Over the past two weeks, one thing with regard to Vringo (VRNG) has become evident. The stock is not tethered to any sort of fundamental valuation in the short run. Its price has rested heavily on a binary event, its trial against Google (GOOG), and moved in a polarized fashion fitting this nature as a speculative investment. Moreover, its aberrant trading volume in the past months (reaching 5 times the 3 month average on the day of verdict) has amplified its seesawing nature further.
The stock's reaction to material news in the past provides a strong litmus test for this decoupling from its fundamental valuation. Take, for instance, Judge Raymond Jackson's denial of Google's motion for Summary Judgment on October 3rd. The stock evaporated in 6 days, closing on October 8th up over 75%.
Having the benefit of hindsight, the rational observer cannot believe that passing the Summary Judgment hurdle made Vringo's equity position 75% more valuable. The stock proceeded to retrace from its high. The event did, however, stoke speculative fervor and bring in a group of new holders who expected to double up by trial's end and who grew more risk-averse with every passing trial day. Why delve into this line of thought? I do so because no investor operates in a vacuum.
In a stock that has come undone and wafted and crested on every rumor, the ability to put oneself in the shoes of other fellow investors is as important as accurate analysis. Although trite, the stock's lows have been lower than they should have been, and the stock's highs have been higher than they should have been. This behavioral analysis of investors provides the lens through which the observer can begin to understand how Vringo's stock has fallen after the jury delivered a verdict in its favor.
Through verdict, the jury made several things a present certainty. First, the Lang patents are valid. Second, Google et al. infringed on those patents. Third, calculation of damages should be based on a running royalty of 3.5% of the increased revenues produced due to infringement. Because of Judge Jackson's laches ruling, the jury calculated past damages from September 2011 onwards, totaling roughly $30 million. Since the stock's halt prior to the verdict, it has fallen 35% to its after-hours close Tuesday. This is amiss given that the verdict increased Vringo's expected value.
However, the verdict was a failure in light of the expectation of investors who demanded certainty from the jury's decision. The jury did not provide that certainty, nor did it provide an eye-popping number. It was simply one part of the natural progression of the case. But those who expected certainty liquidated their positions after the announcement of the verdict, and downward pressure took the stock to where it is now.
The next point in the case's progression involves Judge Raymond Jackson's closing ruling on the case, of which the jury's finding is akin to a recommendation. The judge will determine the legal skeleton in which the jury's findings fit. The occurrence of this part in the process was a certainty before the verdict, and it remains a certainty now. The variable that has changed is that the judge will begin under the assumption that the Lang patents have been deemed valid and infringed upon by a jury (subject to his decision of whether the patents fail the obviousness test, which the jury's verdict directly addressed).
The legal considerations that will come into play during the judge's decision are too random, organic, and complex to predict. What can be ascertained, however, is the judge's framework for decision. As a rational agent, Judge Raymond Jackson has developed this judicial framework through past experience. In his adjudication of the patent lawsuit of ActiveVideo Networks Vs. Verizon (VZ), he not only modified the damages recommended by the jury upwards, but also assigned a future royalty. In his intellectual property rulings and elsewhere, his philosophy has been one that involves a large degree of judicial activism.
It is in this light that I expect his ruling on the Google Vs. Vringo case. Two things will occur with greater probability than not. First, followers of the Vringo trial have speculated that the jury's damages calculations deviated from their intent. I believe this to be true. The jury's intent of assigning a 3.5% ongoing royalty is clearly indicated in the verdict.
Because of the complexity of the case, the muddling of damages figures by the laches ruling, and the judge's abstract answers to its questions on damages, the jury mistakenly applied the royalty percent to the Google figures provided by Vringo's damages expert, which already had the 3.5% royalty included. It accurately adjusted for the laches ruling for every other defendant except Google by reducing the damages listed in evidence to a 35% approximation that represented the period of September 2011-September 2012.
Some will argue that this is mere speculation. The 9 people who reached this verdict are average citizens who utilized their general understanding to deliver a verdict in a specialized case. Which scenario seems more possible: that the jurors made an error in the mathematical application of their intent, or that all 9 of them became convinced by some unbeknownst reason to lower the damages attributed to Google by, coincidentally, the royalty they had previously determined?
And, if the damages are not corrected to the jury's actual intent, Google, a company which posted revenue for the trailing twelve months of almost 25 times that of AOL (both coming in large part from advertising) will pay two times the damages assigned to AOL. If the damages assigned to Google had been calculated in the same manner that was used for its co-defendants, its past infringement would total $158 million, not $15.8 million. What if the jury made the mistake on the co-defendants' damages, not on Google's?
This possibility runs against the intent provided in the verdict to apply a 3.5% royalty to earnings based on infringement. Given Jackson's judicial history, I view a positive adjustment of the jury's verdict to be more probable than not. Precedent in a similar trial scenario points to a way in which this change could be carried out by Jackson.
Second, Jackson will follow in the path set by the jury's verdict of ongoing royalties and assign some royalty % to which Google's future salient revenues are subject. Estimates of the total this royalty would come to run the gamut of $30 million a year and all the way to more than $100 million annually until 2016, when the Lang patents expire.
A hundred different individuals would calculate this running royalty a hundred different ways. But it resides solely with the determination of the judge, which will most probably come somewhere within the above range. The one thing that can be said is that this ongoing royalty will largely depend on Jackson's opinion regarding the first issue. That said, given Jackson's previous rulings in this case and his decision regarding ongoing royalties in the Verizon case, the probability of ongoing royalties is very likely.
Only a fraction of the value of these two occurrences is currently priced into Vringo's stock, as the market's myopic focus on the size of the jury's damage award has led the stock to once again trade at an attractive price. Two weeks ago, using this same mode of educated speculation, I estimated that Vringo was likely to win its case against Google in a jury verdict. To be certain, Vringo is a speculative investment. Combined with this nature and its outsized volatility, the stock continues to offer an opportunity for educated investors of positive expected value.
Disclosure: I am long VRNG.