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Finance

The Goldmines and Sinkholes of Intellectual Property Investing

Most investors entrust their money to the ups and downs of the stock market. But there is a “techonomic” alternative that offers great opportunities for high risk-adjusted returns: investing in intellectual property.

If you want to use the stock markets to invest successfully in intellectual property, the first step is to identify pervasive emerging technology trends. Then find companies that hold core intellectual property associated with these growing markets.

A recent success story has been VirnetX (VHC), a leader in automatic secure virtual private network (VPN) technology. The company saw its stock price more than quintuple since August 2010, after it began to work harder monetizing its intellectual property. The rally began after the U.S. Patent and Trademark Office (USPTO) declared that two key patents of VirnetX that Microsoft licensed a month before were indeed valid, as VirnetX filed patent suits against Apple, Cisco, NEC, and Aastra, claiming these companies infringed five VirnetX patents, including the two found valid by the USPTO.

So where are fresh opportunities? One area of rapid growth is mobile banking. In the United States just 30 percent are using it currently, but further growth as well as increasing adoption of “remote deposit capture,” a technology that allows you to deposit physical checks via your smartphone provide great promise. Bank of America rolled out the system earlier this summer. The owners of companies holding the underlying intellectual property for mobile banking services will focus on monetizing this growth. ATMs allowed banks to reduce the cost of processing a check from a few dollars at a branch to less than a dollar at an ATM: remote deposit capture is set to bring down that cost a lot further. With over 20 billion checks processed every year in the U.S., widespread adoption of remote deposit capture could translate into post-tax annual cost savings in the billions of dollars. Mitek (MITK) is a public company with key patents in the field that could hold a lot of value.

However, despite their promising upside, intellectual property stock investments come fraught with hidden pitfalls, and Mitek is a case study for at least three of them. The patents held by Mitek have recently been challenged in court by USAA, a financial institution catering to the U.S. military, which argues that the Mitek patents are invalid and unenforceable. It also claims some rights to the intellectual property itself, should the Mitek patents be found valid by the court. As a result, Mitek has seen its stock market value fall dramatically. This illustrates the first pitfall: the risk that a key patent could be found invalid, either following a legal decision or simply as the result of rumor or attack.

A second pitfall is hidden in patent claims that are not broad enough to prevent the emergence of non-infringing alternatives, innovations that are designed to work around existing patents.

And here is the final pitfall: enforcing patents can take years of costly litigation; it requires adequate cash flow and cash reserves—even to defend dubious claims. Worse yet, litigation often has interim results which are at odds with what reasonable analysis would have predicted, leading in some cases to very large, unpredictable share price movements.

More often than not, however, these pitfalls of intellectual property investing can be mitigated by sophisticated due diligence and specialized expertise. To those who successfully navigate the inherent perils, IP investing offers outsized returns.

One good example is the case of Tessera (TSRA), a leader in chipset miniaturization technology.

Tessera lost close to 50 percent of market value in one session in December 2008 after the International Trade Commission (ITC) made an initial determination against the company during a patent action it brought against several wireless manufacturers. The commission initially found that while Tessera’s patents were valid they had not been infringed by the respondents. The stock continued to trade at a significant discount until the ITC reversed its initial determination. It ruled that Qualcomm, Motorola, and four other wireless chip makers had infringed on Tessera chip packaging patents and it stopped those companies from importing chips to the U.S. unless they posted a bond equal to 3.5 percent of the products’ value. The result: Tessera stock rose over 100 percent.

New technology trends are constantly emerging, and there is an inherent volatility associated with intellectual property driven stocks. But if you can avoid the hidden pitfalls, there are hidden goldmines to be found.

Laetitia Garriott de Cayeux is the CEO and Chief Investment Officer at Ajna Capital LLC, which she founded in 2008. She manages and controls a private fund that holds a position in Mitek stock.

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One Response to “The Goldmines and Sinkholes of Intellectual Property Investing”

  1. AnujMathur says:

    Great article Laetitia. What forthcoming catalysts are you particularly intrigued by for MITK, TSRA, VHC (or any other IP plays)?

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