Key Patent Players: Stocks With Large Potential

by: Alexander Maxwell

Patent stocks have become an interesting concept as of late. Some people call them patent trolls, however from a pure speculation standpoint their idea has been quite interesting. There is a large amount of money to be made through correctly predicting a court's decision, and through being able to get in early in some of these patent companies. If you are looking to speculate based on some upcoming court decisions, I would refer you to my recent article. This article will address some of the patent companies that are currently generating buzz around the investment community.

One company that seems to constantly be in the headline these days is Vringo, inc. (VRNG). Vringo has had a much publicized lawsuit against Google (NASDAQ:GOOG), in which the jury awarded Vringo $30 million plus a 3.5% royalty rate until the expiration of Vringo's patents. Vringo was litigating over how Google ranks ads, claiming that the algorithm used by Google infringed upon Vringo's patents. A key question of the trial has been 3.5% of what, Vringo maintains that it was 3.5% of the 20.9% revenue increase which Google saw as a result of infringing upon Vringo's patents. Google maintains that subsequent to how the jury calculated past damages, that it was 3.5% of 2.9% of the revenue increase. I would lean, however, towards the former.

It is very rare for a judge to award co-defendants different royalty rates, and as the jury used that rate for everyone except for Google, it would seem as though the jury made a simple arithmetic error. I would also support this conclusion due to the fact that the 20.9% royalty rate was the one that Vringo showed to the jury, so there would be no basis for a different royalty rate. Remember, during the trial Google chose to try to argue for a lump-sum, and presented no counter royalty number. This should hurt Google now that the jury has come back determining that Vringo is entitled to royalties. However, the judge has still not officially ruled on what is going to happen, Vringo seeks to have the rate increased, while Google would like to see the entire verdict thrown out. It is very rare for a judge to go against what a jury has said, so I would not expect any sort of judgment where the case is thrown out.

Vringo has also recently received some press when it was announced that Vringo is in settlement discussions with Microsoft (NASDAQ:MSFT). Vringo is suing Microsoft for the exact same thing as Google, related to the search patents that Vringo owns. Vringo is also currently suing a third company, ZTE. Vringo has filed these lawsuits in Germany, Britain, and recently in France. These are related to telecommunications infrastructure patents, which Vringo obtained from Nokia (NYSE:NOK). Also importantly, Vringo just announced that the judge has rejected Google's Judgment as a Matter of Law motions. The court also rejected Vringo's motion for a new trial solely on past damages. This however, does not completely close the door as to whether or not the judge will correct the mathematical error of the jury. Vringo is a company with huge potential, and a company that has the potential to be a thorn in the side of large corporations for many years to come. Vringo is also working on its next generations of patents, due to a recent agreement signed with Virginia Tech.

A much bigger patent player, with a proven track record is VirnetX (NYSEMKT:VHC). Virnet X has won patent infringement lawsuit against some of the biggest players in the industry; including a recent win against Apple (NASDAQ:AAPL) to the tune of $368 million. This verdict was due to VirnetX's patents related to network technology. Also of note is that the judge ordered for Apple to pay Virnet X more than $330,000 per day until the companies reached an agreement amongst themselves. Despite VirnetX's success, it has not been without bumps in the road. One major road-bump came when a jury ruled that Cisco (NASDAQ:CSCO) did not infringe upon patents owned by VirnetX. Ironically, this was over the same technology as the technology utilized by Apple.

VirnetX has made a history of going after industry titans, considering that it settled a similar lawsuit in 2010 versus Microsoft for more than $200 million. Virnet X is once again taking on Apple, this time going after Apple for the next generation of devices. As is typical, VirnetX asks for an injunction, the odds of this happening are relatively low within the United States of America. It is probable, however, that VirnetX and Apple might settle, provided that the judge does not rule that these products were covered within the scope of the original lawsuit. Apple does not want another courtroom embarrassment and also there is solid basis for the demands of VirnetX, and the price that Apple would have to pay is much clearer, now that a court has ruled for both sides what the value of a license from VirnetX would be worth.

Another idea which is interesting if they do go to trial is the idea of treble damages for willful infringement. This time around, Apple knows about VirnetX's patents, it knows about the enforceability of the patents, and it knows that they exist. With this in mind Apple continues to infringe upon the patents, and hence could be hit with the status of a 'willful infringer' which would open for the doctrine of treble damages. With continued courtroom success, investors have very high hopes for this company. VirnetX has shown its willingness to battle in court with the biggest companies in the world, and it is large lawsuits like the ones mentioned above that shareholders have come to expect from VirnetX's legal team.

Now, shifting to a much smaller player in the patent litigation field, but one with similar potential should it win in front of a jury is MGT Capital Investments (NYSEMKT:MGT). MGT is a company with a rather small $10.74 million market cap. MGT represents, in my opinion, one of the better values out of the patent plays as it has a huge amount of upside potential should it win its upcoming patent lawsuit. MGT filed a lawsuit in November 2012 in the Southern District of Mississippi for patent infringement. In the lawsuit they allege that the defendants infringed and continue to infringe upon MGT gaming's (a majority owned subsidiary of MGT) patents regarding a "Gaming Device Having a Second Separate Bonusing Event". The defendants are some very big names within the gaming industry: Caesars Entertainment Corporation (NASDAQ:CZR), MGM Resorts International (NYSE:MGM), Penn National Gaming inc (NASDAQ:PENN) and Aruze Gaming America. These are all companies that MGT has identified as either producing the infringing products, or as operators of the infringing products.

A significant upcoming event in the next few months would be MGT's Markman Hearing regarding its lawsuit. For those of you who don't know, a Markman hearing is a hearing in which the court determines the language of the patent that can be displayed to the jury. This is obviously very important, as if a company gets its interpretation of the definition of the patent into the court, it could help to serve as a basis for its lawsuit. Similarly, the risk would be in this hearing for the plaintiff if the court tailors down and gives a much more narrow definition/interpretation of the patent, as it should be much harder in that scenario to determine patent infringement. The Markman hearing date has the potential to send the price of the stock way up, for examples see Vringo, ParkerVision, and VHC before and after their Markman hearings.

Anyways, back to MGT's lawsuit, MGT has a good lawfirm in Nixon & Vanderhye representing them in their patent lawsuit. A courtroom verdict or settlement for a small cap stock like MGT would be huge for the stock price, and would help to demonstrate the enforceability of MGT's patent portfolio. This is key, as if MGT wins it would open up the doors for licensing deals with other companies who are making similarly infringing slot machines, as these companies would also not want to lose in court versus MGT. With a small market cap, but the potential for significant damages to be inflicted upon the defendants, MGT has some fantastic potential to generate results for its shareholders. MGT is one of my favorite buys in this article, due to its relatively small market cap, and the large potential for damages. Obviously, the downside to this risk is if MGT loses its lawsuit, it would have paid money for its attorney fees for absolutely nothing.

Keeping with the David vs. Goliath theme, another company who has recently emerged in the patent space is Worlds, Inc. (OTCQB:WDDD). Worlds holds many different patents regarding the construction of Massively Multiplayer Online Roleplaying Games (abbreviated: "MMORPG"). Worlds made headlines when it filed a lawsuit against Activision Blizzard (NASDAQ:ATVI). This is related to ActivisionBlizzard's extremely popular World of Warcraft and Call of Duty games. In this lawsuit, World's seeks unspecified damages, and demands a trial by jury.

Just like MGT, Worlds also has an upcoming Markman hearing date, which should help to boost its stock price (provided that the ruling goes mostly World's way). The Markman hearing date is currently June 27th, 2013. Worlds is another stock with a relatively low market cap at $31.09million at the time of the writing of this article. For this reason, Worlds represents one of the better risk reward ratios versus the other stocks in this article. Also, given Worlds' recent $2.3 million dollar financing agreement, the risk of dilution by Worlds in order to fund its lawsuit has largely been contained. The interesting concept with what Worlds is doing is that it seems that if the company should win its lawsuit, similar to MGT, it would pave the way for a great deal more in terms of licensing deals with companies that create similarly infringing products. With both Worlds and MGT suing some of the biggest companies in their respective industries, are they future VHCs or just wannabes?

Another very interesting play is Document Security Systems (NYSEMKT:DSS). This company is actually not your 'traditional patent troll' in the sense that it has revenue which is actually rather substantial, and an underlying business. In Q4 of 2012, DSS reported $5.4 million in revenue. However, the reason that the company is a patent play is due to Document Security Systems' upcoming merger with Lexington Technology Group. This merger is on pace to close in the spring of 2013. This should be well in time for Lexington's Markman hearing on October 2nd, 2013.

So what exactly makes Lexington/DSS an interesting patent play? It is who Lexington is suing that is grabbing headlines, they are suing Facebook (NASDAQ:FB) , LinkedIn (LNKD), Novell, Broadvision (NASDAQ:BVSN), and Jive Software (NASDAQ:JIVE). Lexington, unfortunately, was not able to keep the case in the Eastern District of Virginia and the judge recently transferred the case to the Northern District of California. This could be significant in terms of a timeline for the case, there is a reason that Facebook and the other defendants wanted to move the case away from Eastern Virginia's fast-track. Not to mention the fact that a jury in Eastern Virginia is not necessarily the same as a jury in Northern California in terms of jury verdicts. Nonetheless, the case does seem to be making progress, and as soon as the merger is completed this stock could become one to watch very quickly going into the Markman hearing.

With DSS also having generated revenue, this stock is shaping up to become a very interesting patent play, and a favorable play for shareholders as the revenue generating Document Security Systems should help to offset the potential negatives of Lexington Technology Group losing (should it lose). A potential downside would be, although unlikely, if the merger does indeed fall through expect DSS's valuation to drop, as part of the movements of the lawsuit seem to already be baked into Document Security System's stock price. This stock has high potential, and is another case of a relatively small company taking on some rather large corporations.

A final patent play that I would like to analyze is ParkerVision (NASDAQ:PRKR). Parker recently had a favorable Markman order versus Qualcomm (NASDAQ:QCOM). Parkervision is a model for what a favorable Markman order can do for a stock. On the day before the Markman order, February 20th, ParkerVision was trading at $2.43 per share. The next day after the favorable Markman hearing is announced, ParkerVision was trading at $4.21 per share. This represents a substantial gain for shareholders due to the favorable markman ruling.

ParkerVision is essentially suing Qualcomm over Qualcomm's utilization of products that ParkerVision asserts goes against its patents on radio frequency technologies. If you would like to go much more in depth, here is the complaint. ParkerVision also survived a significant hurdle recently when the court denied Qualcomm's motion to dismiss ParkerVision's claims of indirect infringement. All that is significant about it means that the judge feels that there is enough evidence to be presented to a jury, not necessarily that the judge believes that ParkerVision will win its case. However, given a successful Markman hearing, it would be a safe statement to say that Parkervision's chances of winning did indeed increase. When ParkerVision won on its claims as to how the patents should be interpreted, the company won a more broad version than what Qualcomm wanted presented to the jury. A broader patent means more potential for a jury to find infringement, and thus to rule in ParkerVision 's favor. ParkerVision after its recent secondary offering, should have more than sufficient cash and cash equivalents to take it through to a jury verdict. Overall, ParkerVision is yet another patent play with substantial potential suing a much larger company.

All of the patent plays mentioned have their merits, but they also face the risk of losing. Trying to predict a court result is inherently quite risky, but there is a great amount of money to be made should an investor pick correctly. Many of these companies are suing industry leaders, and each of the stocks mentioned, in my opinion, have the potential to grow in value as they continue to sue much larger corporations. Investing in patent stocks is inherently risky business. If a small cap company loses it is possible for the patents that the company holds to be worth nothing. However, it is also possible for a company to hit the proverbial jackpot like VirnetX has in terms of its Apple and Microsoft litigation.

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.