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Will T-Mobile's Aggressive Patent Defense Derail On Track's Momentum?

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midastouch017   Thursday, 01/30/14 01:47:04 PM
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Will T-Mobile's Aggressive Patent Defense Derail On Track's Momentum?

Jan. 29, 2014 12:53 PM ET | 2 comments | About: OTIV, Includes: TMUS
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)

Recent developments in On Track Innovations' (OTIV) ongoing patent case, coupled with OTIV failing to capitalize on the near-term opportunity presented by the favorable Markman ruling received by the company in July 2013, have materially changed our view of OTIV's near-term patent monetization prospects - both in the T-Mobile (TMUS) case, and related future litigation. Investors whose investment thesis is predicated on a large return from OTIV's patent monetization efforts should consider the below carefully, while those who give little or no weight to the company's patent prospects are perhaps best positioned to disregard our opinion at this stage. To what extent the meteoric appreciation of OTIV's share price, since we first identified the company as a potential patent play, is completely divorced from the company's patent monetization efforts we do not know. Perhaps the best evidence that OTIV's patent efforts carry weight with investors is the large jump the stock made on the news of the favorable Markman ruling back in June. Of course, the stock has continued to rise as respected Seeking Alpha contributors have offered additional support to a bullish evaluation of OTIV's prospects - and we recommend investors interested in the operational side of OTIV to that material.

For those whose consideration of OTIV is predicated on the likelihood of the company securing a large settlement from T-Mobile, or even a large damages verdict at trial, our continued monitoring of the docket in the T-Mobile case and OTIV's patent enforcement efforts suggests that such investors need to be vigilant moving forward. In short, the T-Mobile case has reached a critical stage, and recent (and likely upcoming additional) developments suggest that the burden is now fully on OTIV to execute on its patent strategy. At the same time, we are well aware that the company's performance on the operational side continues to trend in a positive direction, creating the very real possibility that even if OTIV sees nothing from its patent assertion efforts, continued near-term share price appreciation could occur.

As always, while we strive to present as accurate an analysis as possible to this audience, the full scope of our read on patent events is necessarily reserved for our consulting clients. That said, we believe the recent filings in the T-Mobile case have exposed some significant infirmities in OTIV's case. Because the District Court litigation is in its "fourth-quarter" stage, there is little OTIV can do to reverse the momentum, short of expanding its patent lawsuit campaign against additional defendants using the '043 and potentially other patents. The effectiveness of such a strategy has been blunted by the passage of time however, considering that the moment of truth for the '043 patent is fast approaching. Any new cases filed would take months to get going, and as experienced defense counsel to large corporate defendants, we personally would advise any future defendant to wait and see what happens in the T-Mobile case before writing anything other than a low six-figure nuisance value check to OTIV. For that matter, based on what we have seen in the T-Mobile case recently, our experience suggests that T-Mobile itself would only settle the case for nuisance value at this point. Having invested in the litigation, including a significant bolstering of the defense team recently, it would make little sense for T-Mobile not to see the case through at this stage, as they have multiple opportunities to win the case outright, even before trial, as we discuss in further detail below.

So why have we become bearish on OTIV's prospects against T-Mobile, and by extension regarding the future value of the '043 patent in particular and OTIV's NFC-oriented patent portfolio more generally? We start by focusing on the three issues at the heart of every patent case: 1) Damages, 2) Infringement and 3) Validity. We conclude with a brief look at how OTIV management has failed to exploit the opportunity presented by the company's favorable Markman ruling, and tie all the elements together to support our conclusion that the patent "contribution" to OTIV's market value is for the moment significantly overstated.

Damages

The heart of every patent case (with the significant exception of generic pharmaceutical actions, which have monetary impacts separate from the litigation itself) is damages. In a patent case, the burden of proof on the issue of damages is on the patentee - in this case OTIV. In our writings for a legal audience (available on request,) we have spent a significant amount of time addressing the ongoing developments in damages law, including the peculiarity that in most patent cases damages are left for late in the case. In OTIV's case, we have not been privy to their damages allegations, which are frequently made in a highly confidential report prepared by a damages expert. We will learn more about the strength of OTIV's damages claims in the near future, when T-Mobile inevitably attacks the methodology used by OTIV's damages expert in either a Daubert motion, summary judgment motion, or both.

In the meantime, we are concerned by a disclosure we uncovered in T-Mobile's amended answer, whereby it raised a new license/exhaustion defense based on a license (previously undisclosed, and with its terms still confidential) that OTIV has apparently granted to Samsung. In short, patent exhaustion, or the "first sale" doctrine provides that the first unrestricted sale by a patent owner of a patented product exhausts the patent owner's control over that particular product. In this case, T-Mobile may argue that authorized licensee's (Samsung) sale of cell phones to T-Mobile gave T-Mobile and other carriers an implied license of the rights to use and resell the cell phone. This is critical, since other than Apple (whose existing smartphones don't use NFC and are not accused of infringement,) Samsung is the second-largest smartphone company. With Apple out of the picture, and Samsung already licensed, OTIV's prospective damages would be severely reduced. Indeed, given that Samsung may have approximately half the US market share for NFC-enabled phones (given that Apple phones are not NFC-enabled), if there is in fact an existing license to Samsung, then OTIV's potential damages in its case against T-Mobile (and other carriers who may be targets for future litigation) would be cut in half.

Likewise, the terms of the Samsung license could be used to cap or strongly influence the royalty rate that OTIV is able to capture from adjudged infringes (should it succeed in establishing infringement and validity,) as well as any potential settlements. In short, the Samsung license is a potential game-changer with respect to the '043 patent's (and other OTIV patents in the family, if also licensed) value, and we do not know the terms - exponentially increasing risk to an investor whose thesis depends on the value of OTIV's patents. We can glean, however, that the relatively late production of the Samsung license to T-Mobile is an indication that the terms of the license are not very favorable to OTIV's litigation prospects. As litigators, we know that when you have good documents you produce them quickly and prominently to drive settlement, while unfavorable documents are frequently shielded as long as possible.

Even without the Samsung license, the uncertainty around the strength of OTIV's damages claims against T-Mobile gives us pause. The more money that OTIV asks for at this stage, the more T-Mobile's resolve will be strengthened and the lower likelihood of settlement before summary judgment and trial get underway (when T-Mobile will have multiple shots at defeating OTIV on a number of issues.) At the same time, the uncertainty as to what OTIV's damages claim actually is -- $2 million?, $20 million? --confirms the need for continued review by investors of litigation developments. It is impossible at this stage for us to comment on the likelihood that OTIV's damages claim meets the legal requirements, for example. Hovering above the entire damages scenario are the general trends in patent damages law, which favor focusing on the true value of the invention (in this case, centering on the NFC-controller chip in smartphones, which T-Mobile does not even make) rather than more general measures as the sales price of the infringing good as a whole. Again, damages law is very complicated, and ever-changing, to the point that many big-firm patent litigators are uncomfortable with the issue as a whole - another reason that damages issues are typically left for the late stages of the case. At bottom, there a lot of question marks about OTIV's damages case at this point, and investors interested in OTIV as a patent play need to factor that uncertainty into their positions.

Infringement

The strength of OTIV's case against T-Mobile requires further evaluation. Recent filings, however, suggest that despite the favorable Markman ruling that the company received, OTIV's infringement case against T-Mobile is at best a work in progress. In particular, it is disturbing to see that OTIV has recently tried to add an inducement claim to the case at the last hour, despite the litigation being initiated in 2012. Such behavior is irregular in a case of this nature, and could be interpreted by T-Mobile as evidence that either OTIV believes its direct infringement case is weak, or that OTIV is not prepared for trial. Either way, T-Mobile's resolve would be strengthened, further delaying OTIV's patent monetization prospects from this case. At this point, the Court has not granted OTIV's request, but the very fact that it was made will only bolster T-Mobile's confidence. Similarly, the fact that OTIV is also trying to change (and has apparently focused its infringement contentions on) the accused products in its pending Amended Complaint is also irregular and a cautionary sign. Once again, this move will embolden T-Mobile, as their lawyers will advise them that either OTIV is unprepared for trial, or not confident it could prove infringement against the products originally accused.

It is important for investors to remember that the best and quickest way for OTIV to turn this patent case into real money is through immediate, or at least pre-trial, settlement, and the steps the company has tried to take on the infringement front recently has reduced the possibility of such a settlement happening. Of course, the entire issue of infringement will come into greater focus during the fast-approaching summary judgment stage. Being on top of those filings will be critical for investors, but once again, the very fact that OTIV is trying to amend its infringement theories and list of accused products confirms that this is a risky time for current shareholders on the patent front.

Invalidity

As with infringement, the issue of the validity of the '043 patent will come into much greater focus during the upcoming summary judgment phase. A recent T-Mobile filing, however, suggests that the company fully intends to aggressively mount an invalidity defense, and has brought to bear significant prior art. Disturbingly for OTIV investors, T-Mobile's brief suggests that OTIV's own validity expert has made it clear that additional claim terms need to be construed in order for a proper analysis of the prior art to take place. If true, such a statement is a major red-flag, as it promises at minimum to negate the positive effects of OTIV's favorable Markman ruling. Of course the danger for all patentees who seek and secure a broad (and thus favorable) Markman ruling is that additional prior art may come into play as a result. While we need to see and evaluate the actual prior art being advanced by T-Mobile, once again, the recent filings demonstrate T-Mobile's resolve in the case, and that the upcoming steps in the litigation are risky ones for OTIV.

Case Schedule

Bringing all of the above into focus are the upcoming case deadlines, which help inform our view that the next few months could be perilous for OTIV's patent prospects, and at minimum deserving of extreme focus by investors whose primary interest in the company is on the patent front. In the most recent Order, the Court has set February 24, 2014 as the deadline for expert discovery. This date is significant as it ends the discovery phase of the case - the record is closed, and the trial (should one happen) would be based on the evidence procured before that date, whether fact or expert in origin. A few short weeks later, on March 7, 2014, the parties will need to file their dispositive motions. Those filings will be a goldmine of information for our team, which we will share with our consulting clients and possibly this audience in some form.

Of course, trial has not been set in the case yet, and because we see no reason for T-Mobile to settle for anything other than nuisance value at this stage, OTIV's patent payday from T-Mobile is likely a long way off, should it ever come.

OTIV's General IP Monetization Efforts

Since its publicly-announced retention of Global IP Law Group this past June, OTIV has failed to file any additional patent lawsuits, and in fact has been sued itself in a pending patent matter in the Southern District of New York. This is despite the fact that patents are at heart wasting assets, and investors have attached at least some value to OTIV's patent portfolio in the current valuation of the company. Of course, the best time to have taken advantage of the company's favorable Markman ruling has already passed, as prospective new defendants will be encouraged by their counsel to take a wait-and-see approach to settlement pending resolution of the T-Mobile case. If the '043 patent is invalidated, or if new claim constructions limit the scope of the claims, this will close a window of potential settlements against additional defendants that could have been secured soon after the first Markman ruling. Couple that fact with the unknown quantity that is the Samsung patent license, and OTIV's lack of progress on the monetization front is troubling. In short, OTIV's leverage vis a vis other potential infringes has severely eroded with the passage of time, making winning this T-Mobile case even more important for the company.

Conclusion

Investment in stocks with a patent component requires constant vigilance. Especially for investments in companies involved in high-stakes patent litigation, when that litigation is against well-capitalized and determined corporate defendants represented by capable defense counsel. At minimum, investors need to consistently monitor the court docket, and watch carefully for schedule changes, and in some cases new defenses or claims. As discussed above, the recent filings in the T-Mobile case, coupled with a lack of favorable news on the patent side from OTIV's management, suggest that investor hopes of a big patent payday face significant challenges. There is a measurable chance that the T-Mobile case could yield nothing, with the upside potentially limited severely -- based on the Samsung license, and whether OTIV's unknown-at-this-stage damages claim passes legal muster. At this point, the onus shifts to OTIV to win its case against T-Mobile, secure a large verdict, and drive revenue from the rest of its portfolio.

One of our core tenets is that for many patent litigation-focused stocks, trading events, rather than holding in the hopes of a favorable outcome, is very often the preferred approach. For those reasons, we will continue to monitor the case (and related OTIV patent developments) very closely, and fully expect to continue to see further twists and turns in this investment story. Thankfully, as patent litigators, we are comfortable with those twists and turns. OTIV investors, on the other hand, may want further assurance that the company's patent monetization efforts can get back on track. Until then, we believe investors in the company will continue to hope for favorable news on the operational side, while the litigation process against T-Mobile heads for the finish line.

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