Investing in IP is a volatile proposition with daily trading leaving investors with a mixture of elation and high blood pressure. The returns are both highly lucrative and can be quite speculative, but fortunately for investors history has left us with a road map of key elements to be mindful of when investing in these future opportunities.
I like to compare these opportunities to the biotech industry. Valuations in both are based on future earnings potential with important key milestones along the way. As a company enforcing their IP goes down the path towards monetization there are hurdles that if completed successfully reduce the risk profile of the investment. This is no different than a biotech going down the process with the FDA. Management, industry, strength of the portfolio, pipeline and monetization strategy are all major factors to consider. Each must be monitored closely and as events occur their implications on valuation must be taken into consideration.
I have personally invested in several of the big names in the industry including VirnetX Holdings (VHC), ParkerVision (PRKR), and Spherix Inc. (SPEX), and follow closely others such as Vringo (VRNG), Acacia Research Corp. (ACTG), InterDigital (IDCC), and Tessera (TSRA). I have taken the good and the bad from my gains and losses along the way to continue to find viable investments in the space. I strongly believe I have found a candidate who fits our criteria. I urge investors to conduct their own due diligence before considering an investment in this company. As seen above, these investments carry a great deal of volatility and risk factors should be strongly evaluated.
Finjan Holdings, Inc. (OTCQB:FNJN) has an IP portfolio of 40 pending and issued patents that have been built in-house and focused on the cyber security industry. To date the company has received over $125 million in licensing agreements and settlements which include a judgment with Secure Computing for $37.9 million, a settlement with Microsoft in 2005 for $8 million, a settlement with an undisclosed technology company for $85 million in November 2012, a settlement with a second undisclosed company for $11.3 million and a license agreement with Trustwave.
The historical success of this portfolio initially drew my attention, but the shareholder base and management team is what intrigued me to dig further and write this blog.
Let's start with the shareholder base. There are ~22 million fully diluted shares outstanding which are very closely held. ~26% of the ~22 million is held by Benchmark Capital. Michael Eisenberg is famous in the investing world and the general partner of Benchmark. He is also Director of Finjan. Michael has focused on internet and technology investments since 2005 in notable acquisition names such as Shopping.com which was acquired by eBay, Inc. (EBAY). In addition to Michael, Eric Benhamou, the former CEO of Palm and 3Com, owns over 3%. He served as CEO of 3Com from 1990 to 2000 and grew revenues 25-fold during his tenure. In his last year as CEO, 3Com was ranked 294 in the Fortune 500 rankings. He also served as CEO of Palm until 2003, and subsequently as Chairman of the Board. Both 3Com and Palm were sold to HP in 2010.
Other majority shareholders include Israel Seed Partners with ~21%, HarbourVest with ~21%, and Cisco (CSCO) with ~8%.
The management team is led by Daniel Chinn, CEO. Daniel was successful in monetizing this IP portfolio to receive over $125 million by himself, which is very impressive. Daniel has an extensive legal and financial background to compliment his IP expertise. Today, Daniel is not by himself and has a very smart and experienced team around him. Phil Hartstein, President, is the former VP and portfolio manager at IP Navigation Group and former managing director at Rembrandt IP. Shimon Steinmetz, CFO, was former technology investment banker at Cantor Fitzgerald, Goldman Sachs and Citigroup.
All management team members are being compensated with reasonable salaries (well below what they are worth based on their backgrounds, in my opinion) and stock based compensation vests over a 10-year period and only exercisable after 4 years. This is a strong indication of what the management team believes the value of the stock could be one day.
Presently, Finjan has filed three patent infringement lawsuits in the Northern District of California against Blue Coat Systems, FireEye (FEYE) and Websense (complaint for patent infringements here, here and here). The latest development in these cases, per PACER docs, was a motion to combine the three cases into one. This motion has been denied and creates significant value for Finjan in my opinion. As a result Finjan and the defendants will be required to prepare each case independently with their own legal teams and money. Therefore, the three defendants cannot share cost and strategies. Additionally, Finjan will state their case to three different judges and more importantly three different juries, diversifying their risk at trial. I will provide more research on this aspect in future articles.
Fundamental Analysis of Investment Opportunity
During the company's online presentation yesterday at an online virtual conference, two slides stood out to me, 10 & 11. Finjan's IP portfolio broadly encompasses the cyber security industry and more specifically software, web infrastructure and networking equipment. On slide 10, each sector of their market and its size is highlighted. The software endpoint and cloud industry is estimated to be $11.2 billion, the web infrastructure web gateway market is $4.1 billion and networking equipment next generation firewall is $4 billion, yielding nearly $20 billion of licensing opportunity this year with a CAGR over the next 5 years of ~5%.
The next slide was even more interesting to me and the basis of my analysis.
On slide 11, the company does an excellent job of laying out the total addressable market (TAM) over the next 5 years. In 2013 it is projected to be $19.3 billion and growing to $22.5 billion by 2017. I have taken these numbers and made a few assumptions; 1) I assumed that Finjan was capable of licensing 1% of the market; 2) Capable of doing so over the next 4 years (2014-2017); 3) I discounted that cash flow 5%; 4) Discounted NPV 30% for legal fees.
Future cash flow = $721.1 million
Discounted 30% for legal fees = $504.8 million
Add Cash of ~$22 million = $531.9 million
The industry for companies enforcing their IP is in somewhat of a gold rush. Everyone and anyone with a portfolio are trying to go after Fortune 500 companies for a piece of the pie and using the public markets as a gateway to get higher valuations and liquidity. The key is to weed through nonsense and find true value with a strong team, burgeoning industry, great IP and strategy capable of carrying out that mission. I believe Finjan is that opportunity. I will continue to follow closely how the stock trades as their current litigation progresses.