Time To Buy VirnetX

| About: VirnetX Holding (VHC)

Summary

Case concerns whether Apple infringes VirnetX patents.

The patents Apple infringes are not invalid, not eligible for appeal.

The CAFC has provided guidance as to an acceptable damages approach.

Virnetx In a jury trial, VirnetX (NYSEMKT:VHC) won an infringement verdict against Apple (NASDAQ:AAPL) that judged Apple's VPN on Demand (VPNoD) infringed VHC patents. The validity of the four patents that were asserted against Apple also were found to be not invalid. The jury further awarded damages to VHC for the infringement of those patents. Apple appealed the verdict to the US Court of Appeals for the Federal Circuit (CAFC). The CAFC affirmed that the patents litigated were not invalid and also affirmed that Apple infringed two of those patents with their VPNoD feature. The CAFC remanded the damage award to the district court because they disapproved of the damage award argument presented at the original trial. In the CAFC ruling, the CAFC presented a method to calculate the damage award that it considered valid. The CAFC ruling is available here. Apple did not appeal the CAFC ruling to the Supreme Court so the validity of the VHC patents and the infringement of the VHC patents by Apple apparently cannot be further challenged. While other matters are being litigated in the upcoming trial, what cannot be changed is Apple does infringe and the four patents litigated in the previous trial cannot be challenged as invalid. Apple will apparently have to pay damages - this is a given.

What did the CAFC say about the damages portion of the verdict? While it's clear that several of the approaches to damage determination and royalty cost presented at the trial have fallen out of favor with the CAFC, the following is what the CAFC said about an acceptable damage determination approach (from the CAFC ruling):

"With those principles in mind, we conclude that the district court here did not abuse its discretion in permitting Weinstein to rely on the six challenged licenses. To begin with, four of those licenses did indeed relate to the actual patents-in-suit, while the others were drawn to related technology. Moreover, all of the other differences that Apple complains of were presented to the jury, allowing the jury to fully evaluate the relevance of the licenses. See J.A. 1600, 1650, 1678-82. No more is required in these circumstances."

The six licenses that are referred to above have an average royalty rate of 1.52%. VirnetX can put forth those licenses as a basis for Apple's royalty rate and it's up to Apple to argue why their rate should be less. VirnetX's published royalty rate also is between l% and 2%. The initial jury awarded VirnetX 1/2% ($368m), far below the rate of the other licenses. These licenses also are based on the price of the whole product.

In the first trial, Apple's damages expert Christopher Velturro indicated that if Apple did infringe VHC'S patents, the damages should be only $9m. Technical Expert Dr John Kelly stated under oath that 100% of calls could be made by simply using non infringing alternatives. Both of these statements will come back to haunt Apple in the next trial.

In an attempt to workaround VHC's licenses, Apple contracted with Akamai for servers to act as relay servers for FaceTime. This approach is not covered by VHC's patents. Over the six weeks that this approach was tried, Apple received over 500,000 customer complaints and had to resort to their previous, infringing implementation. Because of the uproar from enterprise customers Apple decided not to implement the same fix for VPNoD. In a hearing to determine the ongoing royalty rate to be paid by Apple to VHC, VHC was awarded an almost 1% royalty. Because of the CAFC remand of the damages, this royalty never started. In the coming trial, the discovery of Apple's work around, its cost and its failure to provide an acceptable solution should convince the jury of the value of VHC's patents. As this trial covers damages for a longer period of time and a wider range of products, the jury could award in excess of $1b. If the jury awarded only 1% rather than the average 1.52% that the comparable license VHC's stock price would skyrocket. Additionally, this time the jury will be deciding whether iMessage and FaceTime also are infringing VHC's patents. This could cause the jury to find for an even higher award.

After the first trial, VHC asked for an injunction on the infringing features of Apple's products. It was not granted because it would impact the customers as no replacement for the infringing features was available. That has changed with VHC's introduction of Gabriel, VHC's software package that replaces the functionality of the infringing features of Apple's products. As customers would no longer be impacted, there is a much higher probability of a injunction after the upcoming trial. The trial begins on January 25th.

As a damage award in excess of the award ($368m) in the first trial is virtually guaranteed, an investment in VHC at this time could result in a significant upside in VHC's stock value. As the trial approaches, I expect to see a significant increase in volume and price. With over 12 million shares shorted, a short squeeze also is a possibility.

Disclosure: I am/we are long VHC.

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.