It's A MARA-Thon, Not A Sprint In The Patent Monetization Space
Jan. 29, 2015 8:42 AM ET | About: Marathon Patent Group, Inc. (MARA), Includes: DSS, PRKR, SPEX, VHC, VRNG
Disclosure: The author is long MARA, VHC, VRNG. A full report including a detailed portfolio section was made available exclusively by purchase through my blog theiphawk.blogspot.com/2015/01/mara-repo... on January 19, 2015. A disclosure was made in the report that I will not buy or sell any stock within 72 hours availability. I am extending the disclosure another 72 hours for seekingalpha publication. Content is researched, written and reviewed on a best-effort basis. Any errors or omissions, please notify me at iphawk@outlook.com (More...)
Summary
MARA has outperformed the rest of the sub $500M sector.
MARA's business model, strategy, and partnership with IP Navigation.
Past financials and my future estimates, which forecast a very strong year in 2015.
Dynamic Advances v Apple litigation history with a hypothetical damages model.
Q4 2014 Review and litigation timeline setting up a busy court schedule for 2015.
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Company: Marathon Patent Group (NASDAQ:MARA) - $7.52.
Target Price: $15 over the next 6 months. $20-$30 over the next 12-18 months.
Intro:
Sprinters run hard and fast for short bursts, exerting all of their energy to hit a maximum speed for a very short duration of time and distance. On the contrary, marathon runners are methodical, steady, and strive for consistency over long intervals, 26.2 miles vs. a few hundred meters. These athletes are polar opposites of one another and the chart below demonstrates the parallel nature within the patent monetization peer group.
The patent space, particularly in the sub $500 million category, has seen the sprinters. Companies like Virnetx (NYSEMKT:VHC), Vringo (NASDAQ:VRNG), Parkervision (NASDAQ:PRKR), Augme (OTCPK:HIPPQ), Document Security Systems (NYSEMKT:DSS), and Spherix (NASDAQ:SPEX) have all had explosive moves higher but have dwindled over time. For the investors that were long these stocks in time to benefit from the positive catalysts, there was certainly plenty of money to be made. However, it's been a challenging environment for the smaller companies and investors have seemingly lost faith in the blue sky, colossal jury award pitch. Fortunately, there is one company that I have followed and have shared with my readers, that has just embarked on its 26.2 mile journey. This company is aptly named Marathon Patent Group.
We have all heard the saying, "a picture is worth a thousand words". The picture below tells the story rather clearly; but, as a courtesy to readers, I will still provide some conventional analysis.
When evaluating any sector or industry, it is always important to run a peer group analysis, identify the outliers and figure out why they are bucking the trend. As you can see from the picture below, the larger cap IP stocks have performed quite well while the smaller cap stocks have gotten annihilated over the last 3, 6, 12, and 24-month time frames. One company jumps off the page that is not only the best stock in the small cap space but arguably the most attractive investment for absolute returns on a risk adjusted basis. For those readers who have lost money in some of the "sprinters" mentioned above, I understand your hesitancy to invest in yet another up and coming IP stock, but keep reading and see if you can spot the differences that sets MARA apart.
Sector Performance:
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The companies under $500m have struggled for a few reasons:
- The companies hold a small number of portfolios, that build a premium on the prospects they will be able to litigate/settle lawsuits for 8 or 9 figure sums. As the companies accrue legal victories along the way the premium increases as investors bid up the valuation with the hopes the companies can resolve the cases. If there are any legal setbacks along the way, the premium deflates in an extreme fashion. VRNG, VHC, and PRKR all saw this happen in 2014.
- The majority of the under $500m names went public through a reverse merger process, which included a sizable amount of warrants, convertible shares, or lockups that expire. The market has not been able to absorb the merger dilution.
- Delays have also been a large factor, which have mostly resulted from Inter Partes Reviews being filed and granted. Defendants are able to ask for a stay of the litigation, which are typically granted and results in a 12 month wait for the patent office to hold a mini trial on validity.
MARA bucked the trend by reverse merging in November 2012 and spent roughly six months clearing out the overhead of the merger predecessor in 1H 2013. The company has subsequently raised money in a handful of offerings, which they have used to acquire more patents. MARA has done very well to date with IPRs with the majority not being instituted at the patent office, which has not delayed any of their litigation campaigns. Most importantly MARA has been able to generate revenue and in recent quarters profits! The company has been able to negotiate licensing/settlement transactions before Markman hearings or jury trials are held.
Strategy and partnership with IP Navigation:
MARA is very different from the other smaller cap patent monetization companies in its space. Perhaps the most defining distinction is the company's ability to monetize several high quality portfolios. The business model and valuation is supported by consistent cash flows that have and will continue to be realized by asserting their patents in various courts around the world and leveraging incremental legal developments into patent licenses and settlements. Instead of shooting for the moon with $500mm jury verdicts, Marathon is able to negotiate license and settlement agreements at significant discounts, which still yield $10-$50mm returns depending on the portfolio. As Marathon's patents make their way through various court systems and secure favorable rulings along the way, the company's negotiating leverage will increase which will lead directly to Marathon striking agreements.
Marathon has a unique relationship with IPNavigation in which IPNav helps source and monetize patent assets. IPNav's founder Erich Spangenberg is Marathon's largest shareholder and many of IPNav's former employees have joined Marathon in leadership positions. While this will certainly increase the company's headcount and overhead, the internal growth will likely reduce the company's net expense as it will not need to outsource as much work to IPNav and other third-party vendors.
Who is Erich Spangenberg? Erich is one of the most successful patent licensors in the world, having filed suit against nearly 2,000 companies and generated over half a billion dollars in licensing and settlement revenue on behalf of his clients. At the end of 2014, Erich resigned as IPNav's head of business, presumably to spend more time working with Marathon.
Past financials and future estimates:
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I use Non-GAAP EPS by backing out non-cash expenses such as patent amortization and stock-based compensation. I believe the Non-GAAP number provides a more reasonable metric to evaluate earnings being driven to shareholders. Patent amortization tripled from 9/30/2013 to 9/30/2014, and it will remain an increasingly growing expense as the company continues to acquire additional patent portfolios.
For baseline licensing revenue, I used a 15% quarter-over-quarter growth rate, which is reasonable considering the combination of existing licensing portfolios, upcoming Markman Rulings and, if necessary, jury trials. As the company acquires additional portfolios, I feel comfortable that it will be able to sustain such growth. To be clear, there will certainly be bumps along the way. Marathon is in the patent monetization business, and should therefore never be managed to meet quarterly expectations. There will be timing issues with patent settlements that will result in some quarters missing expectations while others exceed. With time, results may smooth out and become more predictable.
The proposed high value litigation settlements are conservative estimates in worst case scenarios using inflated discounts. As the company continues to successfully defend IPR proceedings and win Markman Rulings, the applied discounts will decrease, thus increasing the nominal settlement figures. Investors won't know the exact proposed damages number until the jury trial is held. I use a 40% margin on the high value litigation as it is a good midpoint between the basic licensing margin of 31% and when there is a high value settlement such as in Q3 2014 with Clouding IP.
With a trailing P/E of 11.20 times 2015 basic licensing + high value litigation, MARA should be a $20.00-$30.00 stock. I feel confident on the P/E multiple because of management's ability to continue refreshing the portfolio pipeline.
Dynamic Advances v Apple
Dynamic Advances v Apple is a monetization program included in my high value litigation, which should be the first real test for my model. The patent application was filed by Rensselaer Polytechnic Institute on May 16, 2002 and claims priority to a provisional application filed May 19, 2000. The patent was granted on February 13, 2007 after a examination at the US Patent Office. The patent was assigned to Dynamic Advances on December 16, 2011 and asserted against Apple (NASDAQ:AAPL) on October 19, 2012. The complaint alleges that iPhone 4S, iPhone 5, iPad with Retina Display, iPad Mini, and iPod Touch infringe the patent through the use of Siri.
Apple filed for Inter Partes Review (IPR) at the Patent Trial and Appeal Board (PTAB) on 10/21/2013 to review the '798 patent. The PTAB decided on 4/15/2014 to not institute review because the information presented did not show that there was a reasonable likelihood that Apple would prevail with respect to at least one claim of the '798 patent. Apple further filed an additional two IPRs on 1/3/2014. Both of these reviews were decided to not be instituted on 6/12/2014 due to the one year time bar. The patent office uses a lower standard to review and invalidate patents using the broadest reasonable interpretation standard (BRI). District Court's use a higher standard to invalidate patents under Philips, which should present a challenge to Apple at an eventual trial.
A Markman hearing was held on April 14, 2014 and a Markman order was issued on June 12, 2014. The opinion was very strong for MARA with nine disputed terms construed. One term was net neutral, six terms agreed with MARA's proposed constructions. Two terms agreed with Apple's constructions. I expect a trial to be scheduled for the first half of 2015, although it might be pushed to early Q3 2015.
Through discovery, a MARA damages expert will propose damages theories to calculate a per unit royalty for infringement of the '798 patent. I estimate a royalty range of $.25 to $1.00 to be proposed. I believe a fair estimate to be $150M.
The Dynamic Advances v Apple is one of many potentially lucrative monetization programs MARA is currently pursuing. A settlement should be highly accretive to the company and shareholders. Securing legal decisions should increase the settlement likelihood and decrease the discount MARA is willing to resolve the case before it gets to trial.
Q4 2014 Review:
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Estimating quarterly revenue from non-recurring patent settlements has historically been very challenging for investors. Q4 2014 will not be any different. There were a number of settlements/dismissals in the Clouding IP and Selene portfolios, which should be covered by the RPX agreements signed on September 30, 2014. CRFD Research and Relay IP also signed agreements with RPX In Q1 2014, but due to timing issues they should not be covered under the RPX agreement. I am not expecting a repeat of Q3 2014 $13.5M number.
Q4 Announcements
- October 13, 2014 - Completed a $5.5mm financing and an acquisition of three medical device portfolios: OrthoPhoenix, TLIF and MedTech Development
- October 22, 2014 - Filed new lawsuits against Apple, Amazon, Box, Dropbox, Google, and SugarSync in the Vantage Point portfolio
- October 27, 2014 - Announced a Markman hearing scheduled for January 20, 2015 in the TLI Communications portfolio
- November 3, 2014 - Received a favorable first instance ruling in the MedTech v. Stryker case in Germany
- December 1, 2014 - Started the enforcement of an injunction against Stryker in the MedTech portfolio in Germany
- December 3, 2014 - The PTAB denied institution of the IPR filed by BrainLab AG and Varian Medical Systems against Sarif's '725 patent. A joint dismissal was filed to terminate the IPR proceeding
Key court dates timeline:
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Risks:
- Investments which have a significant reliance on the legal system carry different risks than traditional operating companies. Predicting the outcome of complex patent litigation is very difficult for investors. Litigation losses will happen along the way at the patent office or at the court level. By taking a diversified portfolio approach any losses should be mitigated.
- The learning curve for patent investments is steeper than most investment classes and there is very little coverage of the sector or investments by the mainstream investment community. Marathon along with other companies in the sector needs to continue to educate investors and analysts.
- Quarterly results could not meet expectations, due to timing issues, deal flow, or legal decisions.
- Patent reform failed in 2014, but there should be a renewed effort to pass new legislation in 2015. The impacts are currently unknown at this time.
Conclusion:
The company has enjoyed early success to date, which I expect to accelerate through the rest of 2015 as the company continues to execute on their monetization programs. A packed 2015 schedule should lead to a number of high value litigation agreements, which could a huge boon for investors. I believe shares could double over the next 6 months and could reach $20-$30 over the next 12-18 months.
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.
