Let's face it, the Vringo (NASDAQ:VRNG) vs. Google (NASDAQ:GOOG) trial was a smashing success for Vringo. As we all know by now, the jury returned a verdict for Vringo this past Tuesday, November 6. Every single one of the jury's findings was not merely a victory for Vringo, but a smashing victory. The jury found that not just Google, but each of its co-defendants, infringed upon 14 separate patent claims asserted by Vringo, found that Vringo's royalty damages should be based on a running royalty, and adopted the 3.5% running royalty rate sought by Vringo. The jury's verdict constituted a wholesale endorsement of every trial position taken by Vringo, and a rejection of every trial position taken by Google and the remaining defendants.
So why does the victory feel pyrrhic?
The past damages, of course. By now, everybody who cares to know, knows that the jury awarded a stunningly low past damages verdict against Google, especially in relation to the co-defendants. The jury's award for past infringement was:
Google: $15.8 million
AOL: $7.943 million
IAC: $6.65 million
Let's break this down a bit.
During the trial, Vringo sought $493 million against all the defendants. This number represented 3.5% of Google's 20% increase in U.S. revenues realized after the launch of their infringing SmartAds system. Broken down by defendant, here are the damages that Vringo sought for all years of past infringement, the apparent multipliers the jury used to determine how much of the total claims occurred during the period not barred by laches, and the actual total sum awarded against each defendant:
As you can see, the jury appears to have used a multiple for the co-defendants that is ten times higher than Google's. In other words, Google's co-Defendants, who were mere customers who used Google's system, were held ten times more responsible than Google, which operated, distributed, and profited most from its infringing system.
This was probably a mistake by the jury, as it makes little sense that the jury would treat Google ten times more favorably than its co-defendants. But at this point, it is speculative to know whether it was actually a mistake, or whether it just looks like a mistake because of some pretty damning circumstantial evidence.
But while that's the issue on everybody's mind, I frankly think that the past damage award is a tree in the forest. It's not the forest.
So What Is the Forest?
The forest is really the jury's decision that Vringo is entitled to a running royalty, and that the rate for the running royalty should be 3.5%. In an earlier article before the verdict was announced, I mentioned my belief that "the biggest damages issue in the case" is whether Vringo is awarded a running royalty. That is because a running royalty would give Vringo not just a slice of Google's past revenues (which is a fixed number), but a slice of future revenues, for the remaining life of the patents. This is a huge royalty base that is both growing and ongoing.
When the verdict was announced, almost all of the immediate market reaction focused on the $30 million past infringement award. I think this was myopic, and wrong. Now that the sticker shock of the past damages award has begun to settle, financial observers are beginning to realize that the really significant damages issue in the case was the issue of running royalty vs. lump sum royalty. Since then:
- Future royalties have been estimated to be worth "$500-$600 million," as reported by one Reuters writer, and "up to $635 million in royalties to Vringo" by another.
- Maxim Group has issued Vringo a Buy rating and assigned it a $10 price target.
In other words, the running royalty issue appears to be worth about $125 million per year to Vringo, until the patents expire in 2016. As has been reported, "this revenue is 'all cash flow' with little, if any, costs associated on a going forward basis."
While so many are huddled around the tree that is the past damage award, they are missing the fact that they are standing amidst a forest of cash flow. I said it before, and I think it bears repeating. The biggest damages issue in the case was the issue of running royalties, and despite Google's best efforts, this royalty is set to run like Forrest Gump.
I Thought Judge Jackson Has To Award Running Royalties?
You would be correct on that. The jury's job was to decide and award damages for past infringement, and to decide if Vringo should get a running royalty. Judge Jackson's job is to determine the amount of the running royalty. The key here is that Judge Jackson asked the jury to make a decision on what they think that running royalty should be. He did not have to do that, but he did. Their answer, after hearing all the evidence, was that the running royalty rate should be 3.5%. Having gone through the trouble of asking, there is no good reason to anticipate that he will stray far from the 3.5% that the jury deemed appropriate. In fact, if Judge Jackson were to depart from the 3.5%, there is a good chance that the royalty rate would be increased, instead of decreased.
Now that you haven't read it (but I know you'll do that next), let me summarize the following points that are salient to Judge Jackson's determination of the appropriate running royalty issue in our favorite case. All cites to Lavelle come from this article.
The court setting the running royalty rate considers that "the post-verdict period is fundamentally different from the pre-judgment royalty rate because of the changed circumstances of the parties." Lavelle, at 14. In other words, once the Court is deciding a post-verdict royalty rate, the defendant (Google) now holds the status of a confirmed infringer. While the Courts apply various approaches:
Regardless of the analytical approach taken, the ongoing royalty entered by the Court is almost always higher than the royalty rate imputed from the jury verdict. The amount of the increase is [sic] any given case is very fact dependent and no rule of thumb or guidelines as to the amount of the increase has developed in the cases. Ongoing royalties increased 33% or 50% or even doubling the jury royalty rate are common. Only rarely is the court imposed ongoing royalty rate the same as the jury's rate.
Somewhat surprisingly, 24 USC § 284, which allows the court to enhance damages up to three times the damage award, plays very little role in these cases. Presumably this is because the Federal Circuit has suggested that the authority to award ongoing royalties flows from Section 293 of the Patent Act and because of the Federal Circuit's rejection of trebling in Adamo.
Lavelle, at 16-17.
With regard to the question of obtaining a lesser ongoing royalty rate than that awarded by the jury:
[E]ssentially all courts seem to agree with the sentiment stated by Judge Robinson when she rejected this argument stating: "The court declines to allow [defendant], an adjudicated willful infringer, to effectively owe less for its post-verdict infringement than the jury found for its pre-verdict infringement under the circumstances." [footnote omitted]
Conversely, patentees commonly seek enhanced ongoing royalties by appealing to the defendant's status as an adjudicated infringer, and this argument meets with good success, though rarely does it result in trebling of the post-verdict damages.
Lavelle, at 17.
This is not to say that Judge Jackson will enhance the jury's suggested 3.5% royalty rate, but to say that if he were to vary from it, it would most likely be upward, not downward. In this case, Judge Jackson put the question of ongoing royalty rate directly to the jury, and having done so, I believe the greatest likelihood is that he will affirm it. If he deviates from it in either direction, it is highly doubtful that it will be a significant downward deviation , although it could arguably be significantly higher.
You Kissed Him Too?
Some of you remember that great looking guy (or gal) in high school, who was just extremely personable and likeable. It seemed like every girl he asked on a date said yes to him. Well, Google's that guy. The only thing is that Google turned out to be a little under the weather, and the doctor just diagnosed four of the girls Google kissed as having the same thing as Google. No worries, it's treatable, but the doctor's bills vary from about $4,300 to almost $8 million. Oh, and you have to treat it regularly until 2016.
The problem is, Google didn't only kiss four girls. Google kissed a lot more than that. If you are one of the many, many, many, who kissed Google, then don't be surprised if you find yourself needing and paying for the same treatment as AOL, Target, IAC, and Gannett. Vringo will be glad to drive you to the doctor.
This isn't news. James Altucher pointed out this dynamic way back in April. Having lost this case, all of Google's customers who unwittingly used its infringing system are now liable to be sued for infringement. This isn't a $15 million problem, or even a $500 million problem for Google. It's more. I don't know how many girls kissed Google. But the ones who did, know it. How do you think they feel? And in the next case, since the system has now been adjudicated as infringing, query whether such infringement might now constitute willful infringement.
The forest is getting bigger, so let's stop staring at the tree.
But What About The Tree?
Boy, you're persistent. The answer is, nobody knows, but here are my thoughts about the tree.
First, nobody really knows if the jury made a mistake. It is possible that the jury did exactly what it intended to do. If they did, there is a reason for it, and the story will come out. I'm not excited about that, but I'm okay with it, because of the forest.
Second, even if the jury made a mistake, there probably isn't a short and easy way to fix it. At the very least, Vringo will have to gather jurors' affidavits to prove to Judge Jackson's satisfaction that a mistake was made. If it is a simple mistake, like a missing zero, then there I suppose there is a possibility that the Judge could address and maybe even fix, the mistake. But in doing so, we would be creating a minefield of appealable issues. If there was a mistake, there is also the possibility that the mistake was not a simple mathematical mistake, but a more significant mistake, like how the damages evidence was to be interpreted, or how the questions on the jury verdict form interrelated. I suspect this may be the case, because of the several questions the jury asked during deliberations concerning damages. Because of those questions, I doubt that the jury made a simple mathematical error, as many hope and suspect. I think that if a mistake was made, it was a mistake of understanding the interplay between the past damage award (the $30 million) and the running royalty, and when the running royalty would ultimately begin. This kind of mistake would be almost impossible, if not absolutely impossible, to fix without a retrial. Any takers for a retrial? I didn't think so.
Finally, we really need to consider that Vringo may not want to go anywhere near trying to get anything changed with the verdict form. Remember the tree vs. the forest. Do we really want to risk tearing the forest down so that we can replant one tree? As a Vringo shareholder, I am much more invested in consolidating our very substantial gains in this trial than I am in chasing more past damages from Google. I'm sure that Vringo's attorneys are looking at this issue, and maybe they've already decided what direction they are going. We'll know for sure when Vringo files its post-trial motions.
You may feel differently, but we really have to understand that the major battle was won, and decisively so. It may be time to take ZTE to the doctor and let Google go about the business of working to earn us some future royalties.
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.