A Tale Of 2 Quarters - Acacia Research Illustrates Patent Play Volatility

| About: Acacia Research (ACTG)

Acacia (ACTG) reported its second quarter earnings on July 30, 2012. By noon the following day, Acacia's shares were down 14% before closing $28.27--a 10% decrease from the previous day. The patent-licensing specialist reported more than $50 M in quarterly revenue, representing a 27% increase over the same period last year but only half as much as Acacia's $99 M 2012 Q1. Acacia generated revenue from 38 new license agreements, representing 27 different licensing programs.

Raw numbers reported by the company suggest a per-agreement average of $1.3 M. On the surface, Acacia's performance looks to be only slightly below average. Consider that, during 2012 Q1, Acacia earned revenue from 40 new license agreements representing 32 different licensing programs. As of March 31, 2012, trailing twelve-month revenues totaled more than $220 MM on the strength of 130 license agreements, for an average of $1.7 MM per license. (For an analysis of Acacia's 2012 Q1 earnings, see Acacia CEO Credits Patent Reform As A "Major Trend" While Announcing Its Biggest Quarter Ever)

Behind the raw numbers, however, Acacia demonstrates a multi-tiered patent licensing approach with a small number of high-value, "blue chip" patent portfolios, surrounded by broad swath of low-end patents. What's more, Acacia demonstrates a key operational failure--lack of execution on the low side--that could threaten the company's stability and long-term growth.

Acacia reports a concentration of 72% of Q2 revenue attributable to a single licensee, leaving only $14 M distributed among a remaining 37 agreements. In other words, outside of this one agreement, Acacia generated an average of less than $380,000 per license. Even worse, a full 85% of the Q1 and Q2 combined revenue is attributed to just four licensees. Thus, of the $149 MM earned by Acacia in 2012, only 15% (or $22 M) worth of revenue can be attributed to 95% (or 74) of its license agreements. Therefore, outside of four major deals (representing 5% of its business in the first half of the year), Acacia generated an average of less than $300,000 per agreement.

Within patent circles, observers and practitioners commonly accept, as fact, that really valuable patents are few and far between. Thus, the fact that Acacia's patent revenue includes a large proportion of low-value license agreements hardly comes as a surprise to most. However, a patent-licensing specialist privately observed in a conversation that $14 million of revenue from a diversified portfolio should be unacceptable in any quarter for a company with Acacia's resources. Stated another way, if license agreements are analogous to sales, Acacia spent 95% of its resources to generate less than 15% of its income.

Top Acacia executives likely focused more of their time on the 5% of deals responsible for the other 85% of revenue. However, for the other rank-and-file human resources, there is surprising little difference between the amount of time required for low value deals versus high value deals. Obviously, management tends to put greater emphasis on the portfolios expected to generate the largest returns. However, the minimum threshold of work required in general makes time spent on low-value licenses extremely costly overall.

With an extremely small percentage of high-value deals driving Acacia's recent revenue growth, volatility can be expected to rear its ugly head sometime soon. When the high seven and eight figure licensing deals fade away, which they inevitably do from time-to-time, how will investors react to the remaining table scraps.

To maintain growth and stability as the company's resources expand, Acacia needs to either learn to turn over licenses in the $500,000 to $2 million range at a very quick pace, or hire someone who can.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.