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Qualcomm (NASDAQ:QCOM) has long been envied for its stable of wireless patents that allow it to essentially just sit and collect license or royalty fees. That model is tough to beat - while there is expense in establishing and defending the patents, there is little to no overhead, capital or risk once agreements are in place with end users. From that point forward, QCOM essentially is a toll booth keeper for the wireless telecom companies, nearly all of whom must pass over their bridge. These “tolls” translated to $636 million in EBITDA for QCOM in the quarter ended March 31.

In the online search market, there may be a company that is now positioned to profit handsomely from a similar model. With very little fanfare, micro cap search upstart announced this week that the US Patent and Trademark office has granted patent #7,231,405 for the process of indexing and retrieving web-related information by geographical location. That the news was not on the front page of the Wall Street Journal is not all that surprising, very few happenings related to companies with such a small market cap get the attention of Wall Street commentators or analysts. However, I think the situation at bears watching and could turn into a very interesting story.

The patent covers local search technology related to identifying location information from web documents, indexing that information and making it searchable geographically. That is a very broad patent that seems to encompass what the major players in search are already doing with their local search applications. This seemingly opens the door to a tremendous opportunity for The breadth of this patent is pretty striking in that it seems to covers much of what Google, Yahoo, AskCity, Verizon, Infospace etc. already do. Though I recognize that QCOM is in a completely different sector with different economics, I thought the similarities in the breadth of their patents in the context of the wireless industry made a good analogy with the untested but seemingly very broad reach of LOCM’s patent when viewed in the context of local search. The other big patent dispute in the search arena would have been an interesting case study, but it never made it to trial. (later changed to Overture, then Yahoo Search Marketing) invented the pay per click business and patented many aspects required to execute the model. When Google came along (also Findwhat/Miva and others) and developed a better mousetrap that built on some of Overture’s patents, they wisely agreed to settle the matter out of court in recognition it would be very difficult to prevail in the lawsuit filed against them by Overture’s new parent company (Yahoo). Rather than fight a losing cause vs. a competitor with very deep pockets, Google paid Yahoo a settlement fee in the $300 million range. Miva/, who was only marginally profitable with the pay per click model, took a similar tack in settling for $8 million plus undisclosed license fees going forward.

While neither QCOM nor the Overture scenario are precisely on point, both give good insight into what we may see happen with LOCM. While the local search industry is in its infancy and is not monetized to the degree we see in the wireless sector, the QCOM situation gives an idea of what kind of revenue can be earned when a company owns patents broad enough to touch just about anything done to monetize that space. The Overture scenario is closer to the heart of the matter in that it deals with search, but I would submit to you that LOCM could be in for much higher compensation than Overture received. First of all, Google had just turned the corner on profitability when it settled. It was pre IPO and Google had all the promise in the world, but nothing like the $12 billion cash hoard of today, not to mention its gargantuan $165 billion market cap. Further, the monetization of search was in its early stages and $300 million seemed like a very large amount at that time. Keep in mind that this was before Google had shown the world how much could be made from search. The investment we have seen from the big players in search since that time and particularly in local search suggests that all appreciate its potential. Thus, it is conceivable that all of the big players would be willing to pay to play if required to do so. If that happens, they all have a lot more to play with now.

The timing of this patent grant is interesting, as a suit alleging that Verizon has infringed on another very broad search patent has just been allowed to proceed to the discovery phase in US District Court in Texas. The owner of the patent, the UK based Geomas, is apparently seeking to establish its right to receive licensing fees from all the major players in search.

Sources have indicated that Geomas may find this to be a fairly tough battle due to the fact that its patent application was filed in the mid 90’s before internet search was as common as it is today. In fact, many of the biggest players in search today cite the Geomas owned patent as prior art in their own filings. Further, defendants in the Geomas suit can take the position that Geomas has never developed a working technology based on this patent, as they are primarily an entity that owns intellectual property and they have little in the way of actual operations. Should LOCM decide to follow in the steps of Geomas and go the litigation route, they have a much better set of facts. The timing (this week) of the patent grant and the elaborate technology platform already in use will diffuse any defendant’s attempt to use the two most promising defenses Verizon will have to the Geomas claims.

A key question is whether LOCM can afford to take on some of the industry’s deepest pockets. LOCM does have a pretty stellar balance sheet for such a small company. It is very rare for a company with a $35 million market cap to have $10 million + in the bank, but LOCM does. With only a very small debt load that leaves its net cash approaching $9 million, it does appear that LOCM could go that route, possibly long enough to extract a significant enough sized settlement that could allow them more resources for litigation against the others. The better question is whether that is the best route to take, as LOCM shareholders might not be patient enough for that approach. Considering the recent flurry of deals among the search elite, they may not have to. As we see more and more deals with ever higher price tags, it would come as no surprise if Google, Yahoo or MSN ponied up to buy LOCM.

With the potential for the local search pie to exceed $10 billion in a few years by many industry watcher‘s estimates, why would Google or Yahoo sign up to pay $10 - $20 million or so per year or pay royalty fees per transaction that could push it to three or four times that level when they might be able to buy the company outright for $100 million or so? With LOCM’s current cash adjusted market cap around $25 million, who is to say that they couldn’t pick it up even cheaper - maybe for what could ultimately amount to a couple of years worth of royalty fees? That case is quite compelling when you consider that not only would they be avoiding the royalty fees for years to come, but they can then determine what their competitors will pay as royalty fees.

The type of one-upmanship we have seen with other recent acquisitions by the big search players’ (i.e. Google/Doubleclick, Microsoft/Aquantive) recent takeovers suggests to me that a bidding war for LOCM could even materialize. If Microsoft were willing to pay $6 Billion to purchase Aquantive just a few weeks after Google outbid them for DoubleClick - what would either of them pay to own a local search patent that could be used to extract payments of $100 million or more per year from the others? According to various industry sources, the market for online ad spending for local search placements is expected to rise to between $10 - $13 billion annually by 2010.

At last count, Google and Yahoo each command about one third of this market, with MSN , AOL, and several yellow page providers taking most of the remaining third. Using the conservative end of those estimates with a total market spend of $10 billion - If Google still controls 1/3 of that market, that would make their annual take about $3.3 billion. What kind of license fee would Google be willing to pay if they were threatened with an injunction that could all but shut down a $3.3 billion revenue per year enterprise? $300 million like they paid Overture? Maybe or maybe not. To spread the risk, suppose instead that they just paid LOCM per transaction (click), some nominal fee like 2% of the revenue. In such a scenario, LOCM would be earning $66 million per year in license fees from Google, with similar arrangements with the other big players in the local search space. Even at just 1% of Google’s estimated local search revenue - that would be around $33 million per year, or about 30% higher than the total existing cash/debt adjusted market cap for LOCM. It is the juxtaposition of that kind of fee revenue vs. the current market cap that requires some serious attention.

So how will this play out? Will LOCM get $10 - $20 million per quarter from each of the search players? Will they get 2-5% of local click revenue from each, possibly resulting in even higher quarterly fee revenue? Or will they sell out for $100 - $150 million and let a bigger player with more resources work this patent for even bigger license fees?

Hard to say at this stage, but one thing is certain - existing shareholders who bought the stock near its current range will likely be very pleased with where this story is headed. While LOCM may never receive the $2 billion + per year that QCOM receives in royalty payments, the prospect of earning even $100 million in royalties per year looks pretty good when you have a total market cap of less than half that.

Disclosure: Author is long LOCM

Source: Could Become the Local Search Industry's Qualcomm?