On August 15th, VirnetX (NYSEMKT:VHC) and Apple (NASDAQ:AAPL) again met in Tyler, Texas in front of a Federal Judge to discuss a fair and reasonable royalty rate for the use of VirnetX technology in Apple's VPN on Demand and FaceTime applications.
Following the hearing, VirnetX shares plunged as low as $17, 17% off the closing price of $20.50. Although I did not attend the hearing, if the feedback I am getting is accurate and I understand correctly, nothing would merit the steep decline share price.
The big headline emerging from the courtroom was that Apple developed a "workaround" to VirnetX's patents for FaceTime. This really should not be news. If we have learned anything, it is that Apple was not going to walk into the courtroom today with nothing. Further, Apple has always employed this non-infringing method by using relay servers, from what we learned in court last year, at least 5% of the time. Now we learn Apple is running 100% of FaceTime calls through relay servers, to implement its workaround.
But the devil is in the details.
VirnetX alleges that evidence shows this could cost Apple an extra $120M a year to continue. Further, Akamai (the company from which Apple leases the relay servers) expressed concern with current capacity, stating increased demand will require expansion of servers in 2014 and beyond.
VirnetX also alleged such a workaround has degraded FaceTime user experience, citing a half million user complaints since the switch.
From a subjective point-of-view, these problems make sense. Why wouldn't Apple have simply done this years ago to avoid litigation if it were indeed desirable and cost-effective?
Apple's workaround actually demonstrates that VirnetX technology is superior and, importantly, valuable. Apple is playing a game, utilizing an expensive and more complex system, while possibly leaving users worse off. It certainly can afford to be stubborn, but it is costing them.
Regardless, I would caution investors against an overreaction here. I would not lose sight of the fact that the judge has not ruled on anything yet. And nothing that occurred today would indicate he would support any royalty rate significantly lower than what VirnetX is proposing. In fact, evidence Avaya settlement and license. What happened in the courtroom today was lawyers simply being lawyers.
Even if the FaceTime workaround is successful, this does not affect the $368M verdict, nor the post-verdict damages, nor the enhanced damages & rate for willful post-verdict use, nor the royalty for use at least until April (even Apple suggests up to .5% could be fair). This also has no bearing on VirnetX's ability to secure royalties on the implementation of future LTE networks. Apple is at best implementing an inferior system to secure and initiate Facetime calls. At worse it is engaging in a ploy to maneuver the justice system.
VirnetX also appears to have asked the court to issue a royalty rate at least up until the alleged workaround began. Arguments about whether these workarounds are "colorably different" could be dealt with separately later. This could be significant if the Judge agrees to that process. Any ruling of a royalty rate will by key in further bolstering VirnetX's licensing agenda, not only for Apple, but for non-litigants on the sidelines…
Disclosure: I am long VHC.