Note: This article covers micro-cap stocks. Please be aware of the risks associated with these stocks.
After some very good feedback and responses to my first article and second article, I have decided to write part two in my patent investing for the second half 2013 series. With the gold rush of IP-centric investments being made publicly available, it is more important than ever to be very selective and informed on the prospects, risks, rewards, and share structure of each potential investment.
First up is Spherix Inc. (NASDAQ:SPEX), a newly reorganized intellectual property company that has been receiving a lot of attention lately as a breakout performer. The company has been raising money and recently announced plans for a patent acquisition from North South Holdings, Inc, for patents that were developed at Harris Corp. The North South deal is expected to close within 60 days of July 1st, 2013, subject to regulatory approval. Investors can execute a search on the U.S. Patent and Trademark Office's assignment database, which will provide all of the information related to the 222 North South patents.
The patent issuance dates range from 1993 through 2007 and cover antennae, pharmaceutical distribution, and wireless technologies. The number of patents is not essential to the evaluation of the acquisition, instead there needs to be high quality patents in the portfolio, which Spherix can monetize through a licensing or litigation campaign. I expect the company to communicate to shareholders more specific plans after the acquisition closes.
On July 17, 2013 Spherix announced an asset purchase agreement with Rockstar Consortium, the winning bidder of the Nortel auction back in 2011. Rockstar will most likely be receiving shares of Spherix as compensation. The exact terms were not immediately disclosed. Spherix expects to initiate a monetization campaign within 30-60 days.
Everything this far looks to be reasonable from a new company focused on acquiring and eventually monetizing intellectual property. However, red flags start to pop up when you start evaluating the current valuation and the expected fully diluted value of the company after the acquisition closes. On the surface there appears to be only 900,962 shares outstanding reported on their July 11th, 2013 proxy filing, representing a company valuation of roughly $6 million. When you read the filing further you can see that significant dilution is involved in the North South acquisition. At the closing of the merger the share structure will include the following:
- 1,019,445 shares of common stock
- 1 share of Series B preferred stock convertible into 1 share of common stock
- 142,261 shares of Series C preferred stock convertible into 142,261 shares of common stock
- 1,488,152 shares of Series D preferred stock convertible into 14,881,520 shares of common stock
- 100,000 shares of Series E preferred stock convertible into 100,000 shares of common stock
- Warrants to purchase 116,708 of common stock
- Options to purchase 2,019,062 of common stock
This translates into over 18 million fully diluted shares. Using the July 16th closing price of $7.00, we are looking at a fully diluted value of approximately $126 million.
The Series D preferred stock does have limitations and will not be converted all at once. A Series D preferred holder is limited from converting shares if their ownership would exceed 4.99% of the issued and outstanding common stock. The Series D holder can increase the limitation to 9.99% of the issued and outstanding common stock on 61 days' written notice to the company.
The Rockstar agreement will likely result in additional dilution. When the terms are disclosed an updated fully diluted value will need to be recalculated.
With the share structure now analyzed, a fully diluted value calculated, and the fundamental nature of the company reviewed, Spherix could be a very lucrative opportunity in the future. I am extremely interested to see the exact assets that were purchased from Rockstar as they were developed at a high quality source in Nortel. The terms of the Rockstar deal will be very important for investors to analyze as they consider an investment in Spherix. The monetization campaign scheduled for later this year should turn some heads as technology titans could be the target of the Rockstar portfolio. While I do not have a current investment in Spherix as the North South merger represents significant dilution, it will certainly be on my radar as further developments are on the near term horizon.
Next, we have at MGT Capital Investments, Inc (NYSEMKT:MGT). MGT is engaged in acquiring, developing, and monetizing intellectual property. MGT has also gotten involved with fantasy sports wagering through their majority interest in FanTD. MGT has also hired an ex-Electronic Arts, Inc executive to create a mobile gaming platform. For all intents in purposes the IP monetization path will drive the value for MGT Capital.
The company is currently engaged in a monetization campaign initiated in November 2012 against Caesars Entertainment Corporation, Inc (NASDAQ:CZR), MGM Resorts International (NYSE:MGM), WMS Gaming, Inc (NYSE:WMS), Penn National Gaming, Inc (NASDAQ:PENN), and Azure Gaming America, Inc. The campaign is proceeding as expected: slowly. A Markman hearing has been scheduled for June 5, 2014, which leaves a substantial amount of time for investors to sit and wait as the slow wheels of the legal system turn.
FanTD and the eventual mobile gaming platform will have a very difficult time generating revenues to contribute to the current $27 million valuation. The company has $8.5 million in cash, zero debt, and previously disclosed that it has an adequate cash balance to support operations through June 2014. With zero catalysts or events on the horizon for the second half of 2013 and much time remaining before the Markman hearing on June 5, 2014, I cannot justify an investment in MGT for my portfolio. In my opinion, investors should wait for the rest of 2013 to pass and re-evaluate the company in Q1 2014, which will prevent them from being exposed to such an expansive litigation timeline. Events that would change my thesis would be additional IP acquisitions, settlements, non-defendant patent licenses, and material revenues being booked from the fantasy sports business.
Lastly, I wanted to provide an update on events that have transpired in my prior two articles.
- 4,535,714 warrants with an exercise price of $.50 were exchanged for 4,535,714 with an exercise price of $1.00.
- The Series A and B convertible notes were exchanged for 7M shares and the payment by the company to such holders of an aggregate of approximately $1,951,400.
- The Series C convertible notes had their restrictive provisions eliminated.
VirnetX Holding Corp (NYSEMKT:VHC) had an appeal filed to the Court of Appeals for the Federal Circuit on July 1st, 2013 by Apple, Inc. The appeal will include all events except for the severed ongoing royalty motion. In regards to the severed ongoing royalty, the Honorable Judge Davis has set a hearing for August 15, 2013. It is unknown if he will issue a bench ruling or need additional time to decide on the matter further. I am in the camp that believes he will need an additional 2-6 weeks to write his final opinion on the matter. VirnetX is also waiting for the Honorable Judge Davis to rule on a retrial motion in regards to its litigation with Cisco. I do not anticipate a new trial to be granted. With patent litigation, I always prepare for the unexpected as anything can happen.
MarathonPG (NASDAQ:MARA) started off Q3 2013 with a settlement with an unnamed payment terminal company. I am anticipating an additional 2-4 settlements in Q3 2013 to be announced. The TQP patent has been removed from the MarathonPG website, indicating that the transaction did not complete. I am hoping the TQP transaction will be replaced by an additional patent acquisition.
Vringo, Inc (VRNG) is currently waiting for an ongoing royalty decision from the Honorable Judge Jackson. There have been no updates on the case.
Disclosure: I am long VHC, MARA. 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.