Personal note: I worked as a software architect for a leading streaming media company from February 1997 through August 2001 and have been able to verify many of the facts in this story through both my own personal experience and my network of connections.
Introduction
Microsoft is accused of stealing a technology called “Faster-Than-Real-Time” streaming from a small technology company called Burst.com. Burst, a company that was started in 1988, sued Microsoft in 2002 for patent infringement and anti-trust violations. The lawsuit is barreling ahead toward trial, although it could also result in a pretrial settlement. If Burst wins at trial, it could result in a significant judgment. Based on my analysis of the capital structure, legal expenses, and tax consequences, Burst is currently trading at a level that implies a $75 million settlement. This stock can easily double or triple from current levels of around $1.00 in the short run, and potentially go north of $5 if there is a large settlement or judgment.
Now, Microsoft has been named in dozens, if not hundreds, of patent infringement and anti-trust cases and many of them are summarily thrown out of court without ever going to trial. Several things separate Burst’s case from the ordinary riff-raff:
1. Based on motions filed thus far, Microsoft employees appear to have deleted approximately seven weeks worth of Burst-related email during the weeks surrounding the Burst meetings. 2. This occurred after a senior Microsoft executive sent out a directive instructing employees to “get rid of your email, do not be foolish” even though Microsoft has been under document retention orders since 1997. 3. Documents have been discovered where a key Microsoft employee colorfully describes how Microsoft’s altered software “nuke[s]” Burst and “kills Burst”. 4. Much of the foundation of the antitrust charges leveled against Microsoft has already been established in the Department of Justice’s landmark antitrust case against Microsoft (in which Microsoft was judged by the court to wield monopolistic power and engage in anticompetitive business practices). 5. I have consulted with an independent antitrust attorney and his opinion is that Burst has a strong case on the antitrust side.
I believe that Burst’s case against Microsoft is very strong and may very well result in a large settlement or judgment. Two recent patent cases resulted in a $600 million judgment against Microsoft (Eolas) and a $1.95 billion settlement with Sun Microsystems.
Those interested in pursuing this in more depth are strongly encouraged to read Burst’s 1st amended complaint filed on 9-10-04 which provides a fresh and detailed history/status report (Case #2002CV02952, Baltimore District, Maryland). A copy of this complaint, plus many other interesting documents can be found at:
At the core of the Burst v. Microsoft case lies a simple, but brilliant, idea that Burst.com patented as early as 1990 (US Patents #4,963,995, #5,164,839, and #5,995,705). The basic concept is some audio/video information is compressed and transmitted to the client in a “burst” so that it takes less time to transmit than the time it takes the original material to play. Then the client software can play the material at its leisure, resulting in (a) a guaranteed TV quality picture and sound quality for the end user and (b) an increase in network efficiency of up to 60%, and (c) a substantial reduction in network transmission problems.
This is a technical leap from real-time streaming, a concept pioneered in 1995 by RealNetworks (formerly Progressive Networks), which allows a computer user to view a compressed audio/video signal while it downloads continuously in the background, rather than wait for the entire file to download and be saved to the users hard drive. In real-time streaming, the server transmits information in “real time” to the client, which is to say that it takes approximately one hour to stream one hour’s worth of video content.
It wasn’t until the advent of broadband that the difference between streaming and bursting would become apparent. While in many cases a broadband user will have a much faster Internet connection than is required to transfer the audio/video information in real time, the amount of bandwidth actually fluctuates moment-to-moment, sometimes providing even greater bandwidth and sometimes providing none at all. Bursting allows these users to take advantage of the high-bandwidth periods to receive packets faster than they actually view them (“Faster-than-Real-Time”) and save them for later viewing. By downloading information before it is actually needed, bursting effectively insulates the user from the unexpected network bandwidth fluctuation problems (the periods when bandwidth diminishes to less than the amount required to play content). It is these problems that would cause a real-time streamed broadcast to stutter or stop, regardless of average available bandwidth.
Since Microsoft implemented bursting in Windows Media 9, the concept has been copied by both of the other major streaming media packages (RealNetworks’ RealPlayer and Apple’s QuickTime). These other products may also infringe upon Burst’s patents and Burst plans to enforce its patents against any infringers after the Microsoft case concludes, if not sooner.
The Story So Far
Burst.com, Inc, originally a partnership that became Instant Video Technologies, and then Burst.com, was co-founded in 1988 by Richard Lang, co-inventor of the patented dual-deck VCR (a clever, but now passé device for duplicating VHS tapes, which has since morphed into DVD-to-Cassette recording devices available at your local electronics outlet). After enjoying some success with his videotape invention, Lang and his Burst co-founder Lisa Walters decided to focus efforts on digital media delivery to networked computers, a concept clearly ahead of its time in 1988. Ten years of hard work and heavy research resulted in Burstware, first released in 1998, a high performance media delivery system for distributing audio and video data over the Internet and other electronic networks (i.e. Cable, Satellite).
Early versions of Burstware were built on top of Intel’s Java Media Framework (JMF), a cross-platform set of tools for building multimedia applications. JMF was based on the operating system independent Java programming language, which had recently become the focal point of an all-out war between industry heavyweights Microsoft and Sun Microsystems. Microsoft viewed the JMF as a huge threat to its budding Windows Media franchise and in October of 1997 Bill Gates took the issue up with Intel CEO Andy Grove personally, characterized by another Microsoft executive as a well delivered threat of ‘thermal nuclear war’. Under attack from Microsoft, Intel abandoned support for the Java Media Framework. All of this has been previously documented in United States of America v Microsoft Corp., the Department of Justice’s much publicized antitrust case, which established that Microsoft’s control of the operating system market constituted a predatory monopoly.
When Intel dropped the JMF, Burst was among Microsoft competitors whose products and productivity were damaged (these actions are one of the key elements in Burst’s antitrust complaint against Microsoft). Burst’s flagship product had to be abandoned, but eventually Burst went with a “if you can’t beat ‘em, join ‘em” strategy and began developing a “plug-in” product for Microsoft’s own Windows Media Player. They took the concepts that made Burstware revolutionary and rewrote them to piggyback on Microsoft’s Windows Media Player (there is a diverse market of many such 3rd party developers that create add-on solutions for Windows media).
Even while writing a plug-in that strengthened Microsoft’s own streaming media offering, Burst continued to encounter difficulties from Microsoft. An updated version of the Windows Media Player in 2000 contained modifications that prevented anyone using the new player version from receiving media files from Burst’s cross-platform servers, effectively ending Burst’s ability to sell a product which operated with the latest version of Windows. From the amended complaint: “One Microsoft document recounts a key employee colorfully describing how Microsoft’s altered software ‘nuke[s]’ Burst and ‘kills Burst.’”. Making Burst’s product unusable with Windows at a key juncture in Burst’s market introduction of its technology resulted in large Burst customers, potential customers and investors walking away from Burstware because there was no upgrade or development path available. Burst’s legal team argues that Microsoft’s actions severely damaged Burst and constituted an important element in Microsoft’s illegal attempt to extend its operating system monopoly into the media delivery market.
I’ll Show You Mine …
In October of 1999, Burst and Microsoft entered into a special non-disclosure agreement for the purposes of exchanging confidential information regarding Burst’s technology. I must impress at this point how unusual it was that Burst could get Microsoft to sign an NDA that deviated from its standard NDA. Typically, if you want to talk to Microsoft you have to sign the standard Microsoft NDA. No NDA, no discussion. Therefore it seems very unusual that they would sign a non-standard NDA in order to get a peek at Burst’s business and technology. One obvious conclusion is that they really wanted to see Burst’s cards, and they were willing to break with ordinary procedure to do it.
In any event, Burst met with Microsoft from October 1999 through December 2000 and shared with Microsoft key trade secrets and confidential information relating to the superior Burst’s technology and its substantial advantages over the technology path that Microsoft had been on up to that point.
Microsoft had continued ongoing discussions with Burst for more than a year, indicating an interest in obtaining license rights to Burst’s patented technology. During the course of those talks, Microsoft invited Burst to become a Microsoft “Partner” and to exhibit Burstware at the Microsoft “Partners Pavilion” at a major trade show. However, by the end of 2000, it became clear that Microsoft had no real intention of licensing Burst’s technology. This, combined with Microsoft’s “breaking” of Burst’s WMP plug-in earlier in 2000, scared off both customers and investors, and by November 2000, Burst was forced to lay-off 80% of its workforce. Talks between Microsoft and Burst eventually broke off in early 2001, after Burst had been decimated and left for dead by Microsoft.
Hey, That Looks Familiar!
Months later, the Burst team was shocked when Microsoft announced Windows Media 9, code-named Corona, in December 2001. As you’ve probably already guessed, Corona incorporated “Faster-Than-Real-Time” media delivery and other technology that infringed on Burst’s patents.
Having slimed down to a mere two full-time employees, co-founder Richard Lang and V.P. of Operations Eric Walters spent the next year putting together their evidence and shopping around to find the best legal counsel possible. Lang settled in with Spencer Hosie, of the firm Hosie, Frost, Large and McArthur, of San Francisco, who has successfully prosecuted many monopolization and price fixing cases against major players in the oil industry, winning settlements and judgments worth hundreds of millions of dollars. Fighting alongside Hosie is the litigation team of Silicon Valley intellectual property firm Carr & Ferrell, which prosecuted most of Burst’s patent applications.
The legal team took the case on a 100% contingency basis, demonstrating faith in the strength of the case. They lawyers are currently eating all the costs of fighting the lawsuit (which could tally up to $5 mln through the start of trial) in the hopes of getting a piece of any settlement or judgment. Hosie and the patent law firm are expected to take expenses plus 33% of any settlement, or expenses plus 40% of any payout after the case goes to trial.
On June 19, 2002, Burst.com filed a lawsuit against Microsoft, alleging violations of the Patent Act, Sherman Act Sections 1 & 2, California Cartwright Act (antitrust), California Business & Professions Code Section 17200 (unfair acts or practices), the California Trade Secrets Act and breach of contract. Specifically, Burst alleges that:
1. Microsoft’s newly announced “Corona” product uses technologies and trade secrets misappropriated from Burst.com. These proprietary technologies are protected by numerous U.S. and International patents and patents pending. Microsoft met with Burst over a two-year period and negotiated unsuccessfully for the rights to use Burst’s innovative technology.
2. Microsoft anticompetitively harmed Burst in violation of federal and state antitrust laws, echoing the finding of federal courts that it monopolized the market for Intel-compatible operating systems.
Since the filing, the case has been in the “Discovery” phase, where both sides gather all of the evidence (including videotaped depositions) and present it before the magistrate presiding, Judge Frederick Motz. After the close of discovery, the magistrate examines all of the facts presented to him and determines how many of the original complaints will continue on to trial.
So far the Microsoft lawyers have been successful at sealing almost all of the evidence in this case, claiming that the evidence contains trade secrets and sensitive information that would materially damage Microsoft’s business should it become public. The truth of the matter is probably that very little of the evidence at hand contains information that would be useful to Microsoft’s competitors. However, there may be a mountain of evidence that paints Microsoft in an unfavorable light, and this is a likely explanation for why Microsoft wants the details and evidence kept quiet.
In the meantime, we can glean clues as to the contents of the evidence by reading Burst’s complaint, Microsoft’s response, and other key court documents.
I’ve discussed most of the historical information I know about the case in the sections above. What I would like to stress at this point is that I worked in the streaming media industry from 1997 through 2001 and have been able to verify many of the facts presented here through my own personal experience or through my network of connections. I have checked in with co-workers who attended Microsoft conferences alongside Burst employees in 2000, when Burst still believed it was in a good-faith relationship with Microsoft. When Corona was announced in December 2001, it was common knowledge in the industry that the Faster-Than-Real-Time streaming technology Microsoft was introducing as its “innovation” had in fact been copied from Burst.
The JMF story is a historical fact, documented in the DOJ’s landmark antitrust case United States v. Microsoft Corp. 395 Findings of Fact from this case were originally granted Collateral Estoppel, which means they would be entered into evidence in Burst v. Microsoft Corp. and accepted as established fact, specifically precluding Microsoft from rearguing any of the findings. Since then, a Federal Circuit Appeals Court has sent the original Collateral Estoppel ruling back to Judge Motz requiring that each finding to be argued on a fact-by-fact basis. I expect that some of the original findings will make it into evidence and some will not. In any event, I have consulted with an antitrust attorney and he has assured me that Burst has a strong antitrust case without applying any of the 395 findings. Any findings that make it into evidence can be thought of as “icing on the cake” that would make the case that much more difficult for Microsoft to defend. Either way, the Clayton Act calls for any compensatory damages to be trebled in antitrust cases.
The other important information that has become public from under the cloud of secrecy in this trial is that there appear to be big gaps in the email evidence that Microsoft has supplied the court. Specifically, Hosie and his legal team searched through 140 boxes of emails, sorted them by date, and discovered that curiously, there were no emails within a few weeks of each meeting Microsoft had with Burst. There were just big gaps! Somehow, all of that email mysteriously disappeared. Fortunately, Burst had its own email records that show that at least 70 emails missing from the Microsoft files.
The clear implication is that there are other internal emails that must have been sent over those time periods that Microsoft has either destroyed or just not supplied. Judge Motz, who is presiding over the discovery phase of this case, seems to have taken a personal interest in the whereabouts of the missing emails and seems to be agitated with Microsoft’s lawyers. In a recently unsealed hearing, Microsoft was ordered by the court to search through its archive of backup tapes for the missing email records. In addition, Jim Allchin (Microsoft’s VP over Windows platforms) had in 2000 sent an e-mail to all employees describing a new company policy of deleting all e-mails “for legal reasons”. The judge has specifically ordered that Microsoft’s legal team unearth the background of this e-mail and fully explain Allchin’s use of the phrase “for legal reasons,” as well as to search the email servers belonging to Microsoft lawyers.
If Microsoft fails to produce the missing emails, then the court may decide to enter a “Spoliation” instruction, which would instruct the jury that Microsoft destroyed evidence and encourage the jury to draw an adverse inference from the destruction of those documents. On the other hand, if Microsoft does produce the emails, then whatever they produce will almost surely be damaging. Why else would they have been withheld in the first place?
The following link is to a big hearing discussing Jim Allchin’s deposition and the search for certain emails:
The discovery phase of the trial is expected to close within a month, probably in October or early November. After discovery closes, Microsoft will likely file motions for Summary Judgment. An earlier motion for Summary judgment and dismissal filed by Microsoft has previously been denied by Judge Motz (near the beginning of the case), which implies that the case will go to trial. Next spring (February to March), Motz will decide how much of the original complaint goes to trial. After that, a trial date will be set (expected early summer 2005) and at this point, it looks like the trial will be presided over by Judge Vaughn Walker in the Northern District of California (although this could change). Incidentally, Burst has requested a jury trial and I think you can imagine what a northern California jury may think about Microsoft bullying around a little Silicon Valley technology company.
What could go wrong?
For better or for worse, in the long-term Burst is a binary investment. They either get a judgment or settlement from Microsoft or they get nothing. In that sense, Burst shares are like a call option that pays off on the outcome of the lawsuit.
Another thing that could go wrong is that Microsoft could attempt further delaying tactics, trying to stretch Burst out until they run out of money, and dampen returns for investors by stretching out the time horizon. This is a valid issue, but most of the good delaying tactics at Microsoft’s disposal have been exhausted during the discovery phase. My lawyer friends assure me that things will start to move very rapidly once a trial date gets set. Also, Burst has enough cash to keep running for one year after the expected start of the trial. If the trial should drag out longer than that, they will probably have to raise money through a dilutive equity issuance. Their burn rate is a reasonable $120,000 per quarter.
Microsoft and Burst could choose to settle at unsatisfactory prices. As you can see from the chart below, any settlement below $75 million would generate a negative return from current share prices, in my opinion. Fortunately, I think that any potential settlement is likely to be much greater than $75 million.
What if Burst loses the case? A complete loss would be devastating. The company’s only real assets are its intellectual property and this lawsuit. Legal cases are tricky and it is difficult to accurately assess the probability of any outcome. According to my legal counsel, Burst seems to have a strong antitrust case and a decent patent infringement case (patent cases are notoriously difficult to win). I believe it is unlikely that Burst would lose on all counts. The patent side could be lost if all 3 patents cited in the case are invalidated (rarely happens), or their patents could be deemed to not apply to Windows Media (which is much more of a real concern).
What could go right?
On the other hand, recent patent infringement settlements and judgments against Microsoft have totaled in the billions. Sun Microsystems recently reached a $1.95 billion settlement with Microsoft over an anti-trust dispute over the Java programming language. A highly publicized patent infringement lawsuit brought by Eolas against Microsoft resulted in a $600 million judgment, which is expected to total nearly $1 billion after interest is added (note: the Eolas case is currently under appeal, which could drag the case on additional years or result in a discounted settlement with Microsoft). The Eolas case is only a patent infringement case and does not have any of the antitrust features of the Burst complaint, which calls for trebled damages.
If the trial against Microsoft results in a successful verdict, then Burst may use 5% of the winnings to pursue additional litigation against other media delivery companies that have also infringed on its patents. The rest would likely be paid out as a special dividend to shareholders, if the Board of Directors votes to do so.
In lieu of a settlement, Microsoft could always choose to acquire BRST in order to obtain the rights to their valuable patent library, and to end the anti-trust issues. The patents could then be used to garner licensing revenue from competitors RealNetworks and Quicktime or force them to remove “Faster-Than-Real-Time” streaming from their products, rendering them inferior. More likely, Microsoft would use the Burst IP, combined with their own, to form the basis for open and cross-licensing with other companies in the media delivery field, and to use the IP as a basis for leveraging Microsoft into world media delivery standards. This is in line with Microsoft’s new intellectual property strategy, characterized in the article below.
The last point is that we could see a substantial run-up in share price in the meantime as each milestone in the legal case provides a potentially positive catalyst. I hate to even mention this company, but the SCO Group (SCOX) saw its shares appreciate 20x before its case against IBM fell apart. There were ample opportunities for early investors to exit their positions with huge gains. That being said, I’d like to distance your thinking on Burst from the frivolous SCO case. Followers of the SCO case will remember that SCO Group was always secretive and would never disclose any concrete details about their case. Burst v. Microsoft is reversed, with Microsoft requesting that hearings be sealed and evidence be hidden from public eyes. Additionally, SCO’s ownership claim of the Unix intellectual property was trivially easy to invalidate due to convoluted arrangements between AT&T, Novell, IBM, and others. As a final point, SCO Group’s management spent a huge amount of their time and resources promoting their lawsuit to the financial press while insiders sold millions of shares. On the other hand, we’ve hardly heard a peep out of Burst’s management, who seems content to sit quietly and let their lawyers do their work in peace. Now which company sounds like it expects to win its lawsuit?
Catalyst:
Microsoft finds emails Microsoft doesn’t find emails Close of discovery Ruling on summary judgments Press Coverage Trial phase begins Potential settlement Potential licensing agreements with Apple, RealNetworks, etc.
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