Vringo's Mission: Take On The Patent Bullies

| About: FORM Holdings (FH)

Following recent coverage of Vringo's (VRNG) entry and subsequent expansion into the patent monetization space, I caught up with Vringo COO Alex Berger and Executive VP Cliff Weinstein to chat about the company's mission, including the resources and relationships the plan to use to monetize IP acquired from Lycos and Nokia (NYSE:NOK). During a private telephone conversation, Berger and Weinstein revealed a lot of information that is simultaneously being shared with analysts, reporters and institutional investors about the purpose behind Vringo and how it intends to build its business going forward.

"We don't want to be the bully," says Berger right off the bat. Rather, Berger sees Vringo's role as taking on corporate bullies who tend to trample intellectual property rights with reckless abandon. Berger distinguishes Vringo from other companies that spend their time "shaking down small companies" despite the fact that the latter receives more attention from popular media. Vringo's recent purchase of Nokia patents expands that mission beyond the Google-dominated search advertising space.

"We really have one big shot on goal with this case against Google (NASDAQ:GOOG)," plus any follow on with the rest of much smaller fish in the search-advertising business according to Berger. To expand and grow the business, "We started looking at acquisitions," says Berger. Through a mutual friend, Berger reached out and convinced David Cohen to come aboard at Vringo. The team immediately began scouting the Nokia portfolio. Following weeks of research and technical diligence, Berger explains, "We decided that we would grow the company with an overnight offering of stock to a tight group of investors to buy this portfolio."

Weinstein summarizes the technology acquired from Nokia, saying "This is a portfolio that, conceptually, comes from the late 90's and early 2000's when Nokia was at the forefront of innovation in building the backbone to these wireless networks." Rather than having a handset focus (which I originally, and mistakenly, posited), the portfolio acquired from Nokia relates to equipment behind the scenes that makes those handsets work. Of course, completing a mobile phone call is far from black magic. Weinstein explains,

What people don't realize is the large infrastructure behind the handsets that makes them operate. We just expect ... when you pick up your cell phone when I call you or you call me, that it just rings on the other line and we pick up, but there are a lot of other things that are happening between bouncing off of various base stations and towers and the handoff that happens between the companies that own equipment, to things like routers and switches.

My earlier reporting mentioned several of the encumbrances imposed by Nokia, but Weinstein explains why the company is not concerned, saying, "we didn't look at it that way." Understanding that Nokia has already licensed the patents, Weinstein explains that "we looked at it from a 'white list' approach. Who can we litigate [with] if need be. Nokia made reps and warranties that, number one, they will cooperate and, number two, that it's open season for some of these companies."

For a sampling of the companies Vringo is likely to engage in licensing discussions, look no further than the market for routers and switches, which Weinstein describes as a $14B annual market. Infonetics tracks a number of companies making routers and switches, including Alaxala (private), Alcatel-Lucent (ALU), Brocade (NASDAQ:BRCD), Ciena (NASDAQ:CIEN), Cisco (NASDAQ:CSCO), Ericsson (NASDAQ:ERIC), Extreme (NASDAQ:EXTR), Force10 (now owned by Dell (NASDAQ:DELL)), Fujitsu (OTC:FJTSF), Hitachi Cable (OTC:HCBLF), Huawei (private), Juniper (NYSE:JNPR), NEC (6701), Nokia-Siemens (a Joint Venture between Nokia (NOK) and Siemens (SI), Orckit-Corrigent (NASDAQ:ORCT), Tellabs (NASDAQ:TLAB) and ZTE (OTCPK:ZTCOF). Infonetics' recent report refers to the router and switch segment as the "second largest telecom market segment in 2011 total revenue (~$14.5 billion)."

Berger elaborates on the impact of the Nokia encumbrances, which he also sees as negligible:

We didn't necessarily care that much about some of the clauses in the agreement [about not suing] carriers. It wasn't really relevant to us because they aren't companies we would look at targeting in a meaningful way anyway. A lot of what's happening here, a carrier is actually leasing from someone else, or if they actually do own and operate it, they didn't design it themselves. We're one step upstream.

According to Weinstein, David Cohen serves as another key asset to help Vringo achieve licensing success, noting "He managed successful litigation against Apple, as well as the Qualcomm litigation." Indeed, a 2011 settlement resulted in Apple paying Nokia more than half a billion dollars with ongoing royalty obligations. Three years earlier, Nokia and Qualcomm settled patent litigation, where the Finnish mobile company sent a one-time $2.3 B payment to the San Diego chip designer. Importantly, most of Nokia's prior patent litigation and licensing efforts involved handset patents, not wireless infrastructure. Recently, Adaptix (a subsidiary of Acacia Research (NASDAQ:ACTG) sued Nokia-Siemens Networks over its own wireless infrastructure patents, but the merits of that case have yet to play out. A substantial subset, though not all, of the Nokia patents acquired by Vringo predate the Adaptix portfolio.

Weinstein and Berger also commented on the economics behind the Nokia purchase terms, and subject of my prior criticism. Briefly, a 35% royalty to Nokia kicks in once gross licensing revenue equals the $22M cash purchase price. Applying a one-third contingency to collections raises Vringo's "break-even" point, and reduces Vringo's net take-home on recoveries above $22 M. Weinstein points out, however, that although a one-third contingency fee is not unreasonable as a starting point, Vringo puts its own capital to work to reduce the amount shared with outside counsel.

In Lycos, we told the market we expect to receive no less than $0.80 on the dollar. We structure our agreements with our service providers with a blend of caps and contingencies and keep the interests aligned.

We anticipate on the Nokia portfolio, going forward with the 35% kicking in, we would net $0.50 on the dollar net to Vringo.

Berger further explains his rationale on how to keep interests aligned between the patent owner and litigation team by agreeing on budgets for various phases of the lawsuits, and then discounting the budget by capping certain phases and trading an upside reward with the litigation team if the patent owner successfully licenses or obtains an award in litigation. Berger continues:

Contingency [litigation] is called lawyer financing, and it's way more expensive from anything you would get from even the most savage investors on Wall Street. You're giving away 40% of the upside plus you're paying expenses, and you do lose a fair amount of control over the case. ... As a company, we don't really want or need for capital because we're public and the market is relatively efficient. So, if you have a good asset, you're able to get it financed. If we're not really interested in lawyer financing, we're able to get it cheaper elsewhere. We're really doing is aligning the law firm's interests with our own.

Vringo as a company is a meritocracy. That applies to everybody in our huddle, whether they are employees, contractors or professionals either inside or from an outside firm.

In addition, Berger hinted about future hiring to bring licensing expertise in house, in an effort to further increase margins, saying "You can watch for personnel announcements from us in the coming weeks about people that we're bringing in that have licensing expertise."

One thing the Vringo team absolutely agreed with me about is the effort involved to generate a return on the Nokia portfolio. While filing lawsuits and accepting "nuisance" level settlements often winds up being the faster, more certain and less costly route to revenue generation, such a model rarely generates positive returns on an 8-figure investment. Berger comments, "Expectations are an enemy to a lot of things in life. I never go into these things with the expectation that we're going to have a quick collection. This might take awhile; it might not. It might be partially monetized, in some areas, relatively quickly, and in others it will take longer. It's a very, very large portfolio and there's a lot of elements to it."

Meanwhile, the Vringo team, including Berger and Weinstein, are doing everything they can to assure investors that the $100,000 AOL (NYSE:AOL) partial settlement is not indicative of Vringo's overall licensing strategy. While transparency dictates that Vringo disclose the amount paid by AOL, confidentiality obligations prevent Berger from disclosing AOL's base revenue or the amount Vringo would have sought at trial. Nevertheless, Google has always been Vringo's primary target in the Eastern Virginia litigation, considering the Mountain View, CA firm's revenues trump Loundon County, VA-based AOL by a margin of nearly 30 to 1. On top of that, a sizable chunk of AOL's advertising revenue relates to their use of Google technology which is still at issue in the case.

Whether the purchase will pay off for Vringo and its investors still remains to be seen, but success will require the ringtone company-turned-IP Monetization firm to maintain discipline with respect to budgeting its outsourced litigation efforts and pricing with respect to any early licensing and settlement agreements. Restrictions on litigating against wireless service providers potentially limits the usefulness of patents covering the infringing use of patented methods by network operators--something Harris Corporation (NYSE:HRS) learned during its litigation with Ericsson in 2010--but Weinstein and Berger say that this has been factored into their analysis as well, giving them confidence going into this new campaign.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.