It's been a truism in business since the days of Adam Smith: Fat margins attract hungry competitors. But apparently margins that look like they're on Slim-Fast attract rivals, too. Just ask Motley Fool Rule Breakers recommendation iRobot (Nasdaq: IRBT ) .
Despite struggling (and usually failing) to keep its operating margin at a bare 1%, the robotics king is attracting competition for the revenue-rich, but profits-poor business of manufacturing robots for the military. There's government contractor Exponent (Nasdaq: EXPO ) and British defense firm QinetiQ's Foster Miller subsidiary, of course. And most recently, iRobot found itself competing with an ex-employee by the name of Jameel Ahed, now president and chief design engineer for Robotic FX, Inc.
Robotic FX makes a tactical surveillance robot called the "Negotiator," which at first glance looks an awful lot like iRobot's own PackBot. A bit too much like the PackBot, if you ask iRobot, which filed suit against Robotic FX in federal court in Alabama and state court in Massachusetts, claiming "infringement of two U.S. patents" and "misappropriation and misuse of confidential information," respectively. Legalities aside, what do these lawsuits mean to iRobot investors (me included)?
The first thing we do, let's pay all the lawyers
First and foremost, they mean higher operating costs as iRobot incurs legal fees to outside counsel. This may drag profits down so that the company can't even hit management's stated goal of achieving a de minimis (there's a legal term for you) profit this year. If the litigation drags on, its goal of 15% operating margins in four years may also be endangered.
A fight worth winning
But as hard as it will be to see profits possibly delayed, this is a price worth paying. In fact, I'd argue that iRobot had no choice but to sue Robotic FX. You see, we learned last week that as much as $180 million in military robot contracts is coming up for grabs. iRobot needs to snag its fair share if it's to remain the leader in robotic technology, and to ramp sales sufficiently to begin generating some significant economies of scale. And Robotic FX stands in the way of that goal. According to a June press release announcing the availability of its Negotiator for sale, Robotic FX asserted that its robot will sell for "a cost of approximately one-third of its closest competitor."
The last thing iRobot needs right now is a doppelganger robot undercutting its sales price and stealing orders at the moment of the biggest robot requisition in U.S. government history. And I suspect management is thinking along the same lines. Its press release informing the public of the litigation describes the Negotiator as "an unproven imitation that does not have the capabilities of our PackBot robots." The statement has little legal significance, but seems calculated to give military hardware buyers second thoughts about buying a knockoff.
Meanwhile, back at the ranch
So Robotic FX must now contend with not one, but two lawsuits. Both come as it vies for a piece of the biggest government contracting action in robotic history. Both target what appears to be Robotic FX's only product. (If you visit the firm's website, you'll find it's almost entirely dedicated to promoting the Negotiator, to the exclusion of containing any information on Robotic FX itself.) What could make life even more difficult for Robotic FX?
Thank you, sir, may I have another?
Might I suggest a third lawsuit. You see, in addition to offering a product that looks a lot like iRobot's PackBot, Robotic FX advertises the Negotiator as resembling another robot in how it acts. Reading once more from the press release, we find Ahed touting Negotiator's "unparalleled efficiency and precision," as well as its ease of use. Ahed boasts that the Negotiator will "require little to no training," thanks to its "intuitive operation ... inspired by the da Vinci machine."
Now, as Rule Breakers investors know well, the da Vinci is the surgical robot designed and built with great success (both sales-wise and profits-wise) by Rule Breakers recommendation Intuitive Surgical (Nasdaq: ISRG ) . Now, I don't know precisely where the line between "inspired by" and "infringing on the patents of" lies. But can there be any doubt that if Robotic FX has gone and infringed on Intuitive Surgical's patents as well as iRobot's, Intuitive Surgical will fight even harder to protect its 38% operating margin, than iRobot is fighting to protect a margin verging on zero?
Like Adam Smith said, fat margins attract hungry competitors. But just because Robotic FX is hungry, doesn't mean these Rule Breakers will let it eat their lunch.
Fool contributor Rich Smith owns shares of iRobot, and he's got his eye on a few other Motley Fool Rule Breakers recommendations as well. (With our average recommendation beating the S&P 500 by a good 12 percentage points, maybe you should check them out, too -- click here to take a free trial.) The Motley Fool has a disclosure policy.