Vringo Stock Doubles On Patent Potential

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 |  About: Vringo, Inc. (VRNG), Includes: AOL, GCI, GOOG, IAC, RPXC, TGT
by: SoundView Technology Group

We've known and fol­lowed some of the goings on at Vringo (VRNG) since late 2009 when we got inter­ested in its video ring­tones busi­ness as a poten­tial avenue for auto­mat­i­cally gen­er­ated 3D pic­tures. The idea may have been far out but we liked what it was doing with more dynamic and richer con­tent deliv­ery in the mobile space.

In 2011 it added some Face­book (NASDAQ:FB) siz­zle to its solid carrier-based story and we wrote up a short overview, Con­nected Con­sumer: Vringo, pub­lished on Seek­ing Alpha.

Yes­ter­day the shares jumped 100% on an arti­cle posted by the pro­lific James Altucher on another site. James is a smart, witty and widely fol­lowed writer who also hap­pens to be an investor. We're not going to repeat it all here so it's worth going back there and read­ing the whole thing. Of course his "Google (GOOG) going to zero" linkbait was a cheap stunt.

Judg­ing by the stock action through­out the day it would seem that his analy­sis is not eas­ily dis­missed. It has also stirred up swirls of con­tro­versy not just in terms of the com­pany itself but the evils and virtues of click bait, U.S. Patent law, research and writ­ing with "con­flicts" of interest.

Rather than get all philo­soph­i­cal on these points let's look at what this is all about from the stand­point of a Vringo investor or poten­tial investor:

On March 12 Vringo agreed to merge with Innovate/Protect (IPC), a com­pany that holds eight long-standing search patents orig­i­nally granted to Lycos. In exchange Vringo is giv­ing a large por­tion of the sur­viv­ing entity to the own­ers of IPC. As noted in the March 30 10-K fil­ing the own­ers of IPC will own 67.55% of the new com­pany on a fully diluted basis.

IPC already has been work­ing the legal ropes against some large poten­tial infringers and it's not just Google; AOL (AOL) , IAC/InteractiveCorp (IACI), Gan­nett (GCI) and Tar­get (TGT) are all named. The core of the patent case is about tech­niques that improve the rel­e­vance of returned search results and related advertisements.

Even though all the recent atten­tion is focused on the poten­tial of the IPC law­suits the video ring­tone and "Face­tone" busi­ness is an impor­tant asset and one that we will come back to in the con­text of the IPC patents. Rev­enue is very lim­ited but the avail­abil­ity via car­ri­ers and on mobile devices could be impor­tant depend­ing on the strat­egy of the com­bined company.

As a purely prac­ti­cal mat­ter the patent busi­ness has become one that looks more like risk man­age­ment than real inno­va­tion, debate and the rule of law. There are a num­ber of pub­lic com­pa­nies now in this space and they are not all "patent trolls." One of them, RPX Corporaiton $RPXC- $16.47, $807M cap, pro­vides this ser­vice to dozens of large com­pa­nies. Soft­ware patents are the most noto­ri­ous to adjudicate.

If we are play­ing a risk man­age­ment game then the con­ven­tional wis­dom is that your most likely out­come is a set­tle­ment that con­sists of a 1% to 4% roy­alty. Altucher's arti­cle (published on TechCrunch) goes fur­ther than it should in terms of talk­ing about "will­ful" vio­la­tions and tre­ble dam­ages. Even as a pub­lic com­pany, some money in the bank and a very strong case I wouldn't want to draw the atten­tion of the entire Google legal team in a fight to the death.

Turn­ing to the num­bers we're going to use a 1% roy­alty rate because it's low enough to imag­ine that Google might agree to it ver­sus a lengthy court process. The vast major­ity of Google's rev­enue is from this form of adver­tis­ing and the rest is a round­ing error. Google has posted about $150B in rev­enue so far and is esti­mated to do $46B this year. It's easy to do the math here - that's a $1.5B set­tle­ment for past use and a $460M roy­alty pay­ment this year. No doubt Google has the best under­stand­ing of the real risk in this case and has a strong nego­ti­at­ing team.

If this case were not against Google these num­bers would be hard to believe but Google has $37B on the bal­ance sheet and is expected to gen­er­ate $19B of EBITDA this year and $23B in EBITDA in 2013. So for Google the sums being dis­cussed cause lit­tle dis­com­fort. At the same time that means it's going to be hard to scare the company. For exam­ple if this went the dis­tance and Vringo won and pro­vided will­ful infringe­ment with a 4% roy­alty the fig­ures would be $18B for his­tor­i­cal vio­la­tions and $2B a year in roy­alty pay­ments. Those num­bers are huge but they would not in fact break Google. I wouldn't want to play "chicken" with the company.

At this point it's worth remind­ing every­one that out­comes in these venues are not the domain of tech­nol­ogy or finan­cial ana­lysts. Even lawyers get sur­prised. Delays are com­mon and as investors flock to VRNG stock expect­ing quick results might leave just as quickly if results are delayed.

In terms of the stock there are quite a few new shares and out­stand­ing war­rants to fac­tor in. Some new pre­ferred has been issued, which is equiv­a­lent to about 21M shares of com­mon. Plus about 16M war­rants struck at $1.76. There are a few addi­tional shares and war­rants (250K and 850K respec­tively) used to absorb the old war­rants of IPC. Ear­lier the com­pany raised $3.6M through an exer­cise of out­stand­ing war­rants and granted an addi­tional 2.5M in the process.

We're going to use a back-of-the-envelope to esti­mate share count since it is a mov­ing tar­get. Google lists 10M shares out, S&P Cap­i­tal IQ lists 14M and our quick math sug­gests about $57M fully diluted shares for a mar­ket cap of $170M at $3/share.

Could there be a Plan B?

What if Google dis­ap­peared and the entire law­suit couldn't pro­ceed? That brings us back to the core busi­ness that existed prior to the merger with IPC. It is after all a mobile busi­ness with social con­text. And we know that dynamic rich con­tent and increased rel­e­vance are big growth areas. Vringo does have some inter­est­ing oppor­tu­ni­ties to develop its busi­ness in and around these markets.

For instance we just wrote some­thing about a pri­vate com­pany called Kovio that will bring item level intel­li­gence to all mobile devices with NFC. This is going to open up myr­iad oppor­tu­ni­ties and Vringo could use its com­bi­na­tion of assets to great effect there. It might not be a patent story per se but the patent port­fo­lio could assist with the adop­tion of Vringo mobile/social plat­form prod­ucts for advertisers.

Conclusion

Investors need to take care on this one. We've noted that the stock action has attracted attention from a variety of sources including some known promoters like Ray Dirks. In the old days we used to refer to these as "cloak and dagger names" because major movements tend to happen in any direction for reasons beyond fundamental analysis.

The fact is we liked the old Vringo business and see serious potential in it. This IP situation has created a whole different facet of the story that is exciting but hard to estimate in terms of magnitude and timing.

Disclosure: I am long VRNG.