In The Republic, Plato painted a picture of some significance with his Allegory of the Cave. In this imagined world, a band of humans lives chained inside a cave, facing a wall that is in front of them. There is a fire behind them, and every so often creatures move in front of the fire, casting their shadows upon the wall that the imprisoned subjects view. From the blurry shadows, the prisoners attempt to ascertain the things that they cannot truly see. After a two week trial, those following the Vringo (NASDAQ:VRNG) - Google (NASDAQ:GOOG) patent lawsuit must feel their situation bears an uncanny resemblance to the imprisoned souls in Plato's cave.
The Past and Present
The current chapter of Vringo's drama began with Judge Raymond Jackson's denial of a motion by Google for Summary Judgment. The stock rocketed upwards as a potential settlement or favorable jury verdict whet speculators' appetites. The stock peaked shortly after, and beat a measured descent when the trial began on October 15th. On Wednesday, Judge Jackson limited Vringo's claim on Google's earnings to the timeframe of September 2011 and onwards. Vringo's stock took a 40% nosedive on the news and now rests 10% below its position prior to Jackson's denial of Summary Judgment.
Yet the ruling has been the only material information that has fallen into investors' laps since the trial began. All the other shadows coming from the courtroom have been positive for Vringo. They range from chatter on Internet message boards to in-depth dissection of court documents by legal experts like Steve Kim. Analysis of the trial has undeniably been lopsided in Vringo's favor. In my mind, this strengthens the arguments I laid out in Vringo Vs. Google: Why the Underdog Will Come Out on Top. The flurry of speculation surrounding the trial has convinced me further that this case will tow the empirical line of the Eastern Virginia Federal Court, in which previous companies in Vringo's shoes have enjoyed a success rate of around 63%. As the verdict nears (expected at the beginning of next week), it is important to note that juries in the district have been exceptionally generous in the past (Source: PwC 2012 Patent Litigation Study). There is no doubt that jury verdicts suffer from enormous randomness - that being said, being on the side of history provides enormous comfort.
With that said, one must approximate the windfall Vringo stands to potentially earn in a post-latches world. For Vringo, Google's enormous revenue growth since 2005 is a boon - a large part of its original claimed damages come from the period after the lawsuit was filed. Under the assumption that Vringo's damages analysis is accepted by the jury, combined with the latches ruling, the sum of past damages potentially owed to Vringo by Google stands at approximately $145 million. The latches ruling also applies to damages by Google's co-defendants, AOL, IACI, and Target. Using a rough ratio of how Google's potential damages were pared by the latches ruling and court testimony, those damages come to roughly $14 million. Past infringement damages, then, hypothetically total $159 million. Add to that some real amount of interest and trial costs, rounding off the number to $170 million.
And the Future
Since the latches ruling, significance has shifted to the potential of future royalties. Judge Jackson's decision created a clear line of when damages begin. But these infringement royalties do not end when a verdict is rendered. More to the point, there is no logical reason that infringement magically ends with the end of the trial, which is a legal proceeding, not an operational business event. Judge Jackson has repeatedly indicated that Vringo's case has legal merit, from his denial of the motion for Summary Judgment to his more recent denial of Google's two motions for Judgment as a Matter of Law. Assignment of ongoing royalties falls on the Judge presiding over the trial. Judge Jackson took this course of action in the 2011 case of ActiveVideo Networks versus Verizon. In fact, Jackson's ongoing royalty ruling amounted to roughly $13 million a month more for ActiveVideo Networks. Sweetening the pot, Jackson tacked on $24 million in damages to the jury's verdict in the case. If the jury finds that Google is liable for patent infringement from September 2011 to the present, Jackson's imminently logical course of action follows his previous patent ruling in the ActiveVideo Networks case.
The question of what a suitable ongoing royalty rate would be is a muddled one. Lisa Tittemore, an intellectual property specialist, writes in The Federal Lawyer:
"Recent Federal Circuit decisions provide guidance as to the views of some of this court's judges on awarding an ongoing royalty after a verdict of infringement. For example, with respect to how an ongoing royalty might be determined, Federal Circuit decisions have encouraged district courts to permit the parties a period of time after the verdict to negotiate a rate but, if the parties do not reach an agreement, suggest that either the judge or the jury - during trial or perhaps even in a separate trial - may set the rate. [...] As for the substantive question of what should be involved in setting a rate, some Federal Circuit decisions indicate that post-verdict royalties for future infringement should be considered 'fundamentally different' from royalties awarded for pre-verdict infringement. [...] [W]hether or not courts will uniformly award a higher ongoing royalty for infringing sales occurring post-verdict than the royalty set for pre-verdict infringement remains somewhat unsettled."
As an indication of what this ongoing royalty sum may be, one could conservatively use Google's Q3 revenue figures and the assumptions for the past infringement calculation referenced above. That sum comes to around $36 million per quarter, which could run all the way through the Lang patents' expiration in 2016. Several factors will modulate Jackson's view on ongoing royalties, chief among them being Google's future revenues, the Lang patents' continued relevance to this revenue, and a potential settlement of ongoing royalties by the counterparties themselves.
I have taken the recent collapse of Vringo's share price as an opportunity to expand my position. Yet, as a final cautionary note, only a jury verdict and the judge's subsequent actions will allow the market to see the shadows on the cave's wall for what they really were and will be.
Disclosure: I am long VRNG. 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.