When communications software firm
VirnetX Holdings (
released quarterly results last Monday, investors may have thought
the company's press release had a glaring error. Sales, which had
never exceeded $21,000 in any prior quarter, suddenly exploded to
$200 million. It was no misprint. VirnetX finally got a nice payoff
after several years of lawsuits regarding patent infringements.
Other companies that sue to get royalties are also hopeful for
similar windfalls. And when these companies prevail, profits can
grow quickly, as patent and royalty income often flow straight to
So how can investors profit from companies with potentially
lucrative patents? I've uncovered three companies sitting on
potential gold mines in terms of their intellectual property.
1. VirnetX Holdings
In the next 12 months, consumers should see an array of new smart
phones offering super-fast download speeds. [See:
The Time is Ripe to Short this Wireless Upstart
Yet as more and more personal and corporate information is sent out
over the mobile broadband airwaves, the risk of data theft also
rises. To tackle that, VirnetX has developed a range of software
encryption tools to keep that wireless data secure. Many companies,
including the major wireless carriers, are working to come up with
their own fixes. But this little-known company has a hunch that any
solution these companies come up with might impinge on its patents.
So they've gone to court.
Lawsuits are never easy -- until you've won a major one. That's why
VirNet's victorious lawsuit against mighty
Microsoft (Nasdaq: MSFT)
is so important, possibly setting a precedent for future legal
activity. In early March, a jury awarded the company $106 million
for Microsoft's unlicensed use of a pair of VirnetX's patents. Two
months later, Microsoft not only agreed to that decision, but
agreed to pay a total of $200 million for the use of all 46 of
VirnetX's patents. Shares quickly soared to $8 back in March when
the news was first announced, but have since fallen back to $6.
Now, VirNextX is gearing up to secure other licensing agreements
for its technology. On Thursday, the company filed fresh lawsuits
Apple (Nasdaq: AAPL)
Cisco Systems (Nasdaq: CSCO)
, Japan's NEC, and others.
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It's impossible to predict if and when those suits will be
resolved, but VirNetX's $270 million
appears to sharply discount the prospect of a few more major legal
victories. Shares could meander in coming quarters, but could spike
sharply higher of any of those defendants choose to settle the
2. Rambus (Nasdaq: RMBS)
With a mountain of technology patents under its belt,
Rambus (Nasdaq: RMBS)
has a long history of successfully suing any firm that appears to
use its Intellectual Property (
) without permission. Friday morning, the company secured a
licensing agreement for a few of its patents with
NVidia (Nasdaq: NVDA)
, pushing Rambus' shares up +5%. During the past decade, the
company has waited for its patents to be broadly used before
seeking legal remedies, which has usually netted between $100
million and $200 million in annual revenue.
Rambus doesn't always take the aggressive legal route. In late
June, it showed it can also play nice, using its considerable IP to
help develop a market, rather than pounce once a market is
developed. Although Rambus is best known for its IP in the area of
semiconductors and telecom, it also has an impressive array of LED
lighting patents, which it acquired and then augmented with its own
The new LED division, which uses back-light technology to provide
sharper illumination, has already found its first major customer:
. Rambus announced in late June that they were teaming up to
develop a range of newly-developed architectural lighting products.
This looks like a win/win for Rambus, as it will require no capital
outlays, and the company can simply share in the profits.
Yet Rambus is mostly still focused on litigating when necessary.
The company has recently had a string of legal victories with firms
and Samsung, which are expected to result in steadily rising
royalty payments in coming quarters. And Rambus' legal momentum
looks set to continue. The company is expected to imminently win a
patent case with Japan's Elpida Memory, which could net close to
$500 million in an upfront license, and then more revenue from
ongoing royalties. Taiwan's Hynix, along with
Micron Technology (
, are also in Rambus' crosshairs after a recent preliminary legal
decision in its favor.
As is the case with all "intellectual property plays," there's no
way to peg any sort of value created by some of these deals.
(Details are sometimes limited for legal reasons.) So how do you
place a value on a company that has erratic, but bounteous
ratio doesn't apply. Rambus lost nearly $1 a share last year, will
likely make more than a $1 a share this year, and it's anybody's
guess what will happen next year on the earnings front.
In this instance,
(market capitalization plus debt minus cash) is a better gauge. The
company has about $600 million in net cash, implying an enterprise
value of around $1.6 billion. Yet the company could snag up to $2
billion or more in fresh patent agreements over the next several
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This is all very imprecise, which explains why most Wall Street
firms simply avoid trying to even value and follow the stock. But
with each passing year, it's apparent that Rambus' team of 290
engineers (out of 350 employees) are on the right track, developing
patents that turn into major money makers. Over the next 12 months,
investors should see further large checks being mailed to Rambus.
3. Interdigital (Nasdaq: IDCC)
With more than 12,000 patents and patents pending, Interdigital is
seen by some as the grandfather of the technology patent movement.
Interdigital, like VirnetX, focuses on wireless technology. The
company's software is used in the majority of all 3G cell phones
and wireless networks, helping to manage bandwidth constraints,
network capacity issues and security.
In contrast to Rambus with its lumpy, occasionally massive one-time
payments, Interdigital likes to secure long-term revenue streams.
As the company has secured new long-term licensing arrangements,
the company's sales -- and profits -- have steadily risen. By 2009,
the company generated a company-record $284 million in
free cash flow
Although Interdigital's sales and revenue have been remarkably
steady for this type of company, a few one-time payments are
nevertheless spiking sales and profits this year. Analysts expect
revenue to rise more than +20%, and
earnings per share (
to surge more than +80% to about $3.20 in 2010. That surge also
means next year's results will show a bit of a pullback.
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With that kind of financial performance, coming up with a
for the stock is indeed tricky. Dougtherty & Co. uses a
weighted average of the next 10 years of
, arriving at a target price of $36 -- roughly +40% ahead of
Analysts at Hilliard Lyons think shares are worth $34, or 12 times
Interdigital's 2010 profit forecast. They also note that the
company's growing cash balance is also of interest. Interdigital
now has $486 million in cash ($12 a share), and analysts wonder if
a share buyback, a one-time large
, or even a bid to go private might be in the offing -- all usually
good things for shareholders.
Note: All three of these companies appear to be racking up
impressive licensing deals that will, over the long-haul, generate
compelling free cash flow growth. Other licensing companies to
Qualcomm (Nasdaq: QCOM)
Digimarc (Nasdaq: DMRC)
Tessera Technologies (Nasdaq: TSRA)
Acacia Research (Nasdaq: ACTG).
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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