Vringo Upside Overstated, Risks Understated

Oct.15.12 | About: FORM Holdings (FH)

Vringo (VRNG) buys patents and sues companies like Google (NASDAQ:GOOG) for infringement. As the Google suit approaches jury trial, Vringo shareholders have been rewarded with just short of a triple in the last half-year.

The beauty of Vringo's business model is asymmetric warfare. Vringo brings a case to trial and jeopardizes the operations of a company. The company cannot jeopardize the operations of Vringo, because Vringo doesn't really have any. The company settles with Vringo, because to do otherwise would cost additional millions in legal fees, at best.

However, pending legislation could force patent trolls to pay legal fees for frivolous suits. This would reduce Vringo's advantage twofold: one, it would cost Vringo more to lose a case, and it could cost Vringo's opponents less to follow through with a defense. That framework would make settlements far more difficult to extract.

So even if Vringo prevails over Google, there may not be a substantial forward multiple on earnings -- the rules of patent trolling could change, affecting future cases. It's something to think about when deciding how much to pay for shares in the present.

Another forward-looking problem with the business model is mobilization of big tech companies against software patents. One has to wonder if all the crazy patent suits these days (rounded corners, injunctions reversed over and over, thermonuclear war, etc.) are really a signal to get in on patent trolling. One has to wonder if sleeping giants have awakened and called their lobbyists. One has to wonder if one is buying at the top of a trend.

Yet another problem is the Federal Circuit. In deciding an appeal, Supreme Court decision Mayo v. Prometheus was cited. Prometheus reaffirmed that laws of nature with obvious improvements are not patentable, and lamented loudly the problem of abstract patents restricting fundamental tools of science. The result: for the first time, the Federal Circuit is going to render specific guidance as to what kind of software is patentable in light of Prometheus. The case in question is CLS Bank v. Alice Corp, which is very similar to Vringo v. Google, in that both deal with software patents describing an abstract idea.

But more than anything, if I was a Vringo shareholder, I would be worried about losing to Google in court. Eric Schmidt:

We are now spending hundreds of millions of dollars to fight these fights against patent trolls, and we're winning.

Finally, I would be worried that Microsoft (NASDAQ:MSFT) hasn't bought Vringo yet. James Altucher claims Google is likely to buy Vringo, not just to stop the litigation, but to obtain patents for suing Microsoft, Yahoo, etc.. But Microsoft could just as easily buy Vringo and sue Google.

In fact, Microsoft is far more likely to do so. First, Microsoft has been failing to compete with Google on merit (Bing is a joke), so it would be natural for Microsoft to look for a dirty trick. Second, Microsoft has a history of monopolizing: patents are a perfect, government-enforced monopoly. Third, Google's search revenues allowed it to provide free apps which undercut Microsoft, so suing for search patents would be historic, poetic revenge.

As many evils as it may have, nothing in Google's history suggests it is anywhere near as monopolistic or lawsuit-happy as Microsoft.

And yet, Microsoft has not bought Vringo. So I don't think Google will either.

Maybe Google will settle with Vringo. Google certainly doesn't want all of its customers to get sued. But maybe Google won't settle. There is a great deal of risk here, and I would wait for a selloff from impatient investors before making a speculative buy. That's just me; I would error towards caution in terms of going up against Google and the Supreme Court.

From an inherent valuation perspective, reasonable upside potential is $12; downside is $2 or maybe $0. But does anyone really know what the odds are? I don't think so. Unless one's name is Eric, Sergey, or Larry.

Instead of Vringo, I would look at buying Neonode (NASDAQ:NEON) and TrovaGene (NASDAQ:TROV). James Altucher is planning to write more articles about them. Altucher's cheerleading is already priced in to Vringo; there may be time to get ahead of the wave with these new picks.

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.