Speculation In The Patent Litigation Segment: Finding The Next Big Stock Movers

by Scott Matusow
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Submitted by Scott Matusow as part of our contributors program.

There has been a lot of buzz lately about Vringo’s (VRNG) patent infringement lawsuit against Google (GOOG). Google’s ad placement system and its possible infringement of the Lang/Kosak Relevancy Filtering Technology with patents 420 and 664 are being called into question. The Lang/Kosak Relevance Filtering Technology has been proven to produce “better” search engine results for user queries. It’s my opinion based on the buzz lately that Vringo will likely win its case against Google, barring a settlement prior to a verdict in the case, which is currently more than half way finished.

As an example just how lucrative these types of lawsuits can be for certain companies and their stockholders, VirnetX Holding Corporation (VHC) won a $105 million judgment from Microsoft (MSFT) in 2010 then settled the case for $200 million.

VirnetX holds 48 patents and patent pending applications all related to 4G communications — The jury determined the patents infringed on in this particular case were U.S. Patent No. 6,502,135 B1, entitled “Agile Network Protocol for Secure Communications with Assured System Availability” and U.S. Patent No. 7,188,180 B2, entitled “Method for Establishing Secure Communication Link Between Computers of Virtual Private Network.”

VirnetX stock is up 700% in three years — a huge gain in such a short period of time.

In this write-up, I will list 2 companies I feel investors/traders should do due diligence on, as it’s my opinion these companies could see some good price appreciation. I have decided to make a speculation bet on one of them which while certainly risky, I feel offers a potentially big reward.

Document Security Systems (DSS)

DSS provides optical anti-counterfeit technology to its clients to protect documents from counterfeiters and identity thieves. As Vringo claims that Google has infringed on its patents, DSS claims in its lawsuit against Coupons.com that coupons has used its technology on billions of Internet generated coupons since 2006. DSS asserts that Coupons.com was a client from 2003 to 2008, purchasing anti-copying paper. Coupons.com allows online shoppers to print coupons from manufacturers and retailers.

The lawsuit originally brought forth 4 claims against coupons.com; breach of contract, misappropriation of trade secrets, unfair competition and unjust enrichment. On August 20th, 2012, the last 2 claims were dismissed by The U.S. District Court for the Western District of New York, with 2 remaining claims moving forward — breach of contract and misappropriation of trade secrets.

On October 2nd, Document Security Systems and Lexington Technology Group, Inc., a privately-owned company that owns and manages intellectual property assets, announced they planned to merge with each other. The very next day, the newly merged company filed a patent infringement lawsuit against five defendants –Facebook (FB) and Linkedin (LNKD) being the most notable companies named.

With the synergy present between Lexington and DSS, the two parties believe the combined market cap will escalate far higher than if they operated alone. Effective synergy takes place when two companies can achieve a 1+1 = 3 situation where everyone wins — including shareholders. This takes DSS’s patent portfolio into consideration with the strong personnel and experience that Lexington will bring to the table.

For Lexington, this is its second major move. First, it purchased the Bascom Research Portfolio. Included in this portfolio is considered to be a great application for patient medical records. The company is making an investment in developing that application which Hardigan feels is revolutionary technology. Along with the medical space, the portfolio also involves the potentially lucrative area of social networking.

With the DSS deal being its second major move, Lexington has made in effect a strategic acquisition which will transform them from a private company to a public one. This is very similar to what happened at Vringo. Innovate/Protect, Inc. (I/P Inc.) saw the opportunity to quickly become public and work with a company that has far more resources, so they merged with Vringo. Obviously, Vringo was excited to acquire the patent portfolio of I/P Inc., including what is now a large lawsuit against Google among other prominent companies.

The DSS business strategy includes not having a high cash burn while still having huge potential. By incentivizing the other parties by giving them a portion of the returns, Lexington is able to pay reasonable amounts for the opportunities. For the Bascom profile, it paid $2 million to owner/inventor Tom Bascom along with the promise of 10% of the revenue produced. Another reason the company is high on this opportunity is because the portfolio is strongly related to social networking where the profits margins are very high.

According to Lexington Technology Group CEO Will Rosellini:

“We strongly believe that Facebook, LinkedIn and the other defendants are infringing our patents. Our pioneering technology was patented as early as 2001-long before the advent of Facebook, LinkedIn and other social and business networks-and covers key aspects of online collaboration and relationship linking.”

An important factor here for DSS and Lexington will be to keep these cases in the state of Virginia where litigation moves swiftly. For District courts, at .93 years on average it boasts the quickest time from suit filing to trial in America. If this court sounds familiar it’s because this is the one nicknamed “The Rocket Docket,” where Vringo is suing Google.

MGT Capital Investments, Inc. (MGT)

MGT Capital Investments, Inc. is a holding company which is led by MGT, the parent company. The assets controlled by MGT include wholly-owned subsidiary MGT Capital Investments (UK) Limited. Also included is Medicsight Ltd, along with its wholly-owned subsidiaries and majority-owned subsidiary MGT Gaming, Inc. MGT Capital Investments acquired a majority interest in MGT Gaming, Inc. on May 24, 2012.

MGT Gaming holds certain intellectual property patents focused in the casino gaming sector

MGT also holds Medicsight, which is a medical technology company focusing on medical imaging software development and medical hardware devices. The Company developed and is commercializing Computer-Aided Detection (“CAD”) applications that analyze Computer Tomography (“CT”) scans to assist radiologists in the early detection and measurement of colorectal polyps. The CAD software received a CE Mark in 2009, which allows for sales in the European Union. In 2011, Medicsight’s software also received clearance from the U.S. Food and Drug Administration. The Company has also developed an automated CO medical inflation device and associated disposable tubing (MedicCO LON) that is being commercialized via a global distributor. The Company continues to explore all strategic alternatives with respect to its majority interest in Medicsight Limited, including sale or license of its global patent portfolio. As of June 30, 2012, the Company holds 66.5% of the issued share capital of Medicsight.

The company recently announced a financing deal. The deal consists of two agreements with various institutional investors providing $5.9 million of capital in support of the Company’s strategy to monetize intellectual property. Also in part, the financing was done to assure the company remained compliant with the listing requirements of the NYSE exchange. I became aware of this financing after I saw the stock double in a few days, and with my experience in the market, I know stocks do not make this type of move on financing alone. Let’s look at what else is contributing to this price move.

MGT is analyzing potential acquisition opportunities in healthcare marketing and technology, as well as various intellectual property assets. As stated above, on May 24th, 2012, the Company announced the completion of the acquisition of U.S. Patent #7,892,088, entitled “Gaming Device Having a Second Separate Bonusing Event.” This invention relates to gaming systems linked to an interactive sign, and includes all filed continuation patents.

The Company recently announced that it has retained Nixon & Vanderhye P.C., a nationally recognized IP litigation law firm, to direct the process of enforcing the Company’s ownership rights derived from this Patent. So, although MGT has no known lawsuits filed at this time, clearly its intention is to move in that direction as they have retained the IP litigation firm.

Looking over the company’s website, searching for more clues to the recent price action after a financing deal, I believe I found a bullet point from its website that could be the possible reason why the stock has performed so well lately:

“Patent acquisition strategy designed to obtain control of assets with a focus on risk mitigation and large potential upside. First property provides large recovery estimate from infringement by casinos and slot machine manufacturers.”

After watching the stock trade for a couple of days, it seems there is little willingness to sell. If the company is planning to enforce its casino gaming profile via a lawsuit soon, the stock can move very high, very fast based on its very low trading float. After considering these factors, I decided to take a speculative position in the stock.

DSS and MGT are in the beginning stages of enforcing their patent profiles. DSS has already filed suits while it seems like a good bet to me that MGT will be doing so soon as well.

While patent enforcement trades based on speculation is risky, as we have seen with Vringo and VirnetX, they can be extremely rewarding. DSS and MGT could carry such a reward for both traders and investors who enjoy higher risk, higher reward scenarios.

Disclosure: I am long MGT.

Additional disclosure: Disclaimer: This article is intended for informational and entertainment use only, and should not be construed as professional investment advice. They are my opinions only. Trading stocks is risky — always be sure to know and understand your risk tolerance. You can incur substantial financial losses in any trade or investment. Always do your own due diligence before buying and selling any stock, and/or consult with a licensed financial adviser.

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