In my opinion, there is much more to Vringo's (VRNG) potential value than the lawsuit against Google (GOOG) or even other lawsuits associated with the Nokia (NOK) patents, and the idea that Vringo is just a patent collection agency is also wrong. In fact, the Google lawsuit may just be the beginning of a much larger story.
Have you wondered why Innovate/Protect merged with a small company that specializes in ringtones? If Lang, Stout, and the others merely wished to collect some past damages and future revenues on the search patents, what would they need Vringo for? Why dilute the value of the patent suit? I think they intend to obtain an injunction against Google, stop them from using the Lang patents in mobile search, and then compete with Google in this rapidly growing market.
Let's start with a quick recap of the value of the lawsuit. As we know, the estimated value of past damages is estimated at approximately $550 million, counting all defendants. Value of future royalties will be set by the judge, assuming Vringo prevails. If we use the current valuation of 3.5% of 20% of domestic revenues, future revenues would be worth slightly more than the past damages, possibly another $650 million or so. This number could be very different depending on what the jury decides, what the judge decides, and what non-infringing search alternatives that Google might build to avoid royalties.
But I think more could come of this - much more. As explained in Mr. Ravicher's preview of the case, if Vringo prevails they will probably ask the judge for injunctive relief. The value of such an injunction against Google, and the associated impacts on the fast growing mobile search segment, and Google's market share and revenues, are worth far more than the lawsuit damages and royalties.
Let me remind all of you that I am not a lawyer. Recent legal developments show that injunctive relief for NPEs (non-practicing entities, or patent holders who do not utilize the patent themselves in the marketplace; also sometimes called patent trolls) is becoming more difficult to obtain. Courts no longer automatically issue injunctions, but rather, they use specific criteria to determine whether it should be issued. One of these criteria is whether the plaintiff will suffer irreparable harm in absence of an injunction. This has become more difficult for NPEs. According to matthewspatentlaw.com, this can be considered an 'Achilles heel' for NPEs.
But I think the merger with Vringo effectively created a practicing entity. They are capable of delivering content to mobile devices through its ringtone and Facetones businesses, so they could do the same in search. If you'd like some further insight on this theory, see this article about Ken Lang and Vringo, where he mentions his 'major new project'.
The possibility of injunctive relief for a practicing entity dramatically changes the entire value proposition for Vringo and damage prospects faced by Google. Vringo could start a new mobile search engine, which has the competitive advantage of the Lang patents, while in turn it could deprive use of those patents by their top competitor, Google. Furthermore, though the injunction would not affect Google's search results outside of the US market, Vringo could emerge as a competitor there as well.
How important might this be? Very important, as mobile search is experiencing the kind of explosive growth that reminds me of the dot.com heydays. According to businessinsider.com, Google's mobile revenue for 2012 is on pace to reach about $8 billion. Though the exact numbers for all categories of mobile revenue are not available, Google executives have said most of this revenue was from advertising. This equals about 20% of Google's projected total 2012 revenue, and mobile is growing fast.
How fast is mobile advertising growing? Faster than Usain Bolt. 2011 mobile revenues at Google were about $2.5 billion. These revenues grew by $5.5 billion, or more than tripled, in just one year. This equals about 40% of Google's total projected year over year revenue growth. The Lang patents only cover US revenue, which comprise about 50% of total Google revenues.
Also, though Google does not break it down by category, search ads (as opposed to display ads or SMS ads, which, as far as I can determine, do not use the Lang patents) according to techcrunch.com, total slightly more than 50% of the mobile advertising revenues. Display ads and search ads are different. Display ads are those found when browsing a website, while search ads are those found when clicking a link after using a keyword in a search engine. Google holds more than 95% of the US mobile search market.
Using the numbers from techcrunch.com as a rough guide, I estimate that US mobile search is worth about $2 billion to Google this year, while US display ads were worth another two billion. Roughly the same revenue figures are likely internationally if we assume that mobile revenues follow the same 50-50 US/International split of overall Google revenues according to their financial reports.
The Lang patents last four more years, until 2016. We don't know how fast mobile search revenues will continue to grow, and I don't think anyone expects it to triple every year like it has this year. If we estimate the growth rate to slow from 300% in 2012 to 200% next year, and then drop to 50% growth rate from 2014 through 2016, US mobile search revenues for Google would reach about $13.5 billion in 2016, giving us a conservative total about $32.5 billion for 2013-2016 combined that could potentially be influenced by an injunction. Google could find itself at a competitive disadvantage in their fastest growing market where they already own more than a 96% share. Google has much to protect in this space.
US search is not the only opportunity in mobile. Again using the assumptions, growth in international mobile (search and display) and domestic display ads give us similar numbers in these segments totaling about $130 billion from 2013-2016, as seen in the table below.
|Search Revenues (Billions)||2011||2012||2013||2014||2015||2016||2013-16|
|Total (Known. 2011-2012)||2.50||8||16||24||36||54||130.00|
|US Search (est.)||0.63||2||4||6||9||13.5||32.50|
|US Display (est.)||0.16||2||4||6||9||13.5||32.50|
|International Search (est.)||0.04||2||4||6||9||13.5||32.50|
|International Display (est.)||0.01||2||4||6||9||13.5||32.50|
Armed with an injunction that prevents Google from using the Lang patents in the states, $500 million in cash for past damages, Vringo's existing infrastructure, and Lang himself, the real value of the Lang patent lies in how much US mobile search market share could a new Vringo search engine potentially take from Google, and how long would it take them to do it.
This leads to other questions. Once a new Vringo search engine is generating revenue and taking market share in US search, how much market share might they be able to take in US display ads where (as far as I can determine, I am not a search expert) the Lang patent injunction would not give Vringo an advantage? How much might Vringo get internationally in both search and display, where Google is not constrained from using the Lang patents? How much of this estimated $130 billion market might such a new competitor achieve?
In Google's favor, it is the default search engine on both Android and the iPhone (though this is changing), and currently holds more than 95% of the US mobile search market. The rest goes to Microsoft's (MSFT) Bing and Yahoo (YHOO). So what is the worst case scenario for Google? Vringo wins the patent suit and is awarded, say, $500 million and injunctive relief in mobile search. Even if we assume that Google builds new technology to avoid future royalties, with this new influx of cash, Vringo and Lang might then build its own search engine and compete with Google at a competitive advantage. They could also compete in the international mobile market (display and search) and the US display ad market, though without this advantage.
The impact of such a new competitor is very difficult, if not impossible, to quantify or predict, so I'll use conservative projections. I've picked these numbers out of a hat, but I think they are conservative. I'll start by assuming that it would take Vringo at least a year to get their new search engine up and running.
For US search, I'll project that a new Vringo search engine might achieve a 10% market share in 2014, 20% in 2015, and 40% in 2016. For US display and international (search and display) I credit them with less, 5%, 10%, and 15%, for these 3 years, where access to the Lang patents does not give them an advantage. Given the growth rate projections above, I estimate the potential revenue generated by a new Vringo search engine, in mobile search to be about $16 billion before the Lang patents expire.
|Projected Revenue (Billions)||2012||2013||2014||2015||2016||2013-16|
|US Search (est.)||NA||0.00||0.60|
|US Display (est.)||NA||0.00||0.30||0.90||2.03||3.23|
|International Search (est.)||NA||0.00||0.30||0.90||2.03||3.23|
|International Display (est.)||NA||0.00||0.30||0.90||2.03||3.23|
|Grand Total (Billions)||16.13|
|Revenue Per Vringo Share||$146.64|
|Discounted by 35%||10.48|
Georgi Dimitrov reported recently that patent holders win some 65% of the time once they get past the summary judgment stage, which Vringo has done. So, we will discount this further by about 35% to factor in the possibility that Vringo does not prevail, leaving us with a value of about $10 billion in lost revenue for Google if Vringo obtains an injunction, and seizes some market share.
Consider also that Google does not want their customers to be sued, nor would they want (for example), Microsoft, Yahoo, Apple (AAPL) or Facebook (FB) to acquire Vringo after an injunction is given and bring their experience and resources into the mobile search market as a stronger competitor. How much more would Google lose if Microsoft, Yahoo, Facebook or even Apple purchased Vringo after the courts issued an injunction?
Throw in the fact that Google has voiced a need for more patent protection and where does all this lead? Google does not want to lose its iron grip on mobile search and Vringo does not want to be left with nothing should they not prevail in the lawsuit. In my opinion the best case for all parties, the best way for everyone to stay unscathed, might be a buyout or merger / stock swap worth approximately $10 billion in Google shares before the injunction (or lack thereof) is announced. Such a stock swap would equal about 6 or 7 Vringo shares for every Google share based on these estimates.
I expect this analysis will generate controversy and message board attacks. But yes, I think Vringo stock could be worth about $100 a share to Google before an injunction is given, and could be worth about $160 a share to Google after the injunction is given. I think the chances of Vringo prevailing are high, and given that it is a practicing entity, the chances of injunction are also high. The value to Google keeping it from a competitor like Microsoft is likely even more.
If they wait until after the injunction is (or is not) issued, it would be far more costly for Google because we've removed their 35% chance of winning from the calculation, and for Vringo, they'd lose much more if Google prevails in the lawsuit. I don't know the legalities of this, but I wonder if it's possible that a contingent offer is already agreed to by the parties behind the scenes to protect both parties from total loss. Something like, for example, $5 billion if no injunction is granted, $10 billion if the injunction is granted. This might explain why no buyout or settlement has been reached.
Considering the impact of the premature earnings release last week, which caused a $70 drop for Google and a rare halt to trading, I think such a merger makes economic sense for Google shareholders. It would save the potential $500 million in past damages, add more value associated with the patents Vringo purchases from Nokia, and also leave Google in a position to sue Microsoft and Yahoo for past infringement and use an injunction of their own to solidify and protect its 95% market share dominance in the rapidly growing mobile search market.
Disclosure: I am long Vringo and have no plans to buy or sell during the next three days. However if a merger, settlement or buyout occurs during this time frame I may sell some of my holdings. I may (or may not, depending on circumstances) also choose to hedge my position when the case is sent to the jury for deliberations.