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DSS: http://seekingalpha.com/article/2520525-document-security-systems-overreaction-to-the-virtualagility-case-creates-an-excellent-investment-opportunity


Document Security Systems - Overreaction To The VirtualAgility Case Creates An Excellent Investment Opportunity
Sep. 25, 2014 10:37 AM ET | About: Document Security Systems, Inc (DSS), Includes: AAPL, COUP, LNVGY, TSM, VHC

Disclosure: The author is long DSS. (More...)
Summary

DSS lost over 40% of market cap as a result of a sector decline related to the VHC case, and this was further aggravated by the PTAB's decision to invalidate VirtualAgility's patent.
DSS has several non-software patents at various stages of litigation. A Markman hearing for the DSS vs. AAPL case is scheduled for November 6, 2014 in Tyler, Texas.
Interest in the Company's flagship product, AuthentiGuard, is high, as it's being evaluated by several prospective clients. The Company has delivered its first fully-integraded AuthentiSuite system to a client.

Document Security Systems, Inc. (NYSEMKT:DSS) is a leader in anti-counterfeit, authentication, and mass-serialization technologies. The company's specialized security programs are designed to protect against product diversion, counterfeit, theft, and other costly and damaging occurrences. DSS provides turnkey security solutions to corporations, governments, and financial institutions around the world. The company's flagship product, AuthentiGuard, has been featured in several national TV interviews. DSS is also known for its robust intellectual property (IP), which has been used for pursuing patent-infringement lawsuits against some of largest and best-known companies in the world, like Apple (NASDAQ:AAPL), Facebook (NASDAQ:FB), LinkedIn (NYSE:LNKD), Samsung (OTC:SSNLF), Taiwan Semiconductor Corporation (NYSE:TSM), NEC Corporation (OTC:NIPNF), Lenovo (OTCPK:LNVGY), and others. DSS has already settled favorably on lawsuits against Broadvision (NASDAQ:BVSN), Jive Software (NASDAQ:JIVE), and Novell (NASDAQ:NOVL).

At this time, it appears that the market is valuing the stock based solely on its software-related lawsuits like VirtualAgility vs. Salesforce and the Bascom cases against Facebook and LinkedIn, and it's completely ignoring the harware-related lawsuits and the growing product-related revenues.

On September 23, 2014, the stock dipped to its lowest point in five years, and has lost 60% of its value in the last 3 months. The slide was initially triggered by the sector's hangover that resulted from the September 15, 2914 sting blow dealt to VirnetX (NYSEMKT:VHC) when the Court of Appeals for the Federal Circuit threw out a $368.2 million royalty award against AAPL. This was further aggravated by the company's report on September 16th, 2014, stating that the Patent Trial and Appeal Board (PTAB) had invalidated the VirtualAgility patent under the patent eligibility (Section 101) standard established as a result of the landmark US Supreme Court case "Alice Corp. vs. CLS Bank International." However, the fact is that VirtualAgility was the least important of DSS' patent-infringement cases, and the less likely to be won. This is why this case was almost never in the conversation until now.

DSS has several hardware-related lawsuits, unrelated to the outcome of the Alice vs. CLS Bank, at various stages against Lenovo, Apple, Samsung, Taiwan Semiconductor Corporation, NEC Corporation, and several others.

The most important near-term catalyst for the company is the November 6, 2014 Markman hearing in the AAPL case in the District Court for the Eastern District of Texas in Tyler, Texas. Below is the status of the most important non-software patent-infringement cases:

DSS vs. AAPL: Markman hearing set for November 6, 2014. Underscoring the importance of this case, on September 5, 2014, Judge John D Love assigned Richard Egan as the case's technical advisor.
DSS vs. Coupons.com (NYSE:COUP) (breach-of-contract case): Waiting for judge's decision from summary judgments hearing held on July 10, 2014.
DSS vs. LENOVO:
DOCKET CONTROL ORDER. First mediation to be completed by 1-19-2015; Second Mediation Completion due by 11/17/2015. Early Damages Expert/Evidentiary Hearing set for 7/2/2015 09:00 AM before Magistrate Judge John D. Love. Jury Selection set for 2/1/2016 09:00 AM before Magistrate Judge John D. Love. Jury Trial set for 2/1/2016 09:00 AM before Magistrate Judge John D. Love. Markman Hearing set for 5/14/2015 09:00 AM before Magistrate Judge John D. Love. Pretrial Conference set for 1/21/2016 09:00 AM before Magistrate Judge John D. Love. Signed by Magistrate Judge John D. Love on 09/18/14.
DSS vs. Taiwan Semi-Conductor:
NOTICE by Taiwan Semiconductor Manufacturing Company, Ltd. Notice of Request for Inter Partes Review of U.S. Patent No. 5,652,084 (Harper, David).

DSS management provided a detailed status of all current patent cases on September 23, 2014, when it discussed the VirtualAgility patents.

Investors also seem to disregard the fact that unlike Vringo (NASDAQ:VRNG), Spherix (NASDAQ:SPEX), ParkerVision Inc. (NASDAQ:PRKR), VirnetX Holding Corp., and other non-practicing entities that generate little or no revenues, DSS has stable and potentially fast-growing revenues once its main anti-counterfeiting and authentication (AuthentiGuard) becomes better-known and is more widely used.

On August 12, 2014, the company reported that it had delivered the first fully-integrated AuthentiGuard customer for DSS' secure digital application and labeling to a customer for printing and hosting, along with the customized mobile application. CEO Jeff Ronaldi commented:

"This win reaffirms the strong value proposition of our AuthentiSuite platform, especially when integrated with our secure printing and packaging capabilities."

CEO Ronaldi added:

"Along those lines, our sales team has been effectively building and expanding our AuthentiGuard pipeline of prospective customers. We are currently in varying stages with several national brands about implementing our AuthentiGuard technology. AuthentiGuard is an ideal representation of our business model, which involves developing and acquiring IP that enables us to bring innovative product and service offerings to market, while actively licensing our IP portfolio."

Looking at revenue growth, DSS has reported the following yearly revenues (See page 3 of the company's September 4, 2014 presentation at the Gateway Conference):

2011 - $13.4 million
2012 - $17.1 million
2013 - $17.5 million
2014 - $17.9 million (TTM)
At the current 83c/share, the market cap is only $35 million, after the Company retired 7.5 million shares being held in escrow related to the Lexington merger (effectively reducing the shares outstanding by 14% to 42 million). As a comparison, the company has over $60 million in assets, including its patent portfolio.
The current price-to-sales ratio is only 2, compared to 88 for VRNG, for instance.

CEO Ronaldi said:

"A major goal for us this year and going forward is to grow and diversify our intellectual property portfolio. Since 2012, we have systematically expanded our patent portfolio from 15 issued patents to more than 120 active patents today, along with seven active cases on file. Looking ahead, we expect to have 10 cases on file by year end and at least 15 by the end of 2015. Our expectations for the future remain high as we build upon the momentum we've established and pursue the widening pipeline of opportunities ahead."

During the September 4 Gateway presentation, CEO Ronaldi stated that if there would be any cash needs going forward, he expected to get it from the pool of IP investors they deal with, instead of diluting the stock (which, at the time, was $1.14).

Regarding the Bascom Research, LLC vs. Facebook, Inc. and LinkedIn Corporation, the September 23, 2014 update stated:

(CAND-3-12-cv-06293; CAND-3-12-cv-06294; PTAB-CBM2014-00138)

In January 2014, Facebook and LinkedIn were granted a stay pending the Supreme Court's decision in Alice Corp. vs. CLS Bank International. Following the Alice decision, the defendants requested and were granted an early summary judgment hearing on the Section 101 patent-eligibility of all four Bascom patents included in the litigation (US patents 7,111,232; 7,139,974; 7,158,971 and 7,389,241). DSS currently expects Section 101 briefings to be exchanged in September and October 2014, with a proposed hearing on November 21st, which is subject to change.
On May 22, 2014, Facebook filed a Petition for Covered Business Method (CBM) Patent Review with the USPTO's Patent Trial and Appeal Board (PTAB) on US patent 7,389,241. Bascom Research responded to the petition on September 3, 2014, and the PTAB's decision on whether or not to institute a CBM is anticipated by December 2, 2014.

DSS Bascom Research Patents have an excellent chance to win the Facebook patent-infringement lawsuit once they pass the Section 101 patent-eligibility test. It appears that the market has given the Bascom patents a zero chance of success, based on the current valuation. However, I give at least a 50-50 chance of success. The law firm representing DSS is a top IP shop, and they will certainly do their best to adapt DSS' position to distinguish the Bascom patents from those that were rejected both in Alice and the post-Alice decisions. The similarities between DSS Bascom Research technology and Facebook's working structures are striking, as explained in detail in pages 34-39 of an excellent article written by J.P. Moreno "The Emergence of Document Security Systems." For reference, the Bascom patents were granted long before Facebook was conceived.
Conclusion:

DSS at 85c/share is extremely undervalued, considering its growth prospects. The market appears to be ignoring any potential proceeds from patent-litigation wins. As a reference, the only analyst covering the stock has a $4 target for DSS. His target was based on assigning a value of $1.65 to the core business and adding a "conservative" $2.65 to account for the potential revenues from setting existing and upcoming patent-infringement lawsuits.

The growth prospects of the company's AuthentiGuard-related products and services are very bullish, according to the most recent quarterly report. Furthermore, there is the possibility of a settlement in the breach-of-contract lawsuit against Coupons.com. Finally, the upcoming AAPL Markman hearings scheduled for November 6, 2014 will become a catalyst for an upward move in the pps as this date gets closer and closer. Recall that DSS went from 86c to over $2.4 in just a few weeks in anticipation of the Facebook Markman hearings initially scheduled to occur earlier this year, but were postponed to wait on the outcome of the Alice vs. CLS bank Supreme Court case.

DSS has been hit with a two-punch combination of the unrelated VHC case and the VirtualAgility patent invalidation. Once the market realizes this and appreciates the intrinsic value of the enterprise, the stock will begin to rally - especially as the November 6 AAPL Markman hearings are about to get underway.

Investors considering buying this or any other stock should always read carefully the risks and uncertainties as spelled out in the company's 10-K and 10-Q filings. Some risks in addition to those listed in the filings are: 1) decline in interest in the company's core products, 2) inability to monetize patents, 3) inability to secure cash needed for continued operations, and 4) loss of key talent.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.