With stocks marching their way forever upward in the past year, there is a lot of talk nowadays about whether the US markets are overvalued.
On this question alone I'll just say that I certainly do not have a crystal ball, and I'll leave the guessing (oops.. I mean accurate forecasting!) of where the market is headed in 2014 to other market pundits out there.
Lately though when looking for good value opportunities, I am mindful of the potential market overvaluation, and I have been leaning heavily on solid balance sheets with real tangible value, as this ensures a strong cushion on the downside risk, even in the event that the market decides to head south. I'm frequently reminded by Warren Buffett's famous quote: "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1."
With these thoughts in mind, Recently I've taken a look at Internet Patents Corporation (PTNT), which I think is a company that has very minimal downside risk; In fact about as little as I've ever seen, as the company currently trades for a market cap of $24.5m yet it has net tangible assets (all cash) of about $31m with no debt. In this article I will cover several points why PTNT is a worthwhile investment today:
- In the best case scenario, if the company wins any of the appeals in its current cases it is likely to appreciate at least 50% in the next 2 years
- CEO Hussein Enan owns about 25% of the company, and at the age of 69 is unlikely to want to continue burning cash for long without positive litigation outcomes. As a result, value is likely to be unlocked sooner rather than later.
- In the worst case scenario, the company is worth at least 20% more than the current market price, a valuation that likely would be realized in the form of a liquidation in the coming 1-2 years (assuming the company fails at its current patent litigation)
Business Primer and Recent Events
PTNT was an early internet company that provided an online insurance marketplace (then known as InsWeb), and in December 2011 it sold off all operating businesses for around $60m. A few months later the company paid out a large special dividend of $38m, and since then it has retained the balance of proceeds. As part of the sale the company maintained the ownership of 6 e-commerce related patents, and shortly afterwards it changed its name to reflect this, and stated its sole business mission was going to be to pursue monetization of this intellectual property. In summary, the company's patents cover things such as:
In 2012, the company initiated its first lawsuits around 2 of its patents:
- The 6,898,597 Event Log Patent, and
- The 7,707,505 Dynamic tabs for a graphical user interface Patent.
Unfortunately the lawsuits have not gone as planned. In April 2013, the 2 defendants in the 597 event log patent case, eBags, Inc. and TellApart, Inc., challenged the validity of this patent, and the case was agreed to be heard by the U.S. Patent and Trademark Office (USPTO). This means in essence that it could be up to a few years before the company will know the outcome. The management and board have also indicated they will not pursue any further monetization of this patent in the meantime.
On the 505 Dynamic Tabs patent case, this one hasn't gone any better, as the patent was ruled invalid in September 2013 by a California district court, and the case was thrown out against all 4 defendants (The General, Tree.com (NASDAQ:TREE), Quinstreet, Active Networks). Internet Patents Corp is appealing this ruling, but has stated it is likely to be a year or more before the case is heard.
In conclusion the company's lawsuits have both hit roadblocks, and the outcome is highly unpredictable and likely not known for 1 or 2 years from now. What's further is that the company has publicly stated it will not initiate any further lawsuits for at least the coming few quarters as it focuses on the cases at hand.
Valuation of the Remaining Assets
So although initial legal actions have been discouraging, I think all is not lost for this company. The valuation of remaining assets, which is almost exclusively cash, is still discounted by more than 20%:
Total liabilities are only $1.3m as of the last filing, which means the tangible book value is currently sitting at $32.2 - $1.3 = $30.9m. This against a market cap of only $24.5m. Sometimes you see stocks with a P/B under 1 which have a substantial amount of assets which are difficult to value (e.g. excess inventory), but this is not the case with PTNT, as we can see that everything is cash and equivalents which is invested in very conservative time deposits or the like.
This company is sitting on more than $30m in cold hard cash, which means that upside from current levels could easily be greater than 25% just based on this fact alone.
What about Operating Expenses?
The company has been running operating expenses of about $400k - $600k per quarter in 2013. This is mostly to pay the salaries of the 3 employees (CEO, CFO, Legal Counsel), general administrative fees for the cost of staying public, as well as some minor expenses for leases. The company operates out of a modest 800 sq. ft office, but they still have some 5 year lease obligations of much bigger properties, one of 10000 and the other 16000 sq. ft, which are the former operating facilities of the company before it sold off its business in 2011. Both are being sub-leased for the remainder of the terms, and the smaller of the two will be completed already September 2014.
The CEO has publicly stated in December that they expect to spend $400-$500k per quarter in 2014, so this will deplete about $2m in cash for the year. However at this run-rate, it would still take more than 3 years to erase the margin of safety from the current market price. This makes today's price very attractive.
Management - CEO Enan Hussein
CEO Hussein owns 25% of the company, and is seemingly quite aligned with shareholders in wanting to maintain what the company has. For sure he has no interest in burning away the cash on the balance sheet ($6m+ of which he is directly entitled to). What I like here is the fact that he is a founder of the original InsWeb company in 1995, and successfully built up that business until its sale for $60m in 2011. So that business was for sure his "baby" in some respects, and he does not want to throw away all of his hard earned cash now after the sale, especially at the age of 69. So we can assume that he has stayed on for a few more years with the strategy to see if they could give it one go at monetizing some of their patents, and thereby greatly increasing his wealth just as retirement looms. But if the strategy doesn't work, he will look to cash out and return remaining proceeds to shareholders. I can imagine that there is quite a short leash on this approach, and I suspect it is why the company has decided at this time not to pursue any more uncertain litigation (and incur more legal fees in the process), and instead it will hold out to see how the current cases develop in 2014.
I don't see a lot of financial risks with this company, but there are a few things to be aware of for potential investors:
- The IRS has recently told the company in July 2013 that its tax returns from 2011 would be audited. Currently the company doesn't expect any financial impact from this, but it is hard to predict the outcome. PTNT does have substantial net operating loss carryforwards, more than $142m for federal taxes alone which doesn't begin to expire until 2019. So i don't see that there is a lot of risk related to this audit even if it turns out the company owes tax. It could be a catalyst to help the stock price get back to the mid $3s going into next year once it's resolved.
- The Innovation Act. This bi-partisan bill is making its way through the US Congress currently, and it is designed to discourage "patent troll" businesses from operating with abusive tactics. Although it is not yet clear what the eventual impact of this bill could be, it has served the purposed to cast a more negative view of patent companies, which could also be contributing to the share price weakness of PTNT. The bill will of course still allow for defense of viable patents, so I suspect that the long term impact of this will be minimal, and especially in the near term in relation to current litigation pending for PTNT. After the company has lost its initial verdicts, it would already seem to be a long shot at first glance to be successful on appeal, although it should be noted that according to some legal sources, success rates on patent litigation appeal can be quite high, even as high as 75%.
The Bottom Line
Even if all litigation fails, investors today would still break even if all the legal cases dragged on for 3+ years. However I think this is inconceivable that management will let this happen for 2 clear reasons:
1) Well before this point the company is likely to either cease operations and liquidate, if it fails to make progress next year on its litigation cases. This seems especially true since the company has publicly stated it will not start any new cases at this time, which seems to indicate they want to preserve current capital and are currently putting all eggs in one basket, to give it one shot for a big settlement.
2) The CEO will want to preserve his own wealth, and at the age of 69 he is unlikely at this point to be going on a shopping spree, pursuing risky acquisitions or other potentially value depleting uses of his hard earned cash.
So put these thoughts together and I believe this company is a boring, yet good investment at today's prices. You cannot lose with almost no downside possibilities, and you could win anywhere from +20% to well over 50-100% in the event that the company suddenly scores a win on one of its pending legal cases. Although the company has sued mostly small cap private internet firms, it is conceivable that they could still win total settlements of $10m or more. This would cause the stock to appreciate significantly from today's level, probably 50% or more, and it would open the door for much bigger claims against larger firms as it would show the legitimacy of the firm's patents. In one sense it could be that was the strategy all along of this company, to start off testing the waters against some smaller firms, and only if successful would they pursue big claims against larger e-commerce giants (and if unsuccessful, liquidate and call it a day).
Investors should take advantage of the recent share price weakness (near 52-week lows) to get in now with a strong margin of safety. With no downside risk, you can sleep at night owning this own, and patient investors should let the upside take care of itself.
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.