Vringo: How Mark Cuban's Large Patent Hedge Bet Could Make A Bundle

| About: FORM Holdings (FH)

I rarely write about companies not related to the pharmaceutical industry these days but couldn't ignore the events surrounding a company I am writing about here. In April of this year Mark Cuban, well known entrepreneur and owner of the 2011 NBA champion Dallas Mavericks, made a significant investment of 7.4% in the company featured in this article named Vringo (VRNG). Mark Cuban has always been someone I admire in business which led me to start following this company. At first, I found his investment really interesting after recalling an interview with him about one year ago that was a foreshadowing to this transaction. I would encourage people to watch this interview that includes the always "frank" Mavericks owner referring to the buy and hold strategy as "a crock of (expletive)." Another comment that I enjoyed is, "Diversification is for idiots." However to his credit, he did clarify that his view in this matter is dependent on specific situations and goals of each individual investor.

Cuban goes on to comment how patent trolls are killing business and refers to the huge impact they have had on his businesses. Because of his negative comments regarding the practice of suing companies over patents, it struck me as odd that Cuban would buy a hefty stake in a company that is doing just that. However, it is obvious that although he isn't a fan of the way patents are handled in the U.S., he is savvy enough to know they can be worth billions of dollars.

In March, Vringo agreed to an all-stock merger with intellectual property firm Innovate/Protect Inc., a company founded in 2011 that holds eight patents related to relevance filtering technology acquired from Lycos Inc.

Fast forwarding to June, Vringo obtained a favorable Markman ruling regarding their highly publicized lawsuit filed against Google Inc. (NASDAQ:GOOG), AOL Inc. (NYSE:AOL), and several other internet companies. Last week, this critical ruling was upheld by the judge with a slight tweaking of the definition of one of the technical terms discussed in the June ruling. The reason why this is an important ruling from what I've studied is that it predominantly leads to a settlement favoring the same party having the upper hand in the Markman ruling -- in this case Vringo.

It makes sense for Cuban to invest in a company such as Vringo. Cuban has stated that he's on the "flip side" of himself since he is effectively "long" several companies related to intellectual rights. Cuban’s investment here seems to suggest his position is an insurance hedge.

Cuban offered the following explanation related to his Vringo investment:

This is a hedge against the unlimited patent exposure all the companies I have investments in face. Patent risk is impossible to quantify. It's unrealistic for most small to medium businesses to have any clue which patents they are at risk over. Vringo's IP from the merger is the flip side of that risk and offers an imperfect hedge. So, I made the investment.

At risk for Google specifically is a portion of the $67 billion in ad revenue they have hauled in over the past decade in the United States. However, Vringo would only have the possibility of receiving a judgment on revenue brought in six years prior to the filing of the complaint. So, according to a recent presentation Vringo made, the date of the complaint minus six years is September 15th, 2005. Also highlighted in this presentation was the equation for determining the award amount in a lawsuit such as the following:

The infringer's sales of the infringing product


A reasonable royalty rate



One previous instance that comes to mind involving a smaller company going after a giant was in 2010 when VirnetX Holding Corp (NYSEMKT:VHC) sued Microsoft (NASDAQ:MSFT). At the time, VirnetX alleged Microsoft used its patented technology for secure virtual private networks (VPNs) in Windows XP, Windows Vista, Windows Server 2003, Windows Messenger, Live Communication Server, Microsoft Office Communicator and Microsoft Office. With the presiding judge in the federal case seemingly siding towards VirnetX, on May 17, 2010 Microsoft settled the case. The only terms made public were that Microsoft acquired unknown licensing to certain VirnetX patents, also making a one-time payment of $200 million to the company.

From the beginning of 2010 to July 4, 2011, VirnetX stock rose from around $3/share to over $38/share.

Another example was when Research in Motion (RIMM) settled a lawsuit in 2006 by paying over $600 million to NTP, Inc., a Virginia-based patent holding company. This patent was based on the Blackberry phone, which had huge sales during the lawsuit time period. This was a long running dispute that had threatened to shut down the then-popular wireless e-mail service for its 3 million users.

Research in Motion continues to see a declining business model and stock price, but recently received a small reprieve in a separate case against it on Aug 9th, when a U.S. judge overturned a $147.2 million jury award against the company, ruling that the BlackBerry maker did not infringe a Mformation Technologies Inc patent covering a remote management system for wireless devices.

One person extremely bullish on Vringo stock is a writer named James Altucher. On March 31st of this year, James was partially responsible for the buzz surrounding Vringo after writing an article for techcrunch.com titled, "Why Google Might Be Going to $0."

An interesting excerpt from this piece is:

Think: NTP suing RIMM on patents. NTP had nothing going on other than the patents. Like Vringo/Innovate. NTP won over $600 million from RIMM once Research in Motion realized this is a serious issue and not one they can just chalk up to a bad nightmare.

Guess who NTP's lawyer was? Donald Stout. Guess who Vringo's patent lawyer is? Donald Stout. Why is Donald Stout so good? He was an examiner at the US Patent Office. He knows patents. They announced all of this but nobody reads announcements of a small public company like Vringo. It's hard enough figuring out how many pixels are on the screen of Apple's amazing iPad 3.

Well, Google must have a defense? Even though their AdWords results are sorted by click-throughs in the way described by the patent maybe they sorted in a different way (a "work-around" of the patent), and didn't infringe on the patent.

Maybe: But look at Google economist Hal Varian describing their algorithm right here in this video. And compare with the patent claim filed in court by Vringo. You decide. But it looks like the exact same to me.

Maybe: But does Google want to risk losing ten billion dollars plus having all of their customers sued. The district the case is getting tried in rules 70% in favor of the plaintiff in patent cases. Most patent trials get settled on the court steps.

After doing the due diligence, it seems to me that a large settlement is the likely outcome before the October 16th scheduled trial date for this case -- when giving full consideration to the Markman ruling recently being upheld.

If this happens, the amount of the settlement and how the stock reacts will be interesting to see, especially because of the fact Vringo has a small market cap, coming in at $189M.

It's my opinion that the stock should really fly high on this type of news. Just how high Vringo's stock price will go remains to be seen -- stay tuned!

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

Additional disclosure: Family member is long VRNG. Disclaimer: This article is intended for informational and entertainment use only, and should not be construed as professional investment advice. They are my opinions only. Trading stocks is risky -- always be sure to know and understand your risk tolerance. You can incur substantial financial losses in any trade or investment. Always do your own due diligence before buying and selling any stock, and/or consult with a licensed financial adviser.