- Spherix is a $71 million company owning over 300 patents that could turn into billions of dollars through litigation, licensing or outright sale.
- Spherix's reverse merger resulted in a complex share structure that nevertheless incentivizes institutional backers toward higher share prices.
- Spherix's lawyer-turned-CEO Anthony Hayes rewarded all shareholders with a 5x cash return on his most recent public company project.
Spherix (NASDAQ:SPEX) is a low float Nasdaq stock that turns intellectual property ("IP") into money through selling, litigating and/or licensing these intangible assets. The company is led by a lawyer who rewarded Mango Capital shareholders with a 5x cash return by monetizing an obscure patent portfolio. Boasting over 90% insider and institutional ownership, Spherix is backed by some of the most successful IP investors in the world, including Apple (NASDAQ:AAPL), and has five active lawsuits: one major lawsuit against Cisco (NASDAQ:CSCO) and four others against Uniden, AT&T (NYSE:T), VTech (OTCPK:VTKLY) and T-Mobile (NYSE:TMUS). As Spherix pursues its aggressive strategy, I wanted to update my research on this young company.
Already a Record-Setting Year for IP
Spherix has enjoyed rapid growth along with the overall IP monetization sector. As PricewaterhouseCoopers predicted, 2014 is already breaking all-time records. Patent lawsuit filings increased by over 30% during the past 12 months, and courts are awarding the largest patent infringement damages ever. IP stocks are outperforming the market this year: Vringo is up 25%, Acacia Research is up 15%, and Qualcomm is up 5%. Consider additional sector activity this year.
- The European Union named copyright its top IP agenda item for 2014.
- An IP reform bill that passed the House of Representatives is under review by the Senate Judiciary Committee.
- Vringo (NASDAQ:VRNG) settled with ADT and ostensibly won an ongoing royalty rate of 6.5% against Google pending the outcome of an oral argument scheduled for May 6, 2014. (I have argued during the past year that Spherix Is The Next Vringo.)
- VirnetX (NYSEMKT:VHC) alleged IP infringement against VPN features in Apple's ubiquitous iOS 7.
- Rockstar Consortium conferred 101 of its patents and applications to Spherix and became its largest shareholder.
- Wi-LAN settled an IP dispute with Toshiba.
- Acacia Research finalized six patent licensing agreements with Toshiba, Videx, Smith & Nephew, HickoryTech, Staples and Aastra USA.
High Institutional Ownership
The vast majority of Spherix's equity is already spoken for. It has attracted and retained investment from world-class IP institutions such as Hudson Bay Capital, Iroquois Capital and Rockstar Consortium, a multi-billion dollar partnership between Apple, Microsoft, EMC, Sony and Ericsson. Institutional investors own 45.28% of Spherix combined, including IP heavyweights Hudson Bay Capital and Iroquois Capital with 9.99% apiece, American Capital Management with 8.96%, and Alpha Capital Anstalt with 5.75%. Additionally, Rockstar Consortium owns a staggering 28% by itself. Executives and directors own approximately one quarter of the company. Added together, insiders and institutions have left just a couple of percentage points of the company - and a tiny retail float - for the rest of the world.
Beyond the high percentage of Spherix's institutional investment shown above, the company obviously benefits from more than just numerical percentages. In addition to raw money, Spherix also benefits from its investors' prestige, reputation, contacts and deal flow. For example, Rockstar Consortium owns over $4 billion worth of IP from Nortel, a defunct Canadian telecom giant that once employed tens of thousands of people. Rockstar Consortium has provided some of these patents, cash, industry contacts and ongoing support to Spherix. Likewise, Hudson Bay Capital and Iroquois Capital made names for themselves when they invested in Vringo when it was just a penny stock prior to Mark Cuban's investment and months before Vringo won a landmark 6.5% royalty award against Google.
Spherix's CEO and major insider shareholder Anthony Hayes also brings prestige to Spherix. He delivered a six-fold cash return to the shareholders of Mango Capital by single-handedly monetizing its patent portfolio. Prior to his work with public companies, he earned Partner status at one of the top 100 law firms in the country, received a commendation from President Bush and was named a Top 10 IP Personality of 2013 by Intellectual Asset Management alongside the Deputy Director of the U.S. Patent & Trademark Office and the Corporate Vice President of Microsoft.
Spherix came to be one of the most followed IP stocks last autumn. In late 2012, large capital funds began slowly buying Spherix's equity and transforming its operations toward IP. As of February 14, 2013, Hudson Bay Capital owned 7.47% and Iroquois Capital owned 6.8% of the company, and a few individuals also began purchasing strategic positions. At that time, Spherix was thinly trading and winding down development of a sugar-free sweetener in preparation for pivoting into the IP sector, mirroring Vringo's winding down of operations before its pivotal Innovate/Protect merger.
As institutional investors prepared Spherix for its launch into IP, speculators discovered the link to Vringo in a February 22 regulatory filing. Speculative trading with a float of just a few hundred thousand shares soon tripled Spherix's share price to $14.89.
Spherix scheduled its formal IP kickoff for September 2013, and it eliminated substantially all debt and operations in preparation for a clean slate IP launch. By early August, a frenzy of investors looking to buy "the next Vringo" before this September launch squeezed into Spherix's tiny float - still below 2 million shares - sending its stock to an irresponsible high of $27.86 per share.
On schedule, Hayes became CEO on September 10, 2013, through a merger with his private company, North South Holdings. He brought with him 222 Harris Corporation (NYSE:HRS) patents plus two CompuFill patents. Soon, Rockstar Consortium (a private company owning a $4.5 billion patent portfolio) would also sell patents and become a shareholder of Spherix at $5.65 per share, adding its prestigious members Apple, Microsoft, EMC, Sony and Ericsson as investors by association. Also of interest, Spherix recently hired Frank Reiner, InterDigital's (NASDAQ:IDCC) Senior Director of Licensing. (InterDigital is one of the most successful IP monetizers in history, selling 1,700 patents to Intel for $375 million cash.) Reiner is now Spherix's Vice President.
During subsequent months, Rockstar Consortium continued to confer patents to Spherix and invest in the company at an even higher cost basis with higher warrant strike prices (up to $20 per share), demonstrating continued confidence in Hayes' ability to monetize its IP that he was now managing on its behalf. For example, Spherix announced on December 31, 2013, the details of an additional acquisition of 101 patents from Rockstar Consortium in a $60 million deal. Today, Rockstar Consortium is Spherix's single largest shareholder by far, and Spherix is reciprocally the only stock primarily backed by IP assets from Rockstar Consortium. In addition to attracting the confidence and investment of Rockstar Consortium - arguably the most enviable IP investor in the world - Hayes has achieved executed milestones like two settlements from Spherix's CompuFill patent portfolio.
An article from last summer contextualizes Rockstar Consortium's investment in Spherix. Maybe the most interesting part of the companies' relationship is how enormous of a stake Rockstar has taken in the firm: presently 28% of the company and vesting toward almost one half if Spherix's stock price rallies above incremental strike prices topping at $20 per share. By becoming a shareholder, of course, Rockstar will financially benefit from any successful assertions Spherix undertakes while removing its five corporate shareholders with sensitive brand names (Apple, Microsoft, BlackBerry, Sony and Ericsson) from negative press associated with patent trolling.
Anyway, following the phases of 1) cleaning slate, 2) pivoting business, 3) hiring key management, and 4) attracting institutional investment, the final phase in Spherix's corporate history is 4) IP monetization. It has several active lawsuits. It announced perhaps its most important lawsuit a few days ago against Cisco. Spherix alleges that the "vast majority" of Cisco's $43 billion in U.S. sales of routers and switches over the five years ended July 27, 2013, has infringed on 11 of Spherix's Rockstar Consortium patents.
Fully Diluted Valuation
Although the market capitalization of Spherix calculates to $21 million based on 7,846,106 shares outstanding as of March 28, 2014, Spherix's fully diluted valuation is much higher. There are 25,858,940 fully diluted shares, putting its true valuation at $71 million.
There are just 259 stockholders of record, indicating limited retail ownership. Institutional ownership is disproportionately high, with Hudson Bay Capital owning approximately 10% of shares outstanding, one hedge fund manager owning another 10%, executives owning and Rockstar Consortium owning 28%. (Not all of these shares are freely trading due to lockup provisions. Also, Rockstar Consortium will receive additional equity and profit-sharing payments if it helps Spherix attain progressively higher stock prices due to strikes set at $13, 15, $17 and $20 per share.)
As a risk reminder, investors need to be aware of the vesting schedules for Spherix's securities in order to properly time their investments. For example, Spherix understandably fell below $5.85 per share on January 27, 2014, due to equity incentive options priced at that strike scheduled to vest on January 28. Similar spikes and drops can usually be explained from scheduled vesting of various options and warrants. I emphasize the word scheduled because if shareholders take the time to read SEC filings, none of this trading action should come as a surprise.
Due to the reverse merger that occurred during summer 2013, Spherix maintains a characteristically complex share structure. Its balance sheet is healthy - a few million dollars of cash for operations with no debt - yet almost all of Spherix's assets are patents, so it has wisely incentivized investors with out-of-the-money warrants to align their interests with the success of the company. As a result, Spherix maintains nine series of preferred stock and several lines of options and bonds, all of which resulted from discussions with sophisticated investors who provided substantial funds and deal flow. For example, Rockstar Consortium has provided millions in cash and 108 patents to Spherix, yet Rockstar Consortium can only realize its maximum return on investment if it helps Spherix attain a share price above $20 per share - the top threshold by which point all of its tranches would be in-the-money. Most of Spherix's prestigious investors have agreed to similar performance-based investment structures.
As an additional consequence of the reverse merger, historical revenue analysis is irrelevant to assessing Spherix's value. Spherix does not have any historical revenue for an IP monetizer prior to the fourth quarter of 2013. The company reported revenues of $0 in 2011, $20,000 in 2012 and $8,000 during the first three quarters of 2013. Although the company launched in 1967 as a scientific research company and rallied thousands of percentage points during the dot-com bubble, it had shed that market capitalization and all prior operations by the time it about-face pivoted into IP in September 2013.
Spherix's assets consist of cash, patents and executive talent and connections (discussed above). By their very nature, patents are complex assets, extremely difficult to value, and often create all-or-nothing revenue opportunities in the form of sudden licenses, settlements or jury awards. All of Spherix's revenue will be derived from IP monetization efforts.
It is impossible to perform a peer analysis, as all IP is unique, and IP monetization is uncorrelated to any other type of business. Note that because there is no centralized market for IP transactions, asymmetric information flow and illiquid pricing can create very lucrative opportunities. Like other New York City ex-lawyers, Hayes became his own millionaire by acquiring and flipping egregiously undervalued IP.
I previously used Spherix's 52-week stock price range as a proxy for the free market estimate, showing that Spherix's patents have been valued from $50 million to $350 million mark-to-market. This large range might seem unreasonable for a company with less than $20,000 in revenue for the past three years, but this type of IP-fueled transformation has plenty of precedent.
- Former penny stock Vringo attained a half billion market capitalization in a few months because of one patent portfolio.
- VirnetX captured $2 billion in market capitalization with only 11 employees and one patent portfolio.
- Sterling Partners acquired IP firm MOSAID for $590 million.
- Motorola Mobility monetized its patent portfolios for $12.5 billion.
- Mango Capital, when it was barely trading even at $0.04 per share, declared a $0.34 per share cash dividend thanks individually to Hayes, who is now Spherix's CEO.
Spherix does have prestigious backers, multiple shots on goal, hundreds of patents, a CEO who has profited with millions from IP monetization, and dozens of active lawsuits and licensing discussions. Nevertheless, there is the risk that Hayes will be unable to quickly monetize Spherix's IP. Again, the full value of Spherix is a speculative assessment of the future monetization potential of its IP. Although the market has valued and continues to value this IP over $20 million, this valuation could prove incorrect one day. The downside risk is a total loss if Spherix is unable to monetize its IP, as it has no other businesses for cash flow.
On both a positive and negative note, Spherix is one of the most volatile and lowest float stocks on the NASDAQ, so trading has always been and will continue to be volatile. Low floats tend to amplify share price movements in both directions due to the small amount of money needed to move share prices a significant percentage. As of March 31, 2013, Spherix's float was just 3.68 million shares, so Spherix's share price could move $1 on only $3.68 million of buying power.
For investors who enjoy an uncorrelated investment with a high-risk, multi-bagger potential, Spherix is a unique opportunity. On the other hand, it is not appropriate for investors not willing to analyze complex share structures or who prefer businesses with forecastable cash flow.
Disclosure: I am long SPEX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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