Description

There have been some requests for event-driven ideas, so here is the first of a pair of ideas with catalysts that should play out in the next 6 months or so.

I’ll start this idea with the caveat that this both a microcap and in the dreaded NPE space. Still, while it lacks the 10x upside of a CRDS, I think the downside here is relatively limited as much of the value lies in trials scheduled for 2015, and in November 2014 they agreed to a large settlement from AT&T in the first case from their litigation against the cell carriers – the gross proceeds of $27.5mm were larger than the current market cap of the company. Proceeds from this case and future cases will be reduced by earnouts and litigation expenses, but I think this indicates that upcoming similar trials against Verizon and the other carriers create a meaningful margin of safety.

I think there is 50% near-term upside from here in a base case, and if management projections are to be believed, cash flow over the next three years alone plus net cash on hand should be equivalent to 2.5x the current stock price.

Background

Clancy wrote this up when it was a shell in August 2014. The company was formerly known as Insweb, and they sold that business in December 2011 while retaining some patents which they believed had value, a $145mm NOL, and $30mm of cash. They attempted to extract value from these patents without success (so far).

In November 2014, PTNT agreed to acquire Prism Technologies, an NPE. Prism began life as a security software company in the 1990s, but transitioned to monetizing the patents they had accumulated.

Prism owns 51 patents and has had a fair amount of success in extracting value from their portfolio. From 2012-2014, they extracted over $75mm in gross proceeds from licensing their technology to major companies such as Microsoft and Bank of America.

In the deal, Prism received 35% of the combined company, $16.5mm of cash, and an earnout that allows them to receive 70% of net proceeds from in-progress litigation in excess of $16.5mm, up to $49.5mm. This was a tax-driven structure, as PTNT owners had to retain majority ownership to protect the NOLs.

After the deal was announced, they bought back over 10% of the company at $3.00 a share from shareholders who wanted to cash out. In the future, I expect management to be willing to return cash to shareholders as they receive proceeds from settlements.

The deal was approved by shareholders last week, and should close shortly. After the deal closes, PTNT will have just over 10 million shares outstanding and $8.8mm in cash ($0.88 per share).

After the deal, insiders and management will own approximately 30% of the company, so our interests are aligned nicely.  I expect that once the deal closes (and management stock options have been struck), the company will be more aggressive about communicating their story.

Pending Litigation

To value the company, I look mostly at pending litigation as well as at management projections. Most pending litigation is around patents they’ve monetized successfully in the past, which gives me more confidence that there is some downside protection.

Gregg Patents – The Gregg patents cover secure data transfer. They filed suit infringement suits against the major wireless carriers in April 2012.

Prism went to trial with AT&T in October 2014, and settled with AT&T for $27.5mm on 11/7/14. They have pending litigation against the other big wireless carriers: Sprint (trial scheduled 4/20/15), T-Mobile (trial 6/15/15), US Cellular (7/13/15) and Verizon (9/28/15). This appears to be the major one for them, based on how much they got from AT&T.

They had previously gone after software companies including Adobe and Symantec on these patents, receiving $3.6mm from seven parties in 2012. They also reached settlements with Microsoft and RIMM over these patents in 2009 and 2010.

Glazer Patents – The Glazer patents relate to the usage of security images for authentication online, something used today by most major banks.

They filed suit against a host of banks including PNC and US Bank in September 2013.  They have a PTAB hearing scheduled for 5/20/15.

They received $45mm in revenue from settlements with 17 parties prior to trial in 2012 and 2013 stemming similar litigation filed in December 2010. The defendants in those were mostly smaller banks.

Weber Patents – The Weber patents relate to multiscreen displays. They filed suit in January 2013 against Nintendo and everyone that ever sold a Nintendo. Trial scheduled for 10/5/15.

Pugh Patents – This is the subject of a lawsuit against Baxter which was settled in November 2014 for $700k plus an additional amount based on the outcome of an IPR.

Valuation

Management Case – In the proxy, management projects gross patent proceeds of $236mm from 2015-2017, which would result in $57.6mm of cash flow to the company after paying all earnouts and expenses. Combined with the $8.9mm of net cash on the balance sheet, that would imply a value of $66.5mm or $6.60 per share. This is clearly an upside case but it shows the potential here.

Base Case – The proxy estimates the present value of the earnout to Prism unitholders at $28.2mm based on probability weighted projections, which implies the current litigation in progress can be expected to be worth about $29mm to PTNT net of expenses. This is conservative because the maximum earnout is $49.5mm, so there are scenarios where PTNT shareholders receive more after the earnout is maxed. But if we add the net proceeds of $29mm in this case to the cash on the balance sheet, we get $3.72 per share.

Downside Case – PTNT is entitled to the first $16.5mm of proceeds before any earnout is achieved. If we assume PTNT only gets $16.5mm of net proceeds from litigation in progress, and add that to the cash on the balance sheet, that gets us to $25.4mm, or $2.52 per share.

Note that the base case and downside case don’t explicitly account for the G&A incurred like the upside case does.  We have to assume in the base case and downside cases that the value of future litigation will be covered by the G&A incurred.

Catalyst

Management communicates the story to Wall Street.

Settlements with the wireless carriers.

Settlements with the banks.