Document Security Systems Has Strong Case Against Facebook (Update)

| About: Document Security (DSS)

Editors' Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Please note that this is an update to an article that was originally published on December 5, 2013. I've corrected a couple of inaccurate statements and added more detail in a key section of the article.

Two weeks ago, I was drafting an update to my November 14, 2013 article about Document Security Systems, Inc. (NYSEMKT:DSS), but my effort was derailed when on November 27, 20913, a Seeking Alpha colleague broke the news that DSS filed a patent-infringement lawsuit against Apple Inc (NASDAQ:AAPL). DSS formally announced the lawsuit in an AH press release later that day. When I issued my original article, the stock traded between $1.03 and $1.11. The stock has gained over 100% in value since then. About 40% of that gain was due to the reaction to the Apple lawsuit.

Despite the significant relative gain in recent weeks, DSS is still extremely undervalued. Particularly now that the Apple Inc. infringement lawsuit has been filed. Before this latest lawsuit, and the progress the company is making in all facets of the business, the only analyst covering the stock had a $4t arget for DSS. His target was based on assigning a value of $1.65 to the core business, and adding a "conservative" $2.65 to account for the potential revenues from setting the existing patent-infringement lawsuits (against Facebook (NASDAQ:FB), LinkedIn (NYSE:LNKD), and the ones already settled (Broadvision (NASDAQ:BVSN), Jive Software (NASDAQ:JIVE), and Novell (NVEL)). The original research and the subsequent update are several months old. An updated research note would likely assign a higher target value. We should know soon if this will be the case or not.

Because of the Facebook and LinkedIn notoriety, not much has been said about DSS' stake in VirtualAgility. VirtualAgility provides a user-configurable platform that allows persons who are not specialists in information technology to create sophisticated, integrated applications. In 2013, VirtualAgility filed patent infringement lawsuits against nine defendants including Dell (NASDAQ:DELL) and Bank of America (NYSE:BAC).

As a reminder, the U.S. District Court for the Northern District of California has set the Markman hearing date for February 26, 2014 for Bascom Research, Inc. vs. Facebook, Inc., and LinkedIn, Corp. The VirtualAgility Markman hearings are set for April of 2014.

Positive Markman hearings are often catalysts for large upward share price movement. These hearings were catalysts behind the upward price movement in ParkerVision (NASDAQ:PRKR) (73% intraday increase on release of positive Markman ruling after a substantial uptrend before the ruling), and Vringo (VRNG) (up 36% intraday increase on release of positive Markman ruling on top of a steep climb ahead of the hearings). Given the market size for social networking, a positive Markman hearing on the Facebook and LinkedIn cases could deliver gains similar to those seen in ParkerVision and Vringo. These cases could potentially result in strong stock performance for DSS shareholders resulting from licensing agreements/royalties and/or settlements. Royalty agreements and settlements typically represent nearly pure profits for the Company (outside of taxes).

My first article on DSS triggered several questions and comments from my readers about the likely success or failure of DSS' patent-infringement cases. I am not going to address all those questions here, but a frequent comment was "there is no way that DSS will get anything from Facebook - it's like David fighting Goliath." Well, I feel more strongly than ever that DSS has a very good chance to win the Facebook case. You will feel the same way if you take the time to read the parallels between the DSS Bascom Patents and the way Facebook work from pages 34 - 39 of an excellent article written by J. P. Moreno "The Emergence of Document Security Systems." The same can be said about the LinkedIn case. At this time I can't speculate about the potential success of company's latest lawsuit, but based on the solid track record of The Lexington Group (now part of the DSS), I believe that DSS management must feel confident that their case against Apple is strong.

The Apple lawsuit has brought several comparisons to other companies that sued Apple before and won. Unlike those other companies focused on patent monetization alone, DSS has a legitimate core business with significant growth potential. One of those companies is VirnetX Holding Corp. (VHC). The disparity comes when you compare revenues and market cap. VHC generated $400K in 2012 revenues vs. $17 million generated by DSS but VHC's market cap is over a billion dollars or ten times as much as DSS'. VHC has recently been trading sideways in an $18 - $20 range but it reached the low $40s twice prior to the jury verdict. On November of 2012 Virnetx won a suit against Apple. The jury concluded that Apple infringes several of Virnetx's patents relative to secure VPN. The particular features that were part of the litigation were FaceTime and VPN On Demand. Both of these features are key to Apple's market penetration. The jury awarded VHC $368M but both parties are currently arguing ongoing royalties.

DSS core business has several divisions and many product lines. I will spend more time going over each division and product in my next article. But for the time being investors are encouraged to watch a video interview featuring Peter Hardigan, DSS Chief Investment Officer. You will learn about some of the state-of-the-art technologies that the company is already providing governments and public as well as private companies to combat document and product counterfeiting. The company's flagship technology is called AuthentiGuard and I expected it to be a huge revenue-engine going forward (more discussion in pages 31 - 33 of J. P. Moreno's report). I project that DSS revenues will at least double by 2015.

In summary, anticipation of the Markman hearings in February, 2014, the VirtualAgility Markman hearings in April of 2014, and announcements of other lawsuits that the company might currently working on, progress on its core businesses, etc. make DSS a compelling investment opportunity with moderate downside.

But as with any investment in the stock market, there are risks involved in buying DSS stock. A negative outcome of the litigation is the biggest risk with an investment like this. Even if DSS ends up winning, which as I mentioned is very likely, the litigation could be time consuming and costly. According to its most recent 10-Q, DSS estimates that its legal fees over the next 12 months will be around $2 million. The company reported $3.2 million in cash in its recent Fiscal 3Q 2013 earnings release. It would appear that DSS does not have an immediate need to raise additional capital. Investors considering buying this, or any other stock, should always read carefully the risks and uncertainties as spelled out in the company's 10-K and 10-Q filings.

Disclosure: I am long DSS. 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.