relationship between the manufacturers and their casino clients. This second relationship refers to that of WMS and its casino clients, Caesars and MGM; and Aruze and its casino client, Penn.
In the first instance, that of WMS and Aruze, the court ruled that the claims against the two manufacturers should be severed. This ruling arose from two main factors. The first is that the WMS-manufactured and the Aruze-manufactured gaming machines that allegedly infringe upon the '088 patent are not the same machines. Both companies design, develop manufacture and sell independently from each other. The second is that the two manufacturers are in direct competition with each other, and as a result, joinder would be inappropriate.
In the second instance, the court ruled that the claims against the manufacturers and their respective casino clients should not be severed. WMS manufactures the gaming machines and offers them to both MGM and Caesars on a revenue sharing basis. The company is also responsible for the maintenance and repair of the machines. The same concept applies to Aruze and its relationship with Penn. The court decided that this ongoing relationship justifies the joint action the MGT claims request. There was however an additional ruling in this instance. While WMS supplies both MGM and Caesars, the two casino operators are direct competitors. Because of this direct competition, the court decided that the two companies could not serve as codefendants, and that the claims against them should be severed.
How does this affect the trial and its potential outcome? Investors can consider the result of the first instance positive for the defendants. To remain codefendants would put WMS and Aruze at a disadvantage for two main reasons. The first is that, with the two companies being competitors, their businesses involve trade secrets and other operational confidentiality. They would understandably be unwilling to share confidential information as part of a common defense, and this would likely inhibit their ability to mount an adequate case. The second is that being codefendants makes it much more difficult to achieve success in a motion to change venue. Conversely, investors can consider the second instance positive for MGT. Joinder of the manufacturers and their respective casino clients will drastically cut litigation costs for the company and, if the case goes to a jury trial, will likely increase any potential damages payout.
The motion to stay
The third motion concerns the staying of MGT's claims against the casino defendants. Legal precedence suggests that if the casinos were distinguishable from the manufacturers in the same way as a retailer would be from a manufacturer, then the claims against the casinos are peripheral. The court found that MGT's claims against the casinos were peripheral, and granted the motion to stay the claims until the claims involving the manufacturers are resolved.
Investors can consider this a small win for the defendants, but only until the outcome of the litigation against the manufacturers concludes. If this litigation concludes favorably towards MGT, the courts will review the staying of the casino claims, and litigation of the claims will likely resume. It is reasonable to suggest that in the event of a favorable outcome in the manufacturer litigation, the chances of a comparable outcome in the casino litigation will increase.
The motion to change venue
Finally, the fourth motion concerns a change of venue. While WMS, Aruze, the WMS defendants and the Aruze defendants all filed motions to change venue, the staying of the claims against the casinos means that the court only considered the motions submitted by WMS and Aruze. In this case, the court concluded that neither company demonstrated it would be more convenient to hold the case at another venue, and denied the motion on both counts.
Investors can consider this positive for MGT, primarily because it avoids any delay in the case.
Putting things into perspective
It is important to realize that while the outcome of these motions is relatively positive for MGT, they are far from indicative of the company's success or failure in the case. Having said this, the court's decisions undoubtedly benefit MGT shareholders in that they keep the case on course for the scheduled Markman Hearing on June 5, 2014.
Patent infringement suit outcomes
While the suit remains on schedule, figures suggest it will never reach jury trial. In recent years a number of high profile cases have concluded in settlement, one example being that of Microsoft (MSFT) versus Vringo (VRNG). However, the vast majority of cases-more than 95%-conclude in settlement before trial. The reason for this is that, in many cases, a defendant will prefer to reach a licensing agreement with the plaintiff to avoid the financial risk of letting the case go before a jury. To illustrate this risk, last year a jury awarded Apple (AAPL) $1.5B in a patent infringement suit against Samsung Electronics (GM:SSDIY).
What then, can MGT investors expect going forward?
As aforementioned, the Markman Hearing will take place in June 2014. During the Markman Hearing, the judge-Judge Carlton W. Reeves-will construct a legal opinion as to what the claims of the patent actually cover. On completion of the Markman Hearing, both MGT and the defendants will likely have an idea as to the potential outcome of the case. If, as a result of the Markman Hearing, the defendants feel that going to a jury trial could result in defeat they may settle. If the companies involved decide not to settle, then the case will likely go to jury trial.
To get an idea of the timescale involved, consider the well-documented case-VirnetX (VHC) versus Apple. VirnetX first filed its suit in August 2010, asserting that Apple and a number of other companies were infringing upon six of its patents. The Markman hearing for Apple case took place on January 4, 2012, and the court issued the Markman Order four months later on April 25, 2012. Shortly after the Markman Order issue, on May 3, 2012, Aastra Technologies (GM:AATSF), one of the companies alleged to be infringing, signed a licensing agreement with VirnetX. NEC Corporation (GM:NIPNF) did the same, signing a licensing agreement with VirnetX on August 3, 2012. Both agreements involved a one-time payment to VirnetX and an ongoing reasonable royalty on future sales. The exact details of the agreement remain unpublished, but a look at VirnetX's royalty rates and guidelines suggests a standard rate somewhere between 2%-5%.
In contrast, Apple did not form a licensing agreement with VirnetX, and the case reached jury trial on October 31, 2012. Six days later on November 6, 2012, a federal jury awarded VirnetX $368.2M in damages. All told, from start to finish the case took just over two years. Another well-documented case, Vringo versus Google (GOOG) (a.k.a. I/P Engine versus AOL (AOL) et al.), echoed this start to finish time, taking two years to complete.
How does this timescale fit into the MGT case?
Applying the same timescale as the VirnetX versus Apple case, it is possible to speculate on the time to conclusion in the ongoing MGT case.
MGT first filed on November 2, 2012. The Markman hearing is scheduled for June 5, 2014, which is only a few months behind amount of time it took for the VirnetX case to reach a Markman Hearing. The courts issued the VirnetX Markman Order four months after the hearing, so applying the same timescale investors should expect the Markman Order around October 2014. At this point, WMS and Aruze will evaluate the Order and make a decision as to the likelihood of success at trial. Investors should therefore expect any settlement agreements, if reached, to be signed late 2014-early 2015. Again imposing the same timeframes as the VirnetX case, if the MGT case does go to trial investors should expect this around May 2015, with a jury decision expected during the same month or the next. This would put the total case time at around two and a half years.
The update this article covers is a positive step for MGT in its patent litigation claims against the aforementioned gaming manufacturers and casino operators. While it would be inappropriate of me to speculate as to the outcome of the trials, a positive result could draw substantial licensing revenue for MGT Gaming and, in turn, its owner MGT Capital. For reasons including, but not limited to, the growing daily fantasy sports industry and MGT Gaming's stake in FanThrowDown, many analysts predict MGT Capital stock is undervalued. A positive outcome in the litigation this article addresses could serve to catalyze the company's revaluation as soon as October 2014.