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Over the past few months, I've detailed the transition at Internet Patents Corporation (PTNT), formerly known as InsWeb (trading under ticker symbol INSW). In October, InsWeb sold essentially its entire business to Bankrate (RATE) for $65 million in cash and announced its plans to become a patent licensing company under its new name. Given that the company's market capitalization at the time was just $41 million, the cash infusion drove the stock sharply higher; it rose 42% in the next two trading sessions.

In January, the company announced a $5 per share special dividend, which was paid in March. Following the divestiture, PTNT had over $4 per share in net cash, and traded around $3.20 per share, before a sharp climb starting in May brought PTNT over $4. The stock has weakened since then, and a 6% drop on Monday brought it down to a close of $3.75.

On Friday, the company took its first official step in protecting its patent portfolio by filing a lawsuit against privately held eBags and its partner TellApart, alleging infringement of U.S. Patent 6,898,597. (The 8-K lists the patent as number 6,898,587, but this appears to be an error.) The '597 patent covers so-called "event logs," which record "website usage events having some business significance," according to the patent description.

PTNT's Form 8-K was silent on the specifics of the suit, such as why eBags and TellApart (which tailors display ads to users who have visited and left retail sites such as eBags) were the initial targets, what damages might be expected, and whether a negotiated settlement is possible.

Indeed, most of Internet Patents' strategy remains relatively murky. As our own Patrick Anderson noted last week, of IPC's six patents only two -- '597 and 7,707,505 -- appear to have any application outside the insurance industry. ('505 covers "dynamic tabs for a graphical user interface" for e-commerce websites.) As such, IPC's would appear to have a wide variety of potential targets for litigation.

That said, it's unlikely that the $35 million company with no litigation experience would take on giants like Amazon.com (AMZN), eBay (EBAY), and the like. The strategy may be to test the patents' power in smaller cases against less-dominant targets, before moving on to more difficult -- but potentially more lucrative -- violators.

That, of course, is just speculation, as is much talk about IPC's future. What is known, as the dust has settled following the asset sale and special dividend, is that the company has $4.44 per share in net cash, according to the most recent 10-Q. Net cash of $34.5 million (including $1.0 million in restricted cash) exceeds PTNT's market capitalization by $5.4 million. CEO Hussein Enan told investors in May that the quarterly operating expense run rate would be about $0.6-$0.7 million, excluding legal fees; in the 10-Q, the company noted that it expected to be unprofitable in 2012.

Given the glacial pace of patent legislation, investors should figure that IPC will burn a fair amount of cash before monetizing its patents. The annual run rate of about $2.5 million in operating expenses should be accompanied by substantial legal expense as well; if IPC is unable to settle with eBags and TellApart, creating a precedent for negotiations with additional targets, it seems likely that the company will create literally zero revenue in 2012, while burning at least $3 million over the year's last three quarters. By 2013, it seems likely that net cash at the company will be approaching the current share price of $3.75, eliminating the current discount on its assets.

On the other hand, investors can be heartened by the fact that CEO Enan owns 25% of outstanding shares, and is taking a salary of $12 (yes, twelve dollars) in 2012, while also picking up CFO duties. Enan's share of the company's net cash balance is about $7.8 million, giving the CEO strong incentive to focus on his role as a shareholder first. Unlike with many cash-rich companies -- where investors must worry about management's intentions to keep their jobs or splurge on overpriced or unnecessary acquisitions -- investors in PTNT should have full confidence that their interests will be aligned with those of management. Those interests may include another special dividend; Enan noted in the Q1 press release that the company will consider another distribution in the first quarter of 2013, once it has more information about the potential success of its new strategy.

PTNT also has a substantial amount of net operating loss carryforwards (known as NOLs): $139 million in federal NOLs, with an additional $83.5 million in state NOLs. (The state of California has temporarily suspended the use of NOLs, and plans to institute deductions. Federal NOLs are subject to Rule 382, limiting their value to an acquirer.) That, and its small portfolio, may make an acquisition of interest to other patent-licensing companies such as Vringo (VRNG).

Again, with Internet Patents, the future is mostly conjecture; even its management can have little confidence in estimating its success in a new field that requires extensive time and capital spent in litigation. Granted, given the $5 million of cash beyond its market cap, and the shareholder-aligned management, the downside seems limited. CEO Enan seems unlikely to waste millions in cash -- a quarter of which is his -- should the litigation strategy fail.

But the upside seems limited as well. IPC's e-commerce patents seem hardly essential to most businesses; targets can choose either to work around the patents or simply wait IPC out, knowing that the micro-cap company may not have the patience or the stomach for protracted, multiyear legislation. The nature of IPC's patents also means the possibility of a massive success -- such as a series of multimillion-dollar judgments in the company's favor -- seems remote. If the company sees some success in the litigation arena, it will provide solid returns to its shareholders; if not, it will likely distribute its cash or sell itself for a marginal premium, allowing the acquirer to use its NOLs and PTNT shareholders to move on to a better opportunity.

Given the modest upside, PTNT seems fairly valued at its current levels. Should it move lower -- perhaps back toward $3 per share, where the cash cushion would move toward the $10 million mark, and a 2013 special dividend could provide a more significant return of capital -- PTNT would be an interesting speculative play. Right now, it seems like a good investment -- but hardly a great one.

Source: Internet Patents Begins A New Phase