I believe that two recent Supreme Court decisions have made the patent licensing business model considerably more risky. As a result, all of the following companies are less attractive investments:
ARM Holdings (ARMHY)
Acacia Technology (NASDAQ:ACTG)
Forgent Networks (FORG)
Neomagic Corp. (OTCPK:NMGC)
Patriot Scientific (OTCQB:PTSC)
Star Scientific (STSI)
...and many others
Last year, in MercExchange v. Ebay (NASDAQ:EBAY), the Supreme Court vacated a long-standing presumption that courts should issue permanent injunctions to stop patent infringement. The High Court ruled that a fair royalty could suffice, especially where the plaintiff is not currently practicing the invention. In a concurring opinion, Justice Kennedy (joined by Justices Stevens, Souter, and Breyer) took direct aim at patent licensing companies:
In cases now arising trial courts should bear in mind that in many instances the nature of the patent being enforced and the economic function of the patent holder present considerations quite unlike earlier cases. An industry has developed in which firms use patents not as a basis for producing and selling goods but, instead, primarily for obtaining licensing fees. ... For these firms, an injunction, and the potentially serious sanctions arising from its violation, can be employed as a bargaining tool to charge exorbitant fees to companies that seek to buy licenses to practice the patent. ... When the patented invention is but a small component of the product the companies seek to produce and the threat of an injunction is employed simply for undue leverage in negotiations, legal damages may well be sufficient to compensate for the infringement and an injunction may not serve the public interest.
Tuesday's decision, KSR v. Teleflex (NYSE:TFX), may be even more significant. In that decision, the Supreme Court made it significantly easier for patents to be attacked on the ground that they were "obvious" in light of prior art. In SCOTUSblog, Michael Barclay of Silicon Valley law firm Wilson Sonsini explained:
This decision makes it far easier to invalidate patents based on obviousness. Thus, this is the most important patent case of the last 20 years, and perhaps since the passage of the 1952 Patent Act. Virtually every litigated patent case includes an assertion of obviousness – and ones that might not have included that defense up until now are more likely to do so. The PTO examines every patent application for obviousness. [The case] will thus have an enormous impact on both the prosecution and litigation aspects of patent practice.
DISCLOSURE: I have no position in any of the companies mentioned here. Not a recommendation to buy or sell any security. For informational and educational purposes only.