The Microcap Speculator

For the past few months, I have had an ongoing dialogue with a reader who is close to Modavox (MDVX.OB). He’s a large shareholder, so assume that he is talking his book. But the story is certainly worth looking into.

Modavox has two main businesses:

1. Broadcast Media - basically just internet talk radio. This division was responsible for about 80% of revenues last quarter, but its not where Modavox’s future lies.
2. Interactive Media - provides behaviorally-targeted advertising solutions and interactive e-learning platforms.

The numbers in a vacuum are not inspiring. For the first three quarters of its 2007 fiscal year, Modavox inked $2,531,779 in revenues, compared to $2,000,255 in the prior year, and lost $650,207, compared to a loss of $397,491 in 2006. At this run rate, Modavox has an enterprise value-to-sales ratio of 17.85, well above Google (9.11), Apple (3.44), and most other high flyers. Plus, its not profitable. Viewed without context, these numbers give little reason to get excited.

But with this stock, the context matters. Modavox has a few broad patents covering, among other things, behavioral targeting of internet ads. It has already brought a patent infringement suit against Tacoda, now a division of AOL. My source believes that scores of internet businesses could also be infringing on the patent portfolio. Think of Tacoda as a test case. If Modavox prevails and its patents are upheld, Modavox could be the next big patent licensor - the Patriot Scientific (PTSC.OB) of internet advertising. And unlike Patriot Scientific, Modavox is actually practising the technology so it shouldn’t be disadvantaged by last year’s Supreme Court ruling in KSR v. Teleflex.

The technology also could make Modavox an attractive buyout candidate. Both AOL (Tacoda) and Yahoo! (Blue Lithium) have recently bought behavioral advertising companies. I’m not sure if Modavox’s business has sufficient scale to justify a buyout, absent the patent bludgeon. That is why I’m focusing on the growth of the Interactive Media division. Revenues are very small now, but substantial growth here will likely be rewarded by the market and attract suitors.

Despite the potential, I’m not a buyer (yet). Modavox is overextended, and the potential patent and buyout catalysts may take some time to develop, if they do at all. For now, MDVX is on my watchlist. If you have anything to add on Modavox, please leave a comment.

DISCLOSURE: No position.

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Patriot Scientific (PTSC.OB) traders have had a wild ride for the past two years. Since January 1996, the stock shot up from 8 cents to over $2. Now, as the weekly chart below shows, the stock is trying to bottom around $.40.

Whether the bottom holds will likely be dependent on the company’s return to profitability. For a few quarters, Patriot Scientific announced not only substantial profits, but numerous dividends, as its licensing joint venture secured key deals with PC, semiconductor and electronic manufacturers to license the Moore Patent Portfolio, of which the company is part-owner. As the pace and (by most estimates) size of the licensing deals began to subside, operating metrics also deteriorated. Last quarter, Patriot Scientific lost $1.96 million on licensing proceeds to the joint venture of $1.5 million.

Today, the company announced that it had reached a deal with Philips Electronics.  “We welcome the expansion of our program with Philips, a proven worldwide leader in medical equipment and consumer electronics. This agreement further validates the strength and broad scope of the MMP Portfolio,” said Andre-Pascal Chauvin, vice president of licensing for Alliacense, Patriot Scientific’s licensing partner.  More importantly, the company suggested that further deals could be in the pipeline: “It’s pretty common to see the pace of deals pick up as a trial approaches,” said Mike Davis, senior vice president, licensing. “A number of major businesses that have been following the case closely needed a little time to evaluate the recent Markman ruling, and are now moving to capture licenses at current prices and avoid significantly higher royalty rates following trial.”

Bottom line:  This is certainly good news for Patriot, but the size of the Philips deal has not been disclosed and I for one will remain skeptical until I see the company transform its dealflow into a significant, lasting revenue stream.  With a market cap. of $164.33M (per Yahoo!), lofty expectations are still baked into the share price.   Unless PTSC starts delivering  profits soon, shareholders are likely to see more disappointment.

DISCLOSURE:  No position.

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I believe that two recent Supreme Court decisions have made the patent licensing business model considerably more risky. As a result, all of the following companies are less attractive investments:

ARM Holdings (ARMHY)
Rambus (RMBS)
Acacia Technology (ACTG)
Burst.com (BRST.PK)
Forgent Networks (FORG)
Neomagic Corp. (NMGC)
Patriot Scientific (PTSC.OB)
Star Scientific (STSI)
…and many others

Last year, in MercExchange v. Ebay, the Supreme Court vacated a long-standing presumption that courts should issue permanent injunctions to stop patent infringement. The high Court ruled that a fair royalty could suffice, especially where the plaintiff is not currently practicing the invention. In a concurring opinion, Justice Kennedy (joined by Justices Stevens, Souter, and Breyer) took direct aim at patent licensing companies:

“In cases now arising trial courts should bear in mind that in many instances the nature of the patent being enforced and the economic function of the patent holder present considerations quite unlike earlier cases. An industry has developed in which firms use patents not as a basis for producing and selling goods but, instead, primarily for obtaining licensing fees. … For these firms, an injunction, and the potentially serious sanctions arising from its violation, can be employed as a bargaining tool to charge exorbitant fees to companies that seek to buy licenses to practice the patent. … When the patented invention is but a small component of the product the companies seek to produce and the threat of an injunction is employed simply for undue leverage in negotiations, legal damages may well be sufficient to compensate for the infringement and an injunction may not serve the public interest.”

Yesterday’s decision, KSR v. Teleflex, may be even more significant. In that decision, the Supreme Court made it significantly easier for patents to be attacked on the ground that they were “obvious” in light of prior art. In SCOTUSblog, Michael Barclay of Silicon Valley law firm Wilson Sonsini explained: “This decision makes it far easier to invalidate patents based on obviousness. Thus, this is the most important patent case of the last 20 years, and perhaps since the passage of the 1952 Patent Act. Virtually every litigated patent case includes an assertion of obviousness – and ones that might not have included that defense up until now are more likely to do so. The PTO examines every patent application for obviousness. [The case] will thus have an enormous impact on both the prosecution and litigation aspects of patent practice.” (emphasis added by yours truly).

DISCLOSURE: I have no position in any of the companies mentioned here. Not a recommendation to buy or sell any security. For informational and educational purposes only.

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After over a year wait, Maryland district court judge Marvin Garbis all but ended Star Scientific’s (STSI) (articles) attempt to reap huge patent royalties from tobacco giant Reynolds American Inc. (RAI). The lawsuit accused Reynolds of infringing a patent owned by Star Scientific for its so-called StarCure method of curing tobacco.

Judge Garbis ruled that the main patent claims were invalid because they were indefinite as a matter of law (in other words, there was not enough of a dispute to put this issue to a jury). He also found that the actual patent date was September 15, 1999, not the 1998 date when Star Scientific filed a provisional application. This is important because Reynolds claims that farmers were already using the method in the summer of 1999, and a patent cannot be granted if its teachings are already being practiced.

Of course, Star Scientific immediately posted a press release stating it will appeal. However, there are so many hurdles it must overcome that, taken as a whole, they seem insurmountable:

1. Star Scientific must convince the Federal Circuit Court of Appeals that Judge Garbis was incorrect in finding the claims indefinite as a matter of law. I understand the Federal Circuit reverses around 40% in patent cases, so this is an uphill battle but not a long shot.
2. Star Scientific must prevail on the inequitable conduct issue. Reynolds and Star had a mini-trial on this issue, which essentially claims that Star was dishonest in its patent application to the Patent and Trademark Office. I didn’t follow that trial and have no opinion on its likelihood of prevailing. Star’s press release says that the judge will rule on this issue within the next few weeks.
3. If Star prevails on the inequitable conduct issue and wins its appeal there will be a jury trial on: (a) whether the method was practiced by any farmers before September 1999; (b) whether Star disclosed the “best mode” of accomplishing the StarCure method in its patent; and (c) whether Reynolds infringed the patent. Star must win on all these issues, plus the appeal and the inequitable conduct ruling to establish infringement.

This epic battle will drag on for a few more years, but as far as I’m concerned, its over. Star lost. I don’t see an investment case there even after it lost more than half of its value.

DISCLOSURE: I have no position in STSI or RAI. Not a recommendation to buy or sell any security. For informational and educational purposes only.

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