VirnetX Vs. Apple: Keys Developments Leading Up To The Battle

| About: VirnetX Holding (VHC)
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On Wednesday, VirnetX (NYSEMKT:VHC) will begin its trial battle against technology giant Apple (NASDAQ:AAPL) in federal court in Tyler, Texas. VirnetX investors have waited years for their case to be heard by a jury. The company accuses Apple of infringing on several of its patents, which utilize domain name systems to trigger secure communication links between devices. At that heart of this case is Apple's FaceTime and VPN-on-Demand products.

Investors will be on the edge of their seats for every word of every witness. I, for one, will be right there with them. But in some ways, the rapid events leading up to the trial might be more of a key determinate to the outcome of the case than the trial itself. A flurry of rulings in the past week have reshaped this litigation and provided much needed clarity to VirnetX investors. Court documents can be found here.

In a short period of time, investors have learned several important facts:

1. VirnetX is asking the jury for relief from Apple of at least $800 million, up to ~$900 million.

Actual hard numbers have never been previously disclosed by the company, although it has been calculated in this range previously. (See here and here.) Such a disclosure provides an enormous amount of clarity to VirnetX investors about the business model and the potential value of the company. Calculating damages for Apple in this range bolsters the company's current lofty valuation of around $1.5 billion. Remember, this number is for past infringement of devices in this case only. It does not cover infringement that is ongoing, for example, in the new iPad models, nor any future product sales.

Of course, VirnetX still has much to prove on this front. A jury can declare damages against Apple at basically any number they deem appropriate-higher, lower, or absolutely nothing. The company must again demonstrate they can entice a settlement or license of such magnitude, as they did from their previous court victory and later $200 million settlement from Microsoft (NASDAQ:MSFT).

But what makes VirnetX attractive from an investment standpoint is that, if successful, they would have an opportunity to license a massive pool of communication products. Documents now reveal VirnetX has secured licensing rates between a hefty 1% and 1.6% of products from former litigants NEC Corp, Mitel Networks, and Aastra. Furthermore, Apple's payment would only be for past use of the intellectual property. Since then, Cupertino has sold billions more in infringing products and will continue to do so.

2. A part of Apple's key invalidity defense did not hold up, as a matter of law.

Apple appeared desperate to include evidence which they claimed was "very bad" for VirnetX. A major theme to their defense, it seems, was that they asserted VirnetX's engineers stole the ideas for their patents. The judge ruled they could not present this evidence, as a fact of law, at least in part because the person they alleged came up with the ideas testified that he does not believe himself that VirnetX stole them. As a result, this will not be part of the case, and Apple's expert's testimony to this theory was struck from the record.

3. Apple appears to have wanted to dismiss their invalidity contentions as part of the case, but was denied.

At the eleventh hour, Apple filed to withdraw its counterclaims that VirnetX's patents were invalid. The judge, however, denied this request.

I would caution all investors on reading too much into each party's actions. However, we can see that Apple was fighting hard for their invalidity defense throughout the summer and up until last week, but then suddenly crammed an emergency motion to dismiss these contentions.

Perhaps Apple's law firm changed strategy after losing part of its defense theory (see point #2 above). Or perhaps this is to preserve the record for a ground for appeal. There were likely several contributing factors. But one clear advantage it would have given them is in regards to the ongoing re-examinations of VirnetX's patents by the US Patent and Trademark Office.

Well over one year ago, Apple, along with Cisco Systems (NASDAQ:CSCO) filed a request with the USPTO for another look at VirnetX's patents, which was granted. Those examinations frankly have not been overly positive for VirnetX thus far, although the process is long, inconsistent, and may not be fully complete for years.

However, since Apple must argue invalidity in court, any upheld jury finding of validity will cut off USPTO re-examinations. In essence, this means that the jury's findings could determine the validity or invalidity of the patents, not the USPTO.

Perhaps more importantly, in federal court, Apple must prove with "clear and convincing" evidence that the patents are invalid. This standard presents a higher bar to clear for Apple. Apple's arguments on this front do not just have to be stronger, they must be "clear and convincing". This is tougher to overcome than a "preponderance of evidence", in which one side's arguments simply must be more persuasive, like a slight tip of a scale. This is the lower standard in which VirnetX must prove that Apple infringes its patents. These elements make up a key aspect of a case like this.

The Apple trial is critical at this juncture for VirnetX. There is a lot on the line for this small company. There are no "odds" of winning. Juries can be unpredictable, witnesses can go off the script. However, recent court decisions have actually strengthened the framework of the litigation in the company's favor. In the end, VirnetX is well-positioned and right where they wanted to be all along. The path the company has chosen, or at least the one they were forced down, is not easy and safe. But if VirnetX gets their way, it could be worth billions. For investors, it does not get any better than that.

Disclosure: I am long VHC. 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.