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Are Patent Litigations Skewing Earnings Reality?

Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

All industries have litigation as a part of their business environment, but none more so these days than personal technology. With patent issues having developed an industry of its own, current issues can affect valuations to an almost absurd degree. I am going to look at some technology companies that have been affected mightily, though not necessarily logically, by patent litigation.

The big news right now concerns Vringo (NASDAQ: VRNG), which has been on a roller coaster the likes of which rarely occurs. On Oct. 31, Vringo's stock fell a shocking 36%, after it was learned the judge in Vringo's suit against Google (NASDAQ: GOOG)AOL, and other search engine sites entered a partial judgment in the matter, limiting the potential recovery. Specifically, Vringo sought damages due to patent infractions from Sept. 15, 2005. Instead, the court ruled that damage calculations would be limited to the period from September 15, 2011, until the patent at issue lapses in 2016. On that news, Vringo lost over one third of its value.

My, how things change. Just a week later, the U.S. District Court issued a judgment in Vringo's favor for about $30 million, with just over half that from Google, and the balance from the remaining defendants. The court would assess future damages, most significantly on 21% of Google's Adworks domestic revenue, on which Google must pay Vringo a 3.5% royalty. We are talking about hundreds of millions of dollars, as based upon historical growth Vringo will be recovering over $600 million just from Google through mid-2016.

On its own, without its patent portfolio, Vringo is not much. The company has a market capitalization of a little over $100 million as I write this, and its revenue through the first half of 2012 was $206,000. The judgment we are addressing could be a real game changer for the company, yet the market has not reacted as one might expect. That is due to the general feeling that Google and the other defendants have a legitimate chance of reversing the District Court judgment in whole or part on appeal.

To me, Vringo is a symbol for a real problem in the domestic economy. That is, the prevalence of "patent trolls," whose sole purpose is to find arcane patents on the cheap, and then troll around for companies who may be violating that patent. There is neither innovation nor wealth creation from that practice.

It is not just the pure trolls like Vringo that are doing it either. Google itself made a major bet on existing patents. Of the $12.4 billion Google paid for Motorola Mobility, $5.5 billion was for the many patents Motorola had developed. I have little doubt one or more Google employees does little more than use Google's nearly infinite resources to search for infringements of the acquired patent pool. But at least Google has a business that creates a great deal of wealth in its core operations.

Another patent troll is Document Security Systems (NYSEMKT: DSS). This company has an actual business with actual clients in document security. But it acquired Lexington Technology Group solely for its' patent portfolio, chief among them a set of patents that strike at the heart of Facebook's document storing and retrieving technology. Document Security Systems has filed suit against Facebook, Linkedin, and others for patent-related issues, but the legal case is nowhere near as far along as the Vringo matter. As the Vringo litigation reaches its conclusion, the results may or may not embolden Document Security Systems.

Vringo and Document Security Systems are "young" patent trolls, as their current litigations are the first major patent cases for both of these companies. Acacia Research and VirnetX (NYSEMKT: VHC) are the better established patent trolls. Acacia makes no claim to being any more than it is: an acquirer and protector of patents, with an army of litigators in its Rolodex eager to enforce existing patent rights. The company has a current market capitalization of some $1.1 billion, about half of where it stood back in August of this year. The market has apparently punished Acacia due to no substantial victories in the past couple month.

But Acacia has hundreds of viable patents, including many involved in the growing 4G LTE cell phone service that is gaining favor in this country. The lack of any "big hits" in the third quarter of 2012 drove revenues down almost 50% versus the third quarter of 2011, and resulted in a quarterly loss. But those types of variable earnings are to be expected of a business whose sole revenue is from court cases. If you believe in patent management as an ethical and viable business model, Acacia is on sale now.

VirnetX has a modest, ongoing business as a software company specializing in internet communications. But most of its money in recent years has been won through patent enforcement. In 2010, it won a judgment of $106 million judgment against Microsoft after it was found to have violated two patents owned by VirnetX. It also recently won a larger judgment, this time against Apple (NASDAQ: AAPL), on a matter concerning four patents dealing with Apple's Facetime technology. The judgment amount was $368 million, and Apple is committed to appealing the matter. VirnetX stock shot up some 30% on the news, but it will be a while before any money changes hands due to the appeals process.

Of course, that is the same Apple that not long ago won a judgment of over $1 billion against Samsung on allegations that the Korean giant misused Apple's iPhone related patents. Obviously, these patent actions are just a small fraction of Apple's business.

The practice of using patents not as a shield, but rather as a sword, is not what patent law is about. I hope that some legislator takes a look at the issue of costs that patent trolling creates in the economy, and finds a legal way to make patent trolling a less attractive line of business. In the meantime, investors should watch Vringo closely, as it still has plenty of time to run up before the latest patent lawsuit is wrapped up.

StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Google. Motley Fool newsletter services recommend Apple and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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