Will This Company Hit Another Home Run in 2012?

Wireless security researcher VirnetX (AMEX: VHC  ) is perhaps the most polarizing stock on the market. Some investors love it for the promise of owning patents in the LTE 4G security space. Others wonder if the patents are as important as VirnetX wants them to be. From the latter point of view, the stock looks tremendously expensive.

Where will the company go in 2012? Let's figure it out together.

The promise
It's easy to see the attraction here. VirnetX is an offshoot of defense contractor SAIC (NYSE: SAI  ) . Like Athena of Greek myth, it sprang into existence fully armed with a cache of security-related patents acquired from SAIC.

The company burst onto the computing scene with a big patent infringement win against Microsoft (Nasdaq: MSFT  ) . Mr. Softy lost a jury trial and was ordered to pay $106 million in damages, but decided to fight on, and eventually settled the case for $200 million.

Of the settlement, 35% belongs to SAIC, according to the original license agreement. It was a very expensive campaign to wage, costing more than $40 million in legal fees. But everything worked out: the legal battle paid off, and VirnetX investors enjoyed a $23.6 million special dividend the next quarter. That's $0.50 per share for a meaty 8.4% payout.

If VirnetX can pull off that trick again, or else start licensing 4G security patents to every player in the mobile industry, investors will be very, very happy. And VirnetX is trying hard. There's one lawsuit involving six patents against networking giant Cisco Systems (Nasdaq: CSCO  ) and iStuff maker Apple (Nasdaq: AAPL  ) . VirnetX has also declared several of its patents "essential" to various 4G mobile standards.

Where's the payoff?
So many irons in the fire and so much promise, and yet 24% of the float is sold short. Shares are trading some 36% below 52-week highs. Why aren't we all backing up the truck to these seemingly outsized returns?

Because there ain't no such thing as a free lunch, my friend. In order to cash in those chips, VirnetX must prove that its technology is indeed both innovative and important. And that might not be the slam-dunk that the Microsoft case implied.

For one, those "essential technology" claims are VirnetX's own. The relevant standards bodies have not, to the best of my knowledge, acknowledged or approved of any of them. That's like your Uncle Dennis declaring that his air guitar skills are essential to saving the economy. Might be true, but you just don't know. The technologies could be perfectly valid solutions to 4G security challenges, but network and phone builders might be able to design around them with totally different technologies.

As for the Microsoft case, it seems obvious that Redmond could have settled for much less -- or perhaps won outright with the right strategy. For one, paying nearly double the original damage award doesn't speak highly of Mr. Softy's performance in this case. For another, one of the patents (the '759 patent) from that proceeding has since been invalidated by a challenge from Cisco. Microsoft paid for that now-worthless patent.

Cisco has since lost another challenge of VirnetX patents. Maybe VirnetX has a legal leg to stand on after all. But it's hardly the bulked-up hunk of meat it looked like in 2010.

So in 2012, I not-so-bravely predict that VirnetX will win some battles and lose a few others -- the fickle fates of justice swing both ways. But there will also be an explosion of competing solutions developed by hardware and software giants with plenty of skin in the mobile game.

In the end, VirnetX goes home with a much smaller paycheck than earlier victories have indicated, and investors are left holding an empty bag. The current $1.35 billion market cap is just not appropriate for a development-stage company with minuscule proven sales and a highly uncertain future.

If you want to invest in technology licensing firms, why not go with a proven performer instead? OLED veteran Universal Display (Nasdaq: PANL  ) has several real-world contracts and is already profitable. Jack of all technologies InterDigital (Nasdaq: IDCC  ) is also profitable and cash-rich, with cheap shares to boot. And that's not all -- check out three more winning ideas in the smartphone wars of 2012.

Fool contributor Anders Bylund holds no position in any of the companies mentioned. The Motley Fool owns shares of Cisco Systems, Apple, and Microsoft, and has also created a bull call spread position on Cisco Systems. Motley Fool newsletter services have recommended buying shares of Apple, Cisco Systems, Microsoft, InterDigital, and Universal Display. Motley Fool newsletter services have also recommended creating bull call spread positions in Apple and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Check out Anders' holdings and bio, or follow him on Twitter and Google+. We have a disclosure policy.


Read/Post Comments (17) | Recommend This Article (14)

Comments from our Foolish Readers

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  • Report this Comment On December 27, 2011, at 11:57 AM, waterworksjeff wrote:

    Ah, once again. Mr. Bylund opens his Motley Mouth and proves that he is, indeed, a Motley Fool. Where to start this time Mr. Bylund? I know, your quote, "That's like your Uncle Dennis declaring that his air guitar skills are essential to saving the economy." Do you expect to be taken as any sort of journalist, much less a serious one, when spouting that kind of drivel? And your assertion, "network and phone builders might be able to design around them with totally different technologies." The work flows for release 10, which require security, have been in the works for many a year. VHC is the only company declaring their patents as essential for any of the Series 33 standards for which they have declared. Competition? Not around the corner, not even in the starting gate.

    Secondly, you say, "For another, one of the patents (the '759 patent) from that proceeding has since been invalidated by a challenge from Cisco." Cisco has requested that the USPTO re-exam this patent and the USPTO has agreed to do so. Their first action, called a first office action, is often a NON-FINAL rejection of all claims. This allows the company to prove to the examiner that the patent claims are the real deal and often times the company does just that, proves the claims valid. For you to say that Cisco has won the re-exam and MSFT paid for nothing is irresponsible at a minimum and criminal at worst. Are you really so ignorant of how patent examinations work as to not know what you are talking about? You call yourself a tech specialist, I'd think you'd know how the patent process works.

    With continued uninformed, blatantly false information in your articles, I ask again are you really this incompetent or on someone's payroll? The fact that this is not an options expiration week makes me think some news will be breaking soon. Kramer and Goldberg will be on TV in the next few days if the patern holds true.

    Pathetic!

  • Report this Comment On December 27, 2011, at 12:25 PM, lbi4ever wrote:

    Anders,

    Please find someone who can do your fact checking. You appear to be timely with your comments as the stock was climbing up over $2 today. You are obviously short on this stock or in kahouts with the shorts. Maybe you should qualify your facts before publishing. Why not check out the European standards for 4g when it comes to VHC. I do enjoy your your statement "I not so bravely predict" that way you can play both sides. Your writings in the past have been quite biased against VHC and yes this one still leans the same way. I look forward to your end of 2012 writings on VHC.

  • Report this Comment On December 27, 2011, at 1:15 PM, flyersdh wrote:

    Stolen from investorvillage.com

    Lots of misinformation in that article. Not sure if he is clueless or doing it on purpose.

    The '759 reexamination is not over with. VHC has until february 14th, 2012 to respond. The '759 was in the original microsoft case but was pulled back by VHC. Microsoft only "paid" for this patent when they settled for $200M. There was not a jury verdict for the '759.

    I believe the true short interest is around 32% not 24%. We will see with the short interest report after the bell.

    SAIC only gets 25% of non-MSFT litigation related revenues. McKool gets an additional 8%. Included in the Msoft settlement payment to SAIC was to fully pay off the purchase of the patents. VHC was on a payment plan to SAIC before that.

    As far as "essential patents for 4G" we will see how that plays out. WSGR are the consultants in that space for Virnetx.

    Who cares about the facts though. Its easier to type up a bunch of planted BS from a nervous group of short players.

  • Report this Comment On December 27, 2011, at 3:35 PM, waterworksjeff wrote:

    Mr Anders will be back to answer any and all allegations after he is finished with his three martini lunch with a representative of a certain hedge fund rumored to have been highly annoyed at a brokerage firm for initiating coverage on VHC while said hedge fund was knee deep in a losing short position of said company.

  • Report this Comment On December 27, 2011, at 4:16 PM, screwfool wrote:

    I could never recommend anything about this website to a serious investor. What a joke.

  • Report this Comment On December 27, 2011, at 4:21 PM, tjsimone wrote:

    Anders-

    Another hit piece on VHC-

    Thank You..I got to buy more cheap shares today..

    Its incredible how bad your stories are. For Example:

    "Shares are trading some 36% below 52-week highs. Why aren't we all backing up the truck to these seemingly outsized returns?"

    Maybe if you told your readers to BUY on October 3, instead of panning VHC, threy would have a 120% gain on their hands....

    How come you dont say shares are trading 120% off their lows?

    Or VHC hads been a 10+ bagger over 2 years?

    Is it because you have an agenda....

    Tom Gardner can send me all the emails he wants to join Motley Fools...I quit because they allow writers like you to represnent them... you add NO value what so ever...

  • Report this Comment On December 27, 2011, at 4:27 PM, mikewn596 wrote:

    Gentlemen -

    Don't waste your breath here. Send email to the King Fools and let them know that they need to expect a letter or inquiry from the SEC. I sent my letter to them after I read it, and am in the process of contacting the SEC. The only thing that will stop people these days are others who are truthful AND take action. Others who are not and do not eventually will be found out and will have to deal with the consequences.

    Mike

  • Report this Comment On December 27, 2011, at 6:09 PM, waterworksjeff wrote:

    We apologize for the delay as Mr. Bylund's three martini lunch turned into a five martini celebration. He'll be back bright and early tomorrow to defend his indefensible position with more clap trap.

  • Report this Comment On December 27, 2011, at 8:18 PM, sparx89 wrote:

    Amazed at how so much can be wrong in a single article, especially by someone who writes for MF (not sure how you still are). Very bold prediction saying VHC will win some and lose some, really sticking to one side there. When you reference a 1.35 bill mkt cap as "not appropriate" due to a lack of sales and uncertain future it really just highlights your inability to understand what VHC does. As they have in the past and plan to do in the future, they have created revenue from legal suites from infringement cases, so selling isn't exactly what they are doing. As for an uncertain future, you must not have heard of Cowen Group which recently said they felt VHC could appreciate 100% in 2012. But if that doesn't satisfy you, check out this http://thestockboss.blogspot.com/. I have researched (do you know what research is?) their case with MSFT and their upcoming cases with Apple, Cisco and others and compared the term claims that are being challenged in their patents. By your article I can tell you can't write, but surely you can read and perhaps better educate your self on how "uncertain" their future really is.

  • Report this Comment On December 28, 2011, at 1:36 PM, TMFZahrim wrote:

    Okay.

    ETSI does in fact judge patents essential to wireless standards but has not yet done so for any VirnetX patents -- or else you'd certainly hear that fact screamed from the company's rooftop. So far, VHC has only started the process by doing the initial declaration.

    From there, it's hardly a slam-dunk win. For example, 223 network patents were declared essential to WCDMA networking but only 89 of them were judged essential in the final tally: http://www.frlicense.com/wcdma1.pdf

    Approve 40% of VHC's 23 declared patents and you'd get something like 9 claims mandatory in every implementation. But again, that still doesn't stop competitors form designing workarounds and protocol-compatible alternatives. And we're assuming an average success rate here -- the final verdict may very well be better or a lot worse.

    The 35% royalty to SAIC came from an SEC filing by VHC: http://biz.yahoo.com/e/111109/vhc10-q.html

    I stand by everying I said in the article, and will say it again unless VHC's unproven patents are accepted by 3GPP, ETSI, and other standards bodies. Guess I'll miss the jump if that happens, but then I'll also miss the drop if the claims are rejected which I see as more than likely.

    Just to reiterate, I don't hold any position in VHC, SAC, IDCC, or any other patent-milking troll. GOOG is moving that way with the MMI acquisition but I'd likely sell my shares if those 17,000 patents are ever used offensively. That strategy makes casino chips out of otherwise perfectly respectable stocks and I don't gamble.

    Anders

  • Report this Comment On December 28, 2011, at 2:11 PM, flyersdh wrote:

    The 35% royalty rate paid to SAIC is for Microsoft litigation. Non-microsoft litigation is a royalty rate of 25%.

    Virnetx owes nothing to SAIC for non-litigation licensing.

    As far as a workaround: the VHC patents are at the core of how devices and computers successfully search and connect securely to each other. Outside companies have tried to workaround the patents and patent it themselves for 12 years.

  • Report this Comment On December 28, 2011, at 4:43 PM, stocktoninterest wrote:

    Stock ON,

    One by one...

    1. " And we're assuming an average success rate here -- the final verdict may very well be better or a lot worse."

    How wish-washy can one writer be? Shall I gather every toss-a-coin statement you make? Nah, why be someone who actually collects the facts, I'll just mimic you.

    2. "I stand by everying I said in the article, and will say it again unless VHC's unproven patents are accepted by 3GPP, ETSI, and other standards bodies. "

    Wow, where to start on this one... You "stand by every[TH]ing {-1sp.} [you] said, and will say it again" ... WAIT, "unless"... UNLESS someone says, "take it back Anders... Take it back now..." Dude, pick a spine, uh, I mean side dude. You're arguments are worthless.

    "Unproven patents" ??? Really... isn't that what the apPROVal process is? PROVing the patent claim is valid... You're just a A+ MO-RON!

    3. "I don't gamble."

    REALLY? I guess you do not now, nor never have, bought a share of any stock in your life... read the SEC docs, nothing is gauranteed... you are BETTING one way or the other. And your buddies may very well lose their 'shorts' on this one when the ITC, and Texas courts continue the precedents being set in favor of VHC's PROVEN patents (mo-ron).

    4. "Guess I'll miss the jump if that happens"

    MISS WHAT? You said "I don't gamble". Easy for you then, there is no jump to miss... except off the brooklyn when you see the stocks you trash skyrocket... oh, but then I'm sure you cling on to the "very well be better" and "will win some battles" ... after all...

    "the fickle fates of justice swing both ways"

    Hey Anders, how many "fates" does Justice have anyway?

    Stock Off.

  • Report this Comment On December 28, 2011, at 7:55 PM, cavalaire wrote:

    “As for the Microsoft case, it seems obvious that Redmond could have settled for much less -- or perhaps won outright with the right strategy. For one, paying nearly double the original damage award doesn't speak highly of Mr. Softy's performance in this case.”

    I am amazed that a self-anointed expert like Anders Bylund with an information science degree thinks he is smarter than all the experts at Microsoft, the lawyers at McKool Smith, Kendall Larsen, and the major shareholders of VHC like Peter Cannell, Vanguard, and BlackRock.

    Moreover, Mr. Bylund has the audacity to call the rightful owners of the patents for VPN “patent-milking trolls.” It is clear that he’s from the Napster generation that believes he has the right to rip people off with impunity, say whatever he wants, and suffer no consequences.

    Rest assured that when we are clinking our champagne glasses here pretty soon, we’ll be laughing at his baseless article and inane rebuttal.

  • Report this Comment On December 28, 2011, at 9:52 PM, waterworksjeff wrote:

    My first thought is, why do I do your research for you. My second thought is, he doesn't do any research.

    You; "ETSI does in fact judge patents essential to wireless standards but has not yet done so for any VirnetX patents -- or else you'd certainly hear that fact screamed from the company's rooftop. So far, VHC has only started the process by doing the initial declaration."

    ETSI: http://www.etsi.org/WebSite/AboutETSI/IPRsInETSI/iprdb.aspx "You should however note that the ETSI IPR Database provides data that is based on the information received. This means that ETSI has not checked the validity of the information, nor the relevance of the identified IPRs to the ETSI Standards and Technical Specifications and cannot confirm, or deny, that the IPRs applications are, in fact, essential, or potentially essential. No investigation, or IPR searches, have been carried out by ETSI and therefore no guarantee can be given concerning the existence of other IPRs which are, or may become, essential. "

    Virnetx: Headline and date: "VirnetX Agrees to ETSI’s Policy Request Posted on 28. Apr, 2011" Verbage: " VHC, an Internet security software and technology company, today announced that ***at the request of the European Telecommunications Standards Institute (ETSI)*** (my emphasis), it has agreed to update its licensing declaration to ETSI under ETSI’s Intellectual Property Rights (IPR) policy. This is in response to VirnetX’s March 15, 2011, Statement of Patent Holder identifying a group of its patents and patent applications that VirnetX believes are or may become essential to certain developing specifications in the 3GPP LTE, SAE project.

    Your entire first paragraph is empty air. ETSI does NOT declare IP as essential and VHC has finished the process by, at ETSI's request, updated its licensing terms to FRAND with compensation.

    You: " stand by everying I said in the article".

    You in the article: "one of the patents (the '759 patent) from that proceeding has since been invalidated by a challenge from Cisco".

    Reality: The USPTO has granted a patent re-examination of the '759 patent and the initial office action is a NON-FINAL rejection of the claims of the patent. Non-final rejection is a far cry (ok, worlds apart) from invalidation and is the usual next step after re-examination is granted.

    You: " I'll also miss the drop if the claims are rejected which I see as more than likely."

    Me: On what facts do you base your conclusion? Have you read the patents? The court filings? The tea leaves? An empty, off-handed opinion based on NOTHING, is irresponsible journalism (but after reading MF's "Fools Rules", I see that they disclaim everything under the sun and factual integrity is not their problem, nor are the opinions given, etc., etc.). In short (pun intended), MF contributors can write what they want about whatever they want with impunity and know that it will be disseminated across the wires.

    Truly irresponsible.

  • Report this Comment On December 30, 2011, at 1:38 PM, tjsimone wrote:

    Motley fools lost me as a subscriber, a few family members, and friends...because of writers like Anders...not only will I not rejoin, I can't recommend them to anyone, and I have been asked...

  • Report this Comment On December 30, 2011, at 4:01 PM, jkarr2 wrote:

    Dear Sirs,

    I was a previous reader/subrscriber to MF years ago and have recently been researching an opportunity for investment advice from a reliable source. Based on this type of research by Anders, I can assure you it will not be MF again. I am not an investor in VHC but have followed the stock for some time with a very strong interest. Even my minimal amount of due diligence on this company produced enough knowledge to recognize absolute "rotten" due diligence on the part of this author. If this is the type of research that MF provides and publishes--NO THANKS!!! Wow, so much of what this author suggests is either flat wrong, or so poorly investigated that it suggests to me there is an alterior motive behind such blatant lies regarding an investment. Also, based on this biased piece of writing, I now will absolutely invest in VHC as I can read between the lines when it appears someone is deliberately trying to keep the price down?? Perhaps not for the author, but surely a friend or colleague? Anyone who does the minimal amount of research can clearly see the falsehoods in this piece. Clean it up please and do the right due diligence that ANY investment deserves!! POOR.

  • Report this Comment On January 02, 2012, at 9:04 PM, nubutu wrote:

    Being new and knowing nothing about this stock nor really these boards I must say I am disappointed at the level of discussion. I feel that there is good information in the article and good information in the discussion. However, the level of flaming, pointless name calling, and impugning the motives of the author is sad. Much too close to what I read on stock message boards.l I expected better from this community.

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