Forget what you may have heard: The United States has not lost
its way as an industrial power. Although many have lamented the
country's multidecade shrinkage in the manufacturing sector, the
most important pockets of product design and development are still
taking place right here in the U.S.
How do we know this? A study by France-based INSEAD, a world-class
business school, conducted a vast study on innovation and noted
that although China is gaining ground, the United States is still
home to the most innovative companies in the world. INSEAD used a
variety offactors to come up with a numerical ranking, and only the
United States received a score above 1,000.
The key takeaway: Don't ignore companies that spend a large
amount ofmoney on research and development (R&D).
To that point,analysts at Merrill Lynch studied three decades'
worth of data and found that "companies that spend on R&D …
have generally created both short-term and long-term shareholder
"The U.S. spends more on R&D than China, Japan, South Korea and
Taiwan combined, and more than the entire European continent," the
I'll be looking at high R&D spenders in another column, but
I want to take a closer look now at a group of companies that can
certifiablyprofit from innovation. These firms own a trove
ofpatents and can garner upfront licensing fees or ongoing royalty
streams as their intellectual property is licensed by product
I reviewed the outlook
for these patent-owning firms back in 2010, and as a basket they
have performed reasonably well.
Virnet X Holding (NYSE:
is a poster child for the wild swings this industry has been
through.Shares surged from around $6 when I profiled Virnet in 2010
to more than $40 in the summer of 2012 but have since fallen back
The company controls patents that help provide security when
transmitting data over high-speed wireless telecom networks.
High-profile legal wins against companies like
helped catapult thisstock to fresh highs in 2012, but a more recent
legal setback in a lawsuit with
Cisco Systems (Nasdaq:
has led investors to question whether the companywill find any
The fact that patentstocks often trade on legal outcomes represents
the greatest challenge for investors. Virnet had never generated
any meaningfulsales until recently, although licensingrevenue is
expected to start rising at a fast pace in coming quarters:
Analysts are targeting $40 million in sales thisyear and more than
$125 million in 2014.
Still, the future of this stock will hinge on further licensing
agreements, not on sales trends alone. Gilford Securities, which
has a $65price target , notes: "The key to maintaining investor
confidence will be (Virnet's) ability to establish legitimate
licensing arrangements in the coming months/quarters. Assuming it
is able to do so, (the recent Cisco legal decision) will not be
viewed as material in due time."
Translation: Other tech firms are likely to avoid major legal
tangles with Virnet, given that the company has already prevailed
over Microsoft and Apple.
The mature patent play
While companies like Virnet scramble to establish the validity of
their core patents through legal challenges, investors can opt for
a safer path in this sector by focusing on patent plays that
already generate robust sales and profit streams. Case in point:
Acacia Research (Nasdaq:
, which controls 250 patent portfolios in a wide variety of
industries. (A patent portfolio is set of patents typically
targeting a particular type of product or protocol.)
Acacia has already signed up many licensees, which has helped
revenue to rise at least 35% in each of the past four years to a
recent $250 million. That figure should approach $350 million by
2014, according to analysts, yieldingearnings per share of more
than $2.50. In the context of Acacia's profits, its shares appear
reasonably priced at the current trading level of around $30.
Part of the charm of thisbusiness model is a focus on reinvestment
in new patents. Acacia takes its profits and identifies fresh new
patents to acquire. During the course of 2012, the company acquired
55 new patent portfolios, which should help to generate enough
revenue tooffset the loss of any expiring patents. Acacia signed up
138 new patent licensees in 2012, up from 125 in 2011, and judging
by a recent string of press releases, the company appears set to
sign up a similar number of new licensees this year.
Although Acacia has historically focused on the technology sector,
"We see the potential for a major expansion of our business as we
move into the medical technology, automotive and energy sectors,"
President Mike Vella noted in a recentcall with analysts.
Risks to Consider:
These stocks can slump sharply if key patents expire, which has
been the case with
, a company once viewed as the top patent-controlling firm.
Action to Take -->
Patent players such as Virnet are quite speculative because they
still face legal challenges. However, if these companies are
successful on the legal front, their shares might zoom upward.
Acacia Research looks like a steady player in this field, with a
broad set of patents targeting a widening range of industries.
Management has delivered solid growth in all of the company's key
metrics in recent years, and further solidgains appear to lie
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of CSCO in one or more of its "real money" portfolios.
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