Network 1 - A Sum Of Parts Value Opportunity

|
About: Network-1 Technologies, Inc. (NTIP)
by: Adam Stich
Summary

Company sells at net current asset value.

There is no debt.

Potential patent litigation or other catalysts could substantially boost stock price.

The investment thesis for Network 1 Technologies (NTIP) is fairly straightforward: The company has low cash burn, a cash and marketable security value equivalent to the current market price, and a variety of ways to win on the upside if only one potential catalysts play out. In a nutshell, Network 1 technologies is a story of litigation. Under the leadership of CEO Corey Horowitz, the company has turned buying patents and litigating them into a truly successful business model.

I would like to start this article by pointing readers to other SA authors that have done extensive work on Network 1. They are listed below in no particular order:

Although I discovered Network 1 Technologies using my own screener, I feel as though these authors added to my perspectives and boosted my confidence in the investment thesis. In addition to reading this article, I strongly encourage anyone interested in Network 1 to read the aforementioned authors.

One of the reasons Network 1 is such an attractive company is its asset light model. Unlike a biotech or a company that requires substantial capex contributions, Network 1 is asset light. Their largest annual expenses are typically legal fees, most of which are based on contingency. In other words, Network 1 pays their lawyers between 10-30% of net proceeds if they win settlements or cases (p. 10 of 2018 10K). For instance, Russ, August & Kabat provide legal services to represent Network 1 in their litigation against Google and Youtube (GOOGL). Should Network 1 win or settle the case, Russ, August & Kabat would earn 15-30% of net proceeds, plus legal expenses.

The Assets - Cash and Marketable Securities:

The assets of Network 1 are primarily made up of patents, cash and marketable securities, and a biotech equity investment. The cash and marketable securities are the easiest to value: As of Q1 2019, there was $21.6 million of cash on the balance sheet ($.91 per share) coupled with $30.8 million of marketable securities ($1.29 per share).

The most recent 10Q shows that the $30.8 million in marketable securities include certifies of deposits, bond mutual funds and corporate credit, all of which earned $301,000 in interest income for the company in the first quarter of 2019. Given that total expenses in the first quarter were $1.1 million, interest income from marketable securities offset around 25% of total expenses.

The Assets - Remote Power Patents (The Crown Jewel):

The second set of assets that Network 1 owns are patents. In total, they own 65 patents. The legacy patents are a part of the Remote Power Patents (RPPs), which have been Network’s 1’s bread and butter for the past 12 years. In fact, it would be an understatement to say that RPPs were a slam dunk for the company. As of the most 2018 10K filing, Network 1 has generated over $144 million in proceeds from these patents alone, nearly all of which from the power over ethernet (PoE) patent. And what was the initial purchase price of the RPPs? A mere $100,000 (2008 10K). Since the initial purchase from Merlot, Network 1 has made milestone payments on a percent of income generated from the patents. Below are my own calculations based on an outline of the initial purchase price and milestone payments:

(Figures from the 2008 10K. Calculations are my own)

For a mere $3.9 million, Network 1 turned the RPPs into a 3692% return goldmine. The real value came from the power by ethernet patent, which allows devices to receive power remotely via an ethernet cable (p. 6 of 2017 10K). As of December 2018, Network 1 may cease to receive further royalty revenue from the PoE patent unless a November 2017 court decision is overturned. In the case, the courts decided that HP (HPE) did not infringe on Network 1’s PoE patent. Consequently, HP, Cisco, Dell and other licensees halted royalty payments to Network 1. Given that the PoE patent was the biggest revenue generating asset, Network 1’s stock tumbled on the news. Over the course of ten days in November 2017, Network 1’s stock dropped from $4.25 to $2.5 .

While this was disturbing, it may have been a helpful jolt to find other revenue generating opportunities earlier than otherwise anticipated. The RPPs were set to expire in March of 2020 anyway, a mere three years after the unfavorable HP verdict (see pg. 8 of 10Q).

Furthermore, Network 1 appealed the case in November 2018 and is seeking restitution of backpay from PoE licensees. If the HP verdict is overturned, then companies like Cisco, Dell and HP would have to make backpay royalties from November 2017 until expiration of the patents in March 2020. Cisco, for one, had an agreement to pay Network 1 $9 million annually until March 2020 (p. 11 of 2017 10K). Thus, a change in verdict for the HP case could easily result in at least an $27 million payment from royalty licensees (an additional $1.17 per share) from Cisco alone. While it may seem like a long shot for Network 1 - a nano cap stock - to successfully appeal against the likes of HP, it would not be unprecedented for them to win such a court case. It has been the David taking on Goliath’s since the company’s first foray into markets. Network 1 has a market cap of just over $50 million, yet it has arguably won court cases (via settlements) from the likes of Apple (AAPL), with a market cap of nearly $800 billion. In the case of Apple, Network 1 settled their Mirror Worlds patents for a cool $25 million, half of the current market cap. Can lighting strike the same place twice? Time will tell.

The Assets - Mirror Worlds Patents:

Like the RPPs, the Mirror World Patents are set to expire in February 2020. Indeed, eight of the nine patents in the Mirror Worlds portfolio have already expired. Nevertheless, the technology has been lucrative. The patents were acquired in 2013, and they cover, "foundational technologies that enable unified search and indexing, displaying and archiving of documents in a computer system,” (p. 4 2018 10K). Originally, the company paid $3 million plus warrants for the patents.

(Figures from 10K filing. Calculations are my own)

Similar to the Remote Power Patents, Network 1 lost a patent infringement case to another large cap company, Facebook (FB), in May 2018. Days after the summary judgment, Network filed a notice of appeals to the federal circuit, and no hearing date has been set (pg. 27 of 10Q).

Cox Patents:

The third basket of patents owned by Network 1 are the Cox Patents, which were first patented in 2000. The company has since filed 32 additional patents from the original Cox patents. Of the 32, 27 have been issued. In a recent press release, the company stated that they expect further issuances from the Cox patent portfolio in the future.

The Cox patents were acquired from Dr. Ingemar Cox in February 2013 for an original purchase price of $1 million. They relate to enabling technology for identifying media content on the internet. Since then, Network 1 has launched two litigation claims against Google and Youtube (GOOGL). Little has happened with the litigation; however, there are court proceedings commencing in August and September of 2019 (p. 39). If the proceedings end in a settlement or a win, this is yet another potential catalyst for Network 1. Unlike the RPP and Mirror World patents, the company has not monetized the Cox patents to date.

M2M/IoT Patents:

In December 2017, Network 1 acquired twelve patents relating to “enabling technology for authenticating, provision and using embedded SIM cards in next generation IoT (Internet of Things).” The company paid $1 million for the patent portfolio and owes M2M the first 14% of $100 million in proceeds, if they’re ever realized. In 2018, they received six additional patents for M2M, bringing the total count to twenty.

Like the Cox portfolio, Network 1 has yet to generate revenue from M2M patents.

Foray into Biotech Investment:

The final asset owned by Network 1 is a passive $5 million investment in a private biotech company called ILiAD Biotechnologies. ILiAD is a developmental stage biotech that is working to create an intranasal vaccine (BPZE1) for Pertussis, whooping cough. In 2018, the FDA cleared a investigational New Drug (IND) for a Phrase 2a study for BPZE1. Assuming successful clinical trials, ILiAD expects to generate $2 billion in annual sales in the adult and adolescent Pertussis prevention market.

Network 1 initiated their investment in ILiAD biotech in December 2018. Since inception, ILiAD has raised $23 million in equity capital, which translates to Network 1 owning 21% of the equity. Due to Network 1’s investment, CEO Corey Horowitz sits on the board of ILiAD.

Summary and Timing of Trade:

From June 2018 to today (June 2019), Network 1 has traded in the range of $3.25 and $2. Given that net current asset value is around $2.20, I recommend looking closely at a trade when it falls around or below that range, as it is today at $2.30. Last week, I saw the price drop as low as $2.12, which would be an excellent point to buy in.

The company’s cash, I believe, is generally safe, as Network 1 has an asset light operational structure. Their cash burn rate is around $1 million as of Q1 2019, prior to dividend and buybacks. On a go forward basis, Network 1 could burn $4 million per year, which leaves about a 12 year runway for current cash levels. Oh, and did I mention there’s no debt?

There is currently a dividend in place of 5 cents per share paid semi-annually. Also, the company issued a share repurchase program in 2017 of up to $5 million. As of December 2018, there was $3.5 million still left in the program (p. 32).

In spite of the positive balance sheet, there remain issues that make timing the trade difficult. The catalysts that could cause the stock to jump 50% or more are based on litigation and or possible settlements.

  • Mirror Worlds Facebook litigation - On August 2017 Network 1 appealed a court order against Facebook (FB). No clear timeline for an appeal decision or a settlement. Either a court judgment in Network 1’s favor or a substantial settlement with Facebook could be a catalyst.

  • Dell Litigation - Dell stopped paying royalities to Network 1 based on the results of the HP verdict. Network 1 appealed the case. Dell’s motion to stay the legal proceedings was denied on May 7, 2019 (p. 38 of Q1 10Q). A “stay” means to drop the proceedings. Consequently, a denial of “stay” means the case will proceed in the courts, which could be positive for Network 1.

  • Cox Patent Portfolio litigation - The court proceeding for claim construction will begin in August and move to discovery in September of 2019. Either a positive court ruling in Network 1’s favor or a settlement with Google could be a catalyst.

  • HP appeal litigation - Arguably the most important litigation underway is the HP case. Network 1 appealed the decision of non-infringement in September 2018, and no date for a hearing has yet been set. A favorable legal proceeding or a settlement could be a substantial catalyst for forcing backpay royalties from the PoE patent.

  • Positive Phase 2A results from the Pertussis BPZE1 from the ILiAD investment could also be a catalyst. The Phase 2a trails, which began in December 2018, are still underway at Vanderbilt university. Phase 2 clinical trails typically take several months to two years, and about one third of drugs clear both phase 1 and phase 2. Given that timeline, ILiAD could release results at any time. Positive results could act as a catalyst, as Network 1 owns 21% of the equity in ILiAD.

  • Monetization of the Cox portfolio or the M2M portfolio could also act as a potential catalyst. However, there is no way to know if or when this could commence.

In summary, an investment in Network 1 provides wonderful sum of parts value. At the current price around $2.30, an investor gets a debt free company with cash and marketable securities equal to the current stock price, a cornucopia of patents, a leadership team that owns 29% of the stock, a legal team with success in patent defense, 21% of a biotech company, and a whole splattering of potential litigation results to boot. In my view, there’s a lot to like.

That being said, an investment is Network 1 is not for everyone. It’s basically a nano-cap, which virtually eliminates large investors from even considering it. However, for individual investors like me or small firms, Network 1 is worth a close look.

Disclosure: I am/we are long NTIP. 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.