This article was edited by Jae Jun. Old School Value does not hold any shares of PTNT.
Introducing Internet Patents Corporation (PTNT)
Internet Patents Corp (NASDAQ:PTNT) is a patent assertion entity that consists of $31 million of cash, 7 patents, almost no liabilities, and $205.9 million in net operating loss carry forwards.
Currently trades at a market cap of $26 million, which is 89% of its cash balance net of all liabilities.
I am recommending Internet Patents Corporation as an attractive asset play with limited risk and 100% upside.
How it Began with Internet Patents Corp
Prior to 2011, Internet Patents Corporation (PTNT), then known as InsWeb, operated a lead-generation website for insurance agents.
The company received a generous offer from Bankrate, Inc. and sold all of their operating assets, other than their patents and deferred tax assets, for $65 million. After paying out $36.6 million of the proceeds in dividends or $5/share, the management set up a $31 million cash reserve and began searching for companies they could sue with the patents they purchased.
Internet Patents currently have 6 patents that cover various website functions and 5 of which relate to data management in the insurance industry. One relates to website functionality in general.
You can view the descriptions for each patent from their website.
Start the Trolling and Suing
Characteristics of a Patent Troll
In 2012, Internet Patents filed law suits against six companies for infringement of two of their patents.
In the cases relating to the first patent, the judge dismissed all charges. Internet Patents Corporation is currently appealing this ruling.
In the case relating to the second, the judge granted ex parte reexamination of the patent. Historically, 10% of appealed rulings are overturned and 40% of reexamined patents make it out of the process without some or all of their claims being altered. So the value of these two patents is questionable.
The other four remain untested.
Internet Patents current operations will most likely wind down some time in the next ten years.
All of the patents expire in 6 to 12 years and their viability will likely be determined in the court room long before that.
There is no plan to develop new patents, although the company is currently pursuing continuations and could potentially acquire other patents if the business has some success.
The CEO is 65 years old and judging from history, at an age where he will likely be hesitant to reinvest in another venture if their current operations prove to be fruitless (he owns 25% of the company).
The Cash Burning Rate
Never ignore cash burn. It can get scary.
Their current cash burn rate is $663,300 per quarter.
This was calculated using the average of their quarterly declines in book value since the sale. Their target operating expense is $500,000 to $700,000 per quarter.
This means they have enough working capital to last 12.3 years ($30.19m cash divided by the quarterly burn rate of $663k divided by 4).
Even further, their federal and state net operating loss carry forwards begin to expire in 2019 and 2012 respectively. The NOL’s will completely expire over the next 12 years.
All signs point towards their fate being decided in this decade.
What is a Company Like this Worth?
What’s it worth?
Subtracting all of the company’s liabilities (including $1.6 million of minimum lease payments), the company has net cash and short term investments of $29.1 million.
It’s currently trading at a market cap of $26 million.
This is about a 19% discount from net cash and represents the disappointing lawsuit developments and the market’s anticipation of the burn rate.
[Jae’s note: This is an asset play. Don’t bother with DCF’s or even a sum of the parts. Keep it simple and monitor the intrinsic value decrease QoQ based on the burn rate.]
Two Likely Scenarios to Internet Patents
Given what can be observed from the company’s short track record, there are two scenarios that I consider likely.
Bull Scenario 1: Internet Patents win one or more law suits and/or successfully generate revenue through licensing.
Assuming just one of their six patents is worth something, the company will realize a large gain in market value.
One settlement could conceivably double their cash position and the proceeds from the trial, as well as any subsequent licensing revenue, is probably going to be entirely tax free with the NOL’s they have. This will lead to multiple expansions since it proves the business model is viable.
Network-1 Technologies (OTC:NTIP) is another patent assertion entity comparable to Internet Patents in every way except one.
They successfully monetized their IP portfolio which also consists of just 6 patents.
They have $29.8 million worth of cash and trade at a market capitalization of $44.5 million. Although their monetization efforts have yielded low revenues and net losses in the last two years, they were able to generate revenues of $32 million in 2010 by winning one significant lawsuit.
FYI Network-1 Technologies trades at a price to book of 1.3.
If Internet Patents is able to realize anything remotely close to NTIP’s level of success, like generating a ~$10 million settlement, Internet Patents is going to be worth $6.74 per share.
That’s close to a 100% upside from today’s prices.
Possible Valuation Outcome for PTNT
Bull Scenario 2: The company gets acquired. Given the focused nature of their patents, the universal appeal of their deferred tax assets, and their rock-bottom price, an acquisition isn’t crazy.
[Jae’s note: The author didn’t specify a value if PTNT is acquired. My wild estimate is $5 a share. Simply the cash multiplied by BV of 1.3 divided by the shares outstanding.]
Bear Scenario: The patents are worthless and management decides to liquidate the company.
Assuming that the burn rate remains consistent, liquidation in the next two years will result in investors breaking even and possibly making a gain.
Past that point, the company’s net current assets will dip below the current share price and the margin of safety erodes.
This is assuming that the patents are worthless and the liquidation value is limited to their net cash balance. In reality, there is a decent chance that they can sell one or all of their patents which is going to cushion the downside.
Besides the possibility of patent sales, there is another reason to believe that their liquidation can yield a significantly higher valuation than the net cash balance.
The net operating loss carry forwards is limited in usefulness to an acquiring company (Section 382 of the Internal Revenue Code), but it definitely has value to acquirers and can serve to sweeten the deal if any of the patents end up being sold.
For these reasons, the downside risk is very limited.
The valuation should be the sum of the expected values of the two bull scenarios.
[Jae’s note: in this case it will be $5.90 per share]
Either way, the current valuation is significantly less than both scenarios.
New investors are essentially getting two years of their operating expenses paid by outgoing investors, who appear to be ignoring both the potential value of the patents and the tax loss carry forwards.
- Asset play with limited downside
- Simple investment thesis to understand
- Comparable company is valued 50% higher
- Value trap potential
- Patents are worthless
- Market can refuse to correctly value the company
This post was first published at old school value.
You can read the original blog post here 100% Upside with this Asset Play Investment Opportunity.