Well, the cards have been dealt. The chips are on the table, and we are all waiting for the final card. Like in poker, we are dealing with a hand that has imperfect information. We know some things and we don't know others. Using this, we can help determine what value the cards in our hand have.
What things do we need to determine a value for in order to determine the value, today, of Vringo (VRNG).
- We need to know the outcome of the Vringo/Google (GOOG) lawsuit. This is the most important thing, but it is not the only thing, as will be discussed below. There are several possible outcomes:
o Google can buy the company.
o Google can settle. In fact, the judge has ordered that settlement meetings begin tomorrow, October 9.
o Google can lose a trial.
o Vringo can win a trial, but the US Patent Office might re-examine the patent validity on the 420 patent. This would effect damages but my guess is not so much. Also, the judge just ruled that this cannot play a role in the trial itself.
o Vringo can lose a trial.
I put these in the order I think of greatest likelihood. As mentioned in Steve Kim's excellent article on Friday, the judge has ruled on various motions in limine mostly in favor of Vringo. The Markman hearings have also worked out in favor of Vringo. Google's motion of summary judgment was dismissed. And perhaps most importantly, the judge has requested that the two parties meet and see if they can settle. This meeting is tomorrow.
For a review of the MILs and what they mean, please refer to Steve's article. Steve and I had a chance to talk on the phone the other day. I thought his knowledge of the case was excellent and, when combined with his legal background, his article was an extremely informative summary of what the latest rulings of the judge mean for this case.
Anything can happen in a court trial. However, I think it is in Google's best interest to buy the company.
1) They get the search patents which they can then use to sue Microsoft (MSFT) and all of Bing's customers, a strategy I also expect Vringo to do if Google settles or loses.
2) They protect their customers from being sued. This also makes it likely that Bing customers will move over to Google.
3) They get the Nokia (NOK) patents (see below for my discussions of what that value is).
4) It will be cheaper for them than settling or, god forbid, losing a trial. Losing a trial is the worst outcome for Google. They will pay a bigger amount, triple damages, and their customers will get sued. This is the disaster scenario. But even settling is no good for Google. They will simply hand over cash without benefit. Buying Vringo actually has strategic value to Google. A buyout can happen in the range of $10-15 a share.
5) They, of course, avoid all of their customers being sued, like how Target (TGT) is being sued right now by Vringo, for instance.
Settling is a better outcome for Vringo shareholders, which is why I think they will get bought instead of have a settlement. Why is it better?
1) Although the lump sum they get will probably be lower than a buyout sum, they will still have the opportunity to sue MSFT and MSFT's customers.
2) They will trade at a 5-10x multiple of a settlement. Let's say they settle for 500 million dollars (I am pulling this number out of a hat.) If they trade at a 10x multiple and they have about 120 million shares outstanding then that's a $20-40 stock price. It's too good to be true, which is why I think buyout is a more likely option.
3) They will be able to use the cash they get in a settlement to buy other patent portfolios and also to more quickly prosecute the patents they currently have in the Nokia portfolio. This would drive up my estimate of the value of the Nokia patent portfolio (see below).
4) Winning in a trial is a possibility, but I don't think Google or their lawyers (Quinn-Emmanuel, who just cost Samsung (SSNLF.PK) a billion dollars in their Apple (AAPL) lawsuit) will not want to do it. Depending on egos and what Larry Page had for breakfast this morning, it may happen. But if it does, I've already listed the reasons why I think Vringo will win. If Vringo wins, sky is the limit on the stock price. Good things like that don't usually happen to me, which is also why I think settlement or buyout is more likely.
5) Every investment must include an analysis of the worst-case scenario. While I think it's unlikely Vringo loses, it's worth seeing what other value Vringo has that can support the current stock price or higher or lower.
What is Vringo Worth Without the Google lawsuit?
Whatever price for Vringo you came up with above, depending on what scenario you think will happen, add the below scenarios and prices to it.
What is the Cash Worth and Why Did They Raise It?
- They have $55 million in cash thanks to astute fundraising. While daytraders have been shorting this stock below $4, institutions have been buying significant blocks of stock ($45 million last Thursday) at higher prices than Vringo is used to seeing. $4.35 was the secondary price.
The big question asked is, "why?" Why raise this money if they are going to settle or get bought out. Why suffer the dilution? Do they have no confidence?
When confronted with several choices, always choose the simple answer rather than the sinister answer.
In just about every outcome, having more money is better. It's that simple.
For instance, let's say they are in settlement discussions with Google. Google can say, "Here's 100 million. Take it or leave it you goddamn trolls!"
When Vringo has $10 million in cash, the judge might've said, "you guys really should take it." And shareholders might insist on that also. But now with $55 million in cash (on a lawsuit that has, so far, only cost them $4 million in legal bills) Vringo can say, "screw that, we're taking this to trial! See you in the courtroom."
As everyone knows in their personal lives: having more cash gives you more leverage in every situation. The Vringo/Google lawsuit is no exception. Congrats to Vringo for strategically raising this money.
So what is $55 million worth? On the one hand, it's worth $55 million, or about 46 cents per share. On the other hand, it's worth more than that.
We already know how Vringo has been using their cash. They used $22 million to buy Nokia's portfolio which, as we will see below, is worth a lot more than $22 million. Up to 10 times more.
So given that Vringo management knows how to strategically use their cash in an accretive manner, I'm going to be conservative and say the cash is worth $1 per share to them.
What is the Nokia Patent Portfolio Worth?
- On the one hand you can say, "it's worth exactly what they paid for it" which is $22 million. But this would be inaccurate. Nokia had strategic reasons for letting Vringo have this portfolio at a cheap price:
o Nokia didn't want to use the portfolio to sue their own customers and vendors. Now they don't have that worry.
o They get 35% of all revenues that come from this patent portfolio and they no longer have to lift a finger to exploit the portfolio.
o Their top litigator in the US, David Cohen, is now Vringo's top litigator. So they knew the portfolio was going to the one place that would maximize Nokia's future revenues.
So Nokia was incentivized to give Vringo a deal on the patents.
What are the patents worth?
- Unlike when this case started, we also need to know what the value of the Nokia patent portfolio is. On the one hand you can say, "it's worth exactly what they paid for it," which is $22 million. But this isn't true. Because of Nokia's 35% stake on any revenues generated by this portfolio, and because of the leap of chief Nokia Litigator David Cohen from Nokia to Vringo, there is a lot more value than $22 million.
I'm not a patent expert on an expert engineer. So it's a good thing a team of expert engineers were hired to independently assess what the patents are worth. You can find their results here.
They conservatively suggest that VRNG can bring in $30 million a year in revenues from the litigation, minus what they owe Nokia, taxes, etc. They don't really do a value analysis but suggest that over the next four years Vringo can bring in $172 million in revenues from the Nokia patents.
Since Vringo can obviously generate revenues over a longer than four-year period, I will do a more standard analysis.
Let's say the 2016 number becomes their annual revenue number (a conservative assumption on top of an already conservative assumption). They owe Nokia a little more than 1/3 and let's say they pay the max in taxes: about $10 million. So $10 million falls to the bottom line. Intellectual property companies in the telco space (I'm thinking IDCC (IDCC) and Qualcomm (QCOM)) seem to trade at about 20 times earnings.
So that would value the NOK patent portfolio long-term at about $200 million in the most conservative assumptions.
Roughly about $1.90 - $2.50 a share, depending on how conservative you want to be.
So with just their cash and the NOK portfolio, I'd make a strong case for $3.50 a share being added to whatever a GOOG settlement is. It should also help GOOG figure out what to pay if they were to buyout the company.
Google wants to save face. They don't want to do business with terrorists. Buying the company for $10-15 allows them to say, "we will strategically use the Nokia portfolio to generate at least this much value for Google, and will continue to use the search patents to prosecute all infringers. We feel this company is worth a lot more than what we are paying for it." And they would be right.
What is the Value of the Facetones Business?
Oh wait, I totally forgot about Vringo's original crappy business.
What's it worth? I have no idea. So let's assign a value to it based on the worst price of the past 52 weeks. Long before there was a Google lawsuit, $55 million in cash, and a Nokia portfolio.
68 cents. So the market probably knows better than me what that business is worth. But let's say it's worth at least the 52-week low.
Now, even without the GOOG lawsuit, we can argue a value of $4.10, give or take.
I like good risk-reward. In the worst-case scenario, this is still a company worth over $4. Any buyout or settlement will value the company significantly higher, which is how I come up with the seemingly ridiculous numbers above. Since I think this case going to trial AND Vringo losing is the least likely of all the scenarios, one can justify a price that is a significant multiple over the worst, most conservative estimate.
By the way, just across my email a few seconds ago: Maxim raised their price on Vringo from $6.50 to $10, based on similar analysis to the above. Given that I think the base business is worth at least $4 in a conservative scenario and given that I think a buyout or settlement is likely OR a trial win by Vringo is more likely than a loss, I think Maxim is being conservative and a $10-15 is a more likely short-term range, with outliers in the case of a settlement or Vringo win.
Extra reading material:
- Read Steve Kim's article here from Friday on the MILs
- Read the Vringo Analysis link I provide above that discusses the value of the Nokia portfolio
- For fun, get a hold of the Maxim analysis although it's similar to what I have here.
- Watch this September 11 clip of a Google VP on Bloomberg admitting that Google was slow to the patent game:
- Vringo files lawsuit against zte in UK. Press release was this morning. Read it here. This shows how aggressive they are going to be on the Nokia portfolio, which makes me think the analysis done above was way too conservative.
I'm long Vringo. There's already significant profits here since I first wrote about it. The most important thing in investing is to make sure you can sleep at night. If you need to take profits off in order to sleep, do so. The purpose of this article was just to answer some questions (why did they raise this money? What is the value of the NOK portfolio? etc.) and provide my own views on where I think the stock can go and why.
Disclosure: I am long VRNG.