A telecommunications revolution is underway as companies begin to shift from 3G technology to LTE, the global 4G standard and the future of communication. Businesses are spending billions to position themselves in this new and rapidly growing market. AT&T’s (T) recent proposed $39 billion acquisition of T-Mobile USA will fast-track the deployment of 4G for the company and further highlights the magnitude of LTE for the industry.
At the forefront of this change is the Third Generation Partnership Project (3GPP), a collaboration between several groups of telecommunication associations. The 3GPP has come together over the past several years to create and define what 4G LTE will be. Part of this process is constructing technical specifications and standards to which manufacturers must comply in order to implement 4G.
In 2009, VirnetX (VHC) notified the 3GPP that its patents may be essential for some of the 4G LTE security specifications laid out by the group, meaning there was no technical way to implement the standards without the use of the company’s intellectual property (IP). This action opened up a dialogue between VirnetX and the 3GPP. While VirnetX contemplated its next move, the 3GPP worked to find a workaround method and possibly rewrite the specifications as to avoid the use of the company’s inventions. After failing to find an alternative over several months, the 3GPP requested VirnetX offer a license based on reasonable terms and conditions that are free from unfair discrimination. This was to ensure that companies could openly implement 4G without being blocked by any intellectual property rights.
VirnetX agreed. On March 14, the company expanded the number of specifications its IP covered within the Series 33 security specifications, and announced the availability of its patents to license in relation to these standards. A copy of the document can be found here.
VirnetX has officially notified the 3GPP — and the world — it is now open for business. The significance of this development should not be overlooked. VirnetX is now on the brink of becoming a key technology licensing company. The 3GPP will soon notify its 400+ member companies that it will need to take a license from VirnetX in order to comply with 4G LTE specifications.
Those needing to take a license include handset makers, infrastructure providers, and operators — essentially any company moving towards 4G. The size of this market in the future will be astounding. Experts within the telecom sector envision 50 billion connected devices by 2020. These include everything from mobile phones, tablets, laptops, and even automobiles. But the company IP extends beyond devices alone. When LTE fully picks up steam, VirnetX’s targeted market is projected to generate a whopping $200 billion per annum.
VirnetX will likely offer a license with an upfront fee and royalties going forward. An ongoing rate of about 1% of sales is fairly standard for an entire essential patent portfolio as foundational and important as VirnetX’s. A 1% rate also appears to be a number proven quite defensible in court and would actually be a relatively low rate compared to other companies with foundational IP such as Qualcomm (QCOM), InterDigital (IDCC), and Rambus (RMBS).
Conservatively taking half of VirnetX’s future target market ($100B) at a standard 1% royalty rate results in a billion dollars in recurring licensing revenue for the company (~$20/share). Much of this will flow straight to the bottom line. The value of the company’s intellectual property is mind-blowing. VirnetX truly is a multi-billion dollar company.
What is most remarkable and telling is that the 3GPP was unable to develop a workaround to VirnetX’s IP. This demonstrates how innovative and foundational the patents really are. In fact, VirnetX may be the only company to declare intellectual property rights for the Series 33 security specifications, one of the most important and integral parts of 4G networks.
Most understand the main difference between 3G and 4G to be speed. But one of the most central changes is in the way that voice and data are transferred. 3G technology was designed for voice first and data second and thus largely utilized circuit switching. In 4G, however, all data and voice will be packet switched. VirnetX’s patents provide ways to secure these packets. In fact, the patents supply the only technical way to secure communication over 4G LTE networks per the Series 33 specifications. VirnetX’s IP was important to securing networks in the past, but it is now essential to implement the future of communication.
Spearheading the licensing effort for the company is law firm Wilson Sonsini Goodrich & Rosati (WSGR). WSGR is well known for advising Google (GOOG) in its initial $2.7 billion IPO and 3Com’s (COMS) $3.3 billion sale to HP (HPQ). The elite law firm is unquestionably the most sought after in Silicon Valley. Being approached by WSGR speaks volumes to the potential of VirnetX’s intellectual property. The company is now equipped with the best and the brightest to optimize and execute its IP licensing strategy.
In addition to this, its world-class scientists and engineers, whose talents were formerly used in national defense security, continue to extend and build on VirnetX’s inventions. The company continues to bolster its IP arsenal as more patents move through the late stages of the patent office's approval process. At least two of these appear to be blockbusters. These patents are even broader, deeper, and clearer than some of the company’s existing IP. They have also been intensely examined and wholeheartedly endorsed by the patent office. They will likely have a major impact, on multiple fronts, on an already groundbreaking patent portfolio in the coming months.
Much focus has been placed on VirnetX’s $200 million settlement with Microsoft (MSFT) and the current litigation against Apple (AAPL) and Cisco (CSCO). Indeed, these are very valuable aspects of the company. The current defendants likely owe VirnetX nearly $1 billion for almost $100 billion worth of infringing products.
But the true value of VirnetX has yet to reveal itself. Investors need to understand that VirnetX’s IP is being laid as the foundation of 4G security. The world is just now beginning to demand the secure communications that VirnetX’s engineers developed years ago. Hundreds of companies will need to take a license. The company finds its inventions at the heart of the future of secure communication.
The real value of VirnetX lies here, and it is worth billions.
Thank you to David Hoff for his research and contributions.
Disclosure: I am long VHC.