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Document Security Systems - Patent-Infringement Activity Is Expected To Heat Up In The Next 2 Months
May. 21, 2014 7:35 PM ET | About: Document Security Systems, Inc (DSS), Includes: FB, LNKD

Disclosure: I am long $DSS. (More...)
Summary

The most recent quarterly report is behind us. DSS will start being valued as an IP play going forward. There are several catalysts to fuel a rally in weeks ahead.
The company's flagship product, AuthentiGuard, is starting to gain more traction and visibility with national TV network demonstrations and the signing of a new client.
DSS will retire 7.5 million shares being held in escrow related to the Lexington merger on July 1, 2014. This will reduce the shares outstanding by 14% to 42 million.

Document Security Systems, Inc. (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. But DSS is better 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 (AAPL), Facebook (FB), LinkedIn (LNKD), Samsung (OTC:SSNLF), Taiwan Semiconductor Corporation (TSM), NEC Corporation (OTC:NIPNF), and many others. DSS has already has already settled favorably on lawsuits against Broadvision (BVSN), Jive Software (JIVE), and Novell (NOVL).

Being a company with real products and services and also trying to capitalize on potentially multi-billion dollar settlements is a blessing and a curse. But unlike other so-called "patent trolls" like Vringo (VRNG), Spherix (SPEX), Parkervision Inc. (PRKR), VirnetX Holding Corp. (VHC), and others like them 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 more widely used). It's a blessing because if all its patent-monetizing efforts fail, and if its core products gain traction, the possibility of a bankruptcy is greatly diminished. It's a curse because the stock is valued based only on quarterly results related to its core business when patent-related news are either adverse or non-existent.

Last week, the stock dipped temporarily to a 52-week low after the company reported another loss for 1Q 2014 on May 13, 2014. It's obvious that the market is giving DSS this valuation based solely on results related to its core business. But DSS has significant upside from IP monetization activities, and that potential value is not reflected in the current $1.1/share.

I believe that anticipation of a June 2014 verdict in the Alice case will fuel a steady rally as the date gets near. Why is this event important for DSS? In January 2014, accused patent infringers FB and LNKD were given a brief respite until June 2014 when the US Supreme Court is expected to deliver its decision in Alice Corp. v. CLS Bank.

US District Court for the Northern District of California Judge Susan Illston granted the FB and LNKD motion for a stay on the patent-infringement cases brought about by DSS subsidiary Bascom Research pending a final decision in Alice Corp. v. CLS Bank "in the interest of judicial efficiency."

Bascom Research brought the case against the social networks in October 2012. The four asserted patents were bought from inventor Thomas Bascom. Speaking at the time that Bascom Research's suit was filed, a DSS executive stated:

"We strongly believe that Facebook, LinkedIn and the other defendants are infringing our patents. Our pioneering technology was patented as early as 2001-long before the advent of Facebook, LinkedIn and other social and business networks-and covers key aspects of online collaboration and relationship linking."

The patents, according to Bascom Research, cover the manner in which users and application developers on the Facebook and LinkedIn platforms make connections between "objects" such as photos, people, events and pages.

A hearing in Bascom Research v. Facebook and LinkedIn was scheduled for 17 January. The defendants' motion to stay the case came ahead of a planned 31 January claim construction opening brief and a 12 March Markman hearing in Alice Corp. v. CLS Bank. A final decision from the Supreme Court is expected by June 2014.

In its 1Q 2014 conference call, DSS management sounded very optimistic about upcoming developments on these cases, as stated by DSS' CEO Jeff Ronaldi:

"As we understand it, the Alice case covers the question of whether the computer automation of a bookkeeping process can be patented. Our interpretation of the case is that while some of the questions of case appear broad, we believe it's likely the case will be interpreted narrowly, that is we believe the court will issue a decision as to the specific technology of the Alice case, but not necessarily rule on the overall patentability of software."

Investors need to be reminded that the patent-infringement cases against Facebook, LinkedIn, and others are software-related. The cases against Apple, Samsung (OTC:SSNLF), and others are hardware-related, and therefore, are not affected by the Alice case.

There were other positive developments that were reported in 1Q 2014:

DSS received nationwide coverage of the conpany's flagship technology AuthentiGuard on Fox Television during a guest spot and live demonstration on Fox and Friends. More information on Authentiguard can be found in pages 31 - 33 of J. P. Moreno's report. The company brought on board former NFL player Pat McInally to represent AuthentiGuard in the sports merchandise and entertainment markets. This has increased visibility and grown the pipeline and resulted in adding a second AuthentiGuard customer.
As of March 31, 2014 the company had a cash balance of approximately $3.4 million. This compares to a combined cash balance on December 31, 2013 of approximately $2.5 million.
The company will retire 7.5 million shares being held in escrow related to the Lexington merger on July 1, 2014. This will reduce the shares outstanding by 14% to 42 million.

Once the Markman hearings on the Facebook and LinkedIn patent lawsuits resume their course after the Alice case ruling in June 2014, the share price could gain rapidly. This was the case before the January 2014 stay. But wise investors will likely be accumulating shares at today's bargain prices. DSS Bascom Patents have an excellent chance to win the Facebook patent-infringement lawsuit. This can be seen clearly on the similarities between DSS Bascom Research technology and Facebook's working structures, as explained in detail in pages 34 - 39 of an excellent article written by J. P. Moreno, "The Emergence of Document Security Systems."

Regarding the potential windfall related to winning the Facebook case, I've stated the following in a previous article:

"Using the available information to date, I will walk you to some simple calculations to try to estimate the potential windfall resulting from potential Facebook and LinkedIn settlements.

In 2012 Facebook reported revenues of approximately $5.1 billion. But the most recent quarter resulted in revenues of $2 billion reflecting significant growth that it's expected to continue. But just to be conservative I will use 2012 revenues. This means that 4% and 5% royalty rates would amount to about $204 million and $254 million respectively. From available information to date, DSS gets to keep at least 60% of the total settlement, with the balance going to other parties including the inventor and Kramer Levin (the law firm representing it). This means that DSS would end up receiving between $122 million and $153 million using the assumptions stated above from a settlement with Facebook. Using the same logic, the company would end up receiving between $23 million and $29 million from a settlement with LinkedIn. These royalty calculations are only for one year! DSS is seeking royalties on future year revenues as well, at least until the Bascom Patents expire in 2022! Facebook and LinkedIn have experienced double-digit revenue growth in recent years, which is expected this to continue for the foreseeable future. This means that royalty revenues for DSS would also grow over time, and therefore the potential appreciation in DSS stock price can be significant."

The potential windfall related to wins against any of the major companies DSS is going after is huge and is not reflected in the current $1.1/share price - particularly now that the shares outstanding have been reduced to only 42 million shares. It is clear that company management believes that this in the case, and for this reason, they've recently hired a well-known IR/PR company. The result of this new initiative did not take long to materialize, as DSS will present at the Marcum MicroCap Conference on May 29, 2014. The press release announcing this event states:

"DSS will discuss the company's recent operational and financial performance, as well as its unique multi-tiered business model designed to provide a stable stream of revenue and profits, rich technology innovation and significant upside from IP monetization activities."

Investors considering investing in DSS, 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.

Editor's Note: This article covers a stock 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.