Submitted by Lisa Bailey as part of our
contributors program
.
Just this week, we have seen two courtroom victories within the
stock market's hottest new sector: patents. VirnetX (
VHC
)
just won
$368 million from Apple (
AAPL
) and Vringo (
VRNG
)
just won
a 3.5% royalty + $30 million from Google (
GOOG
). In the wake of this success, a new firm has entered the scene:
MGT Capital Investments (
MGT
). Like its successful peers, MGT's strategy matches the
high-profile, mega-dollar criteria. It is suing for what could be
billions in damages from corporations like MGM Resorts (MGM),
Caesars Entertainment (CZR), Penn National (PENN) and WMS Gaming
(WMS).
On May 10, 2012, MGT announced the acquisition of a majority
interest in a slot machine-related patent. Last Friday afternoon,
MGT made a public announcement that the law firm it had hired to
help with the monetization of this patent had filed a lawsuit on
behalf of MGT. The plaintiffs in this case are three major casino
operators and two slot machine manufacturers, listed above. This
lawsuit offers a potential for significant return to investors in
MGT common stock.
The downside risk is somewhat limited due to MGT's micro-cap
market capitalization of less than $16 million as of the date of
writing. MGT also has relatively low operating expenses and has
hired one of the leading intellectual property law firms in the
nation, Nixon & Vanderhye. With zero debt and about $7 million
in cash, MGT might not have to raise additional capital for years
or-if it prevails in the lawsuit-ever.
This is good news for investors in common stock. In particular, for
shareholders of firms like VirnetX and Vringo, the possibility of
holding through a court decision without a single dilutive capital
raise sounds like an elusive dream. (Both firms diluted
shareholders heavily along the way to their respective jury
trials.)
Background on the '088 Patent
Steve Brandstetter and James Devlin filed a patent application
in October of 2001 and the U.S. Patent And Trademark Office granted
patent 7,892,088 (the '088 patent) in February of 2011. This patent
relates to gaming on networked slot machines and the chance for one
or more of players to participate in a separate bonus event. The
bonus event must occur on a separate display and is in addition to
any individual winnings on the slot machine.
Typical assertion of a patent like this allows the patent
holders to assess past damages from the time when the patent was
granted and seek future licensing or royalty fees. The
enforceability of the patent could stretch over 20 years in
total.
Patent litigation is a complex undertaking that requires hiring
of a team of lawyers, negotiating with the companies that infringed
on the patent, and eventually receiving a payment or encountering
defeat. The whole process can take months and cost millions in
legal fees. This is why Brandstetter and Devlin partnered with MGT,
which will now manage the patent assertion process.
MGT acquired a 55% interest in the '088 patent in exchange of
$200,000 in cash, a 4-year warrant to buy 350,000 MGT shares at an
exercise price of $4.00 per share, and a consulting contract at
$5,000 per month with Steven Brandstetter. Also, MGT has the option
to purchase an additional 25% in exchange for $1 million in cash
(which they have not yet exercised) and 4-year warrants to buy
250,000 MGT shares at $6.00 per share. Thus, currently, MGT and its
shareholders own 55% of patent 7,892,088 with the option to
increase this stake to 80%, should they choose to do so.
Yes, Risks, but With a 10-Bagger Potential
Investing in any company pursuing high-stakes litigation carries
risks, including the need for extensive funding of a multi-year
lawsuit. In general, there are a few likely scenarios. Under the
most negative scenario for MGT, the court will find the patent
claims unfounded. The reward in this case is negative, up to the
amount of expenses incurred in pursuing the patent case. On the
positive side, however, the reward could be in the hundreds of
millions or even billions of dollars. According to the American
Gaming Association, casinos in the United States recorded $36
billion in revenues for 2011, deriving over 60% of these revenues
from slot machines. Even a small percentage of these revenues as a
reward for MGT would mean a 10-bagger return or more for MGT
shareholders.
Depending on the outcome of the negotiations, the royalty
percentage or the court order, MGT could receive a large, new
source of revenue over the 20-year life of the patent. A $500
million present value of future payments by the casinos and slot
machine manufacturers has been bullishly forecasted by one writer.
After paying the lawyers' contingency fee of about 33-40%, followed
by paying J&S a 20% share, about $250 million is left for MGT
and its shareholders. This is more than ten times the current
market value of MGT. Any investing professional will agree that the
odds of increasing an investment by a multiple of ten in a few
years are extremely low.
Unique Investment Opportunity
Regardless of the risks and outcomes, MGT common stock presents
a unique investment and diversification opportunity. Most companies
with high beta or correlation to the market are biotechnology,
finance, and energy and precious metals exploration companies. If a
gold explorer strikes gold, shareholders are rewarded, and if not,
they lose their investment. However, gold exploration depends not
only on the geological and management teams but also the price of
gold. If the price of gold suddenly plummets, many gold projects
will become unprofitable. Similarly, a competing biotechnology
company may have a discovery making the recent medical discovery of
another medical company less valuable. In contrast, investing in
MGT and its intellectual property is not correlated to another
event, asset or market value. Nevertheless, it still dependent upon
the time, effort, and skill that MGT devotes to the patent
monetization process. Thus, even if the stock market plummets or
gambling revenues slide, MGT could still claim and receive
significant patent infringement payments. The reward potential is
dependent almost entirely on MGT negotiation and litigation skills,
the gaming industry's ability and desire to fight these efforts,
and the court system.
The Patent Sector: Wall Street's Newest Buzz
Stocks
MGT is positioned in one of Wall Street's hottest sectors.
Recently, courts have sided with patent holders, even in lawsuits
wherein patents were extremely broad in nature. Such was the case
in a Californian court which ruled that Samsung had infringed on
Apple's patents, ordering the company to pay a massive $1 billion
to Apple. According to an article in the World Intellectual
Property Organization, about 25% of patent lawsuits in the U.S. are
successful. A 25% success rate is in fact significant given the
costs and large awards in most cases that are successful. More
recently, the recent victories of high-profile companies like
Vringo and VirnetX have reignited the patent sector with over $500
million in lawsuit damages awarded within the past week alone.
Conclusion
MGT's recent announcement transforms the company from an
illiquid, debt-laden stock to an active and debt-free opportunity
to pursue a large legal award. The stock has already doubled in
price since the announcement of its business model pivot, but the
market capitalization is still very low due to the small number of
shares outstanding.
Ultimately, the outcome of their legal battle is far from
certain. As in any case, there are many details that could lead to
an unexpected outcome. MGT is trying to monetize a patent with a
potential for a large win, but it could fail outright and lose a
few million dollars in fruitless expenditures. In any case, shares
of MGT are likely to experience significant volatility as the
battle over monetizing
the '088 patent
progresses.