Apple's Patent Case May Create Short-Term Opportunities

By Maxwell Fisher - August 6, 2012 | Tickers: AAPL, GOOG, NOK | 0 Comments

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While Apple (NASDAQ: AAPL) recently released earnings results, of potentially longer-term impact is the news that the long-awaited patent infringement trial between Apple and Samsung Electronics has begun. The earnings release, which dropped the price of the stock by $25 per share, is certain to have a continuing significant impact on the market, as Apple has become the bellwether for technology and possibly the economy.

Despite the importance of this earnings release, the outcome of this patent case is likely to send reverberations through the market for years to come. Additionally, as is nearly always the case with Apple, it will take several days to sort out what the numbers mean. The company has adhered to the following pattern: 1) put out guidance that contains puritanically conservative estimates; 2) release earnings that demolish the original consensus numbers; 3) declare earnings to be a positive upside surprise; and 4) express surprise when the stock falls on the "positive" news because it was not as positive as the most vocal analysts expected. It will be a few more days until the real impact is clear. This sort of a dance should not come as a surprise to any of the Apple faithful as it follows the corporate procedure that has worked for the company for other releases - 1) estimate that first day demand for a new product will be five million units; 2) produce an unnecessarily low number of units allowing news outlets to report on the "unbelievable" demand for the product; and 3) express surprise when customers get upset and buy an Android phone, allowing Samsung to become the largest smartphone producer in the world. There is a clear answer when you get beaten: sue.

There is, of course, some merit to the suit. Many Samsung products do bear a significant resemblance to Apple's products, just as Apple claims. The case is not, however, open or shut either way. It is extremely unusual for two behemoth companies like these to leave the fate of something this important in the hands of a jury, but that is what is apparently going to happen in this case. Not only will the jurors be given the opportunity to decide the outcome of the case, they will have the chance to set the number that one company owes the other. Samsung has counter-sued and claimed that Apple violated several of its patents.

While a settlement is almost impossible at this point, Apple has placed a dollar figure on the damages it believes it has suffered at the hands of Samsung: $2.5 billion. In order to settle Samsung's claims, Apple has suggested that it pay $0.005 per unit it produced that might be in violation of the Samsung patents. This figure is significantly below the amount demanded by Samsung. The difference in these amounts can be traced to the method of calculation. Samsung wants the percent royalty applied to the retail price of the offending devices, while Apple argues that the percentage should be applied to a $10 component.

The case is likely to take months, if not years, to be fully resolved, but some patent experts have commented that a victory by Samsung on all counts is not an unthinkable result. This result would not only cost Apple billions in licensing fees, it could force several Apple products off the shelves. From this perspective, the outcome of this case is far longer reaching than the results of a single earnings announcement.

Other companies that have a lot to gain, lose or learn from this case include Nokia (NYSE: NOK), Google (NASDAQ: GOOG) and even Research In Motion (RIMM). Nokia was at ground zero of this battle when suits between Apple and Nokia were filed as far back as 2009. This case has since taken on a life of its own, but the impact will be felt by each of these players. Google's role in the case is somewhat secondary, but as the Samsung products in question all run on the Android operating system which is owned by Google, a finding against Samsung will certainly have an impact on Google's penetration into the market. While most consumers would likely be able to easily transition to a non-infringing device, it is unclear what this process might look like when the time comes. Lastly, Research In Motion, which has slipped further and further from the market dominating position it once enjoyed may be able to use the suit as a road map forward if that company is to survive.

How to Trade the Case

Any time uncertainty is added to a situation it creates both risk and opportunity for an investor willing to take a position. What is interesting about this situation is that it is very unusual for companies of this stature to roll the dice with a jury. In most cases, the involved corporations negotiate a settlement that is somewhat painful for each, but avoids the truly catastrophic outcome. The willingness of each of these tech giants to let the case go to the jury may be a testament to the strength each feels its case carries. On the other hand, the few billion dollars at stake is significant but not crippling to either should the case be lost. Regardless of the outcome, this case will likely determine how courts will regard similar issues for years to come.

At the highest level, the market will likely over-reward either company on positive news about the case. This will create short-term trading opportunities, either by reacting quickly or betting on a reversal of the inevitable overreaction. As it is difficult to have a properly diversified portfolio these days without owning some Apple stock, monitoring the case is the prudent course of action.

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