Big Profits In Intellectual Property, But Beware Of Risks

by: Glen S. Woods

There is quite a market for intellectual property (IP); whether from the technology or the medical sector, patents are bought and sold and litigated on a regular bases. IP companies have made millions buying patents and suing other companies that have infringed on them. Billions of dollars are being spent to amass portfolios, and IP companies that control the rights to use proprietary technology create revenue by charging upfront licensing fees, ongoing royalty fees, and suing companies that may have infringed on their property.

Many of these companies that buy patent portfolios are non-practicing entities (NPEs), which means the company does not focus on leveraging its own technology, but rather acting as a service provider, teaming up with an array of patent owners to help them monetize their IP assets. NPE companies allow inventors and small businesses to stand up to flagrant patent infringements by large multinational corporations that can throw their money and weight around. As Paul Ryan, CEO of Acacia Research Corp. (NASDAQ:ACTG), pointed out, "There was a huge unmet need in the marketplace for an outsourced patent licensing company, particularly for individual inventors and entities such as universities, research centers and start-ups that did not have the expertise or money to go out and commercialize their innovations."

Acacia Research has become one of the leaders in IP by partnering with inventors and patent owners, licensing the rights and sharing in the revenue. Acacia has amassed control over 250 IP portfolios covering technologies used in a wide variety of industries, including patents for Wireless Infrastructure and User Equipment Technology from Nokia Siemens Networks relating to 2G, 3G and 4G wireless technologies. As a partner to the patent owner, Acacia is a non-practicing entity (NPE). And it often pursues legal action against infringers, though historically Acacia has found itself settling infringement issues and then licensing the patent to the corporation it was suing. And as the company's IP portfolio grew, so did revenues and income. In four years, Acacia Research went from a market cap of less than $100 million to a market cap of $1.6 billion today. While the company has been the darling of the IP industry, seeing its stock rise to a July 2012 high of $44.98 per share before working its way back down to a more realistic value, things may not be as rosy as they once were. On Friday April 19th, the bottom fell out of the stock, dropping 27.32%, falling over $8 dollars to close at $21.49 per share.

What caused this 2012 high flyer to fall was that the company announced its first quarter earnings plunged to $5.11 million or $0.11 per share compared to $49.93 million or $1.09 per share for the same period in 2011. First quarter revenues dropped to $76.86 million from $99.04 million in 2011. And while the stock may have been overvalued, the company still is generating profits; according to CEO, Paul Ryan, Acacia had its second highest quarterly revenues in company history. In 2012, the company posted revenues of $250.7 million compared to $184.7 million for 2011, representing a 36% growth rate and the fourth consecutive year that the company saw revenues grow over 35% annually. Acacia also finished 2012 with plenty of cash: $311.3 million in cash, cash equivalents and short-term investments, and that was after investing $26.7 million to repurchase over 1.1 million shares of the company stock at an average price of $23.67. Though I see the stock falling as a case of "great numbers last year, but what have you done for me lately," this is still a company that knows how to generate profits from the IP business, and in 2012 the company invested $328.3 million to acquire a record 55 new patent portfolios and took control of a number of major new portfolios to drive future revenue growth. Now that the stock has fallen, it gives investors an excellent entry point, as its PE has dropped to 16.73 per share. I think that now may be a good time to buy.

Vringo, Inc. (VRNG) was originally in the ringtones for smartphones business, but with its merger with IP Engine, has moved into purchasing patents. Vringo has been battling giants like Google (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) in hopes of generating hundreds of millions of dollars for patent infringements from old technology patents it acquired from Lycos. Last year Vringo was expecting a positive outcome to its lawsuit against Google, and incidentally Vringo filed suit against Microsoft this January based on the same two patents. The company had a lot riding on the lawsuit; it was expecting to win a judgment upwards of $493 million. Though Vringo did win and the jury upheld the validity of the patents-in-suit, finding that the asserted claims were infringed, it was determined that damages should be based on a running royalty. Vringo was awarded a total of $30 million, a drop in the bucket to what it was expecting. Google is appealing the decision. Microsoft on the other hand appears to be possibly negotiating a settlement.

Vringo also has filed an IP infringement against the giant ZTE Corporation (OTC:ZTCOF), a leading global provider of telecommunications equipment and network solutions, claiming that ZTE infringed on three patents whose rights are held by Vringo. The patents, which were part of the 500 patents Vringo acquired from Nokia (NYSE:NOK), are related to mobile phones and infrastructure gear.

Vringo is a $231.5 market cap company, and has seen its stock drop almost 26% over the past six months, mostly due to the results of Google lawsuit announcement. The stock now sits closer to a price reflecting its current business. Revenues for 2012 came at $369,000, $269,000 from mobile-based products, and $100,000 from a partial litigation settlement in August. The company saw a net loss for 2012 of $20.8 million, mostly due to legal costs of $9.5 million with the ongoing litigation against Google and ZTE. Cash and cash equivalents on hand as of March 21, 2013 was $54 million.

What might be a good visual to explain the ups and downs of investing in companies (like Vringo) that trade on legal outcomes of IP patent infringements, days before the Google verdict was read, an erroneous report by an online website was published stating that Google had won the case. Vringo's stock plummeted from $4.46 per share down to $1.87 to finally close at $2.56 per share.

Another example would be Marathon Patent Group (NASDAQ:MARA), an up-and-coming IP services and monetization company, which saw its stock rise 11.76% on Friday April 19th upon announcing it acquired Patent 5,331,637 (a seminal patent cited by over 254 others from owners such as Cisco (NASDAQ:CSCO), Google, Sun Microsystems , IBM (NYSE:IBM), Avaya (OTC:AVYA), and Microsoft), from MOSAID Technologies, one of the world's leading intellectual property management companies. Continuing to build on its IP portfolio, on April 22nd the company announced through the acquisition of CyberFone Systems, LLC it secured a foundational patent portfolio consisting of ten U.S. patents and 27 foreign patents along with one patent pending. The portfolio, which has a large and established licensing base, has been cited in patents owned by IBM, Cisco, Siemens (SI), and in 439 other patents issued or pending in the U.S., and, according to the company, should provide licensees significant value. Earlier last month, Marathon, through its subsidiary Sampo IP, LLC, announced it filed suit against Computer Entertainment America LLC, Siemens Energy, Inc, Dell Inc. (DELL) and four other companies for patent infringement relating to its patents on communications systems and methods.

Whether one agrees with the ethics of buying IPs with the intent to pursue litigation as a way of generating revenue, one can't argue with the success of such a business model. Small companies, individual inventors, universities, and research labs own roughly 60% of all patents, and most lack the skills required to effectively evaluate their IP and mount a successful monetization campaign. Large corporations, on the other hand, do have the skills necessary, via in house or outsourcing, and generate 99% of patent monetization revenues. That is why I still see companies like Acacia Research and Vringo, which have the skills to evaluate IP and can successfully monetize the assets and continue to amass and control a large number of patent portfolios, as good long-term investments. What I like even more is that both companies have seen their stocks drop to what looks to be very good entry points.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.