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Litigation Trading: An Introduction to Wall Street’s Interest in Patent Cases

Matthew P. Larson

©2015. Published in Landslide, Vol. 8, No. 1, September/October 2015, by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association or the copyright holder.

Investors pounced on shares of Masimo Corporation (NASDAQ: MASI) last October, following a jury verdict awarding the company $466.8 million in patent infringement damages against Philips Electronics.1 Investors traded over 3.9 million shares—more than five and a half times the stock’s 30-day moving average trading volume—boosting the company’s share price to a 12.9 percent gain, while Masimo’s peer Standard & Poor’s (S&P) SmallCap 600 Index (SML) suffered a 1.3 percent drop on that day (see fig. 1).

Investor Interest in Patent Litigation

Wall Street and the investment community are taking a tremendous interest in patent litigation. The prospect of massive damages awards and threat of injunctive relief blocking core products from target markets stand to significantly impact the business operations and financial performance of the companies involved in patent disputes. Not surprisingly, investors have taken notice.

Figure 1

Given the inherent uncertainty of litigation outcomes, milestone litigation events can bring about major movements in a company’s stock price.2 This volatility is as much an opportunity for appreciable return on an investment as it is a trap for the unwary shareholder. Given significant positions at stake in the financial markets, investors are brushing up on patent law to stay ahead of the market.

In this article, we’ll take a brief look at how patent cases can impact a company’s financials and how the stock market has reacted to past patent litigation events involving publicly traded companies. Even for attorneys with little interest in the stock market, understanding how investors are reacting to milestone litigation events can provide attorneys with the ability to provide an additional level of analysis to clients, advising on the potential impact a case may have on the company’s valuation. Such insights can be particularly helpful when advising a client on managing investor relations, preparing for funding rounds, or considering the effect of the litigation on option-based compensation packages.

Valuing Patent Litigation: The Investor’s Perspective

Litigation is typically considered to be an overhang on a company’s stock price. Lawsuits more often than not entail costly legal expenses and serve to distract company executives and key personnel from normal business operations. In addition, uncertainty surrounding the ultimate outcome of any given case clouds the impact that the litigation may have on the companies involved. This requires investors to quantify the value and ultimate impact that litigation could have on a company’s future performance in order to capitalize on litigation-driven increases or hedge against potential losses.

The issues being litigated in patent cases are important to investors because of the tremendous effect the litigation can have on a company’s financial performance. In particular, investors are primarily interested in two factors: the financial impact that a litigation may have on a company—considering the value of both potential damages and injunctive relief—and the expected timing. This information allows investors to anticipate how case developments could trigger corresponding adjustments in the company’s stock price.

Much like settlement decisions, many trading decisions are made around key events in patent cases that affect the value of the case, either in terms of the amount of money at stake or the likelihood of a company’s success. Events involving claim construction, summary judgment, trial, and appeals all affect the litigation’s ultimate outcome. Key case developments affect the company’s exposure in litigation, which in turn affects the stock as investors reconsider the company’s value and anticipated performance accordingly.

As a result of this process, the investment community is showing increasing interest in patent litigation, anticipating case developments and determining how those events may impact a company’s financial performance.

Navigating Procedural Milestones

The highly technical subject matter involved in patent cases, when coupled with the seemingly unintelligible patent jargon and procedural developments unique to patent law, further presents the opportunity to make use of information that, while publicly available as part of the court’s docket, is not widely understood by the general public. When making investment decisions surrounding patent litigation, major investors and funds will frequently retain industry experts or counsel to watch dockets, attend key hearings, and advise on the status and potential outcome of individual cases. Insights from attorneys and industry experts allow investors to parse out meaningful information that becomes available in the litigation so as to anticipate the timing, impact, and potential outcome of market-moving developments.

Because key patent litigation events take place according to a court’s schedule, market-moving developments occur independent of general stock market trends that may affect a company’s peers. The stock prices of companies involved in patent litigation that could affect their financial performance often show increased volatility surrounding key milestones in patent cases, meaning the stock price could change dramatically over a short period of time. Key rulings and developments often change the course and potential value of an ongoing litigation. Investors respond to these changes by adjusting their investment holdings, triggering short periods of increased volatility in a company’s stock price.

Distinguishing Meaningful Cases and Events

Not all patent cases involving publicly traded companies are market moving. Generally speaking, litigation could move stock prices if the amount at stake is significant relative to a company’s financial metrics, including its market capitalization, revenue, and cash holdings, or if the case threatens products and services at the core of the company’s business operations. Smaller companies will be greatly impacted by damages awards that are insignificant to larger entities, and cases targeting flagship products are more likely to be impactful than disputes involving ancillary services.

For example, after Monsanto (NYSE: MON) was awarded $1 billion in royalty damages—the fifth largest patent damages award in U.S. history3—in its August 2012 patent trial against DuPont (NYSE: DD),4 Monsanto’s stock gained a mere 1.2 percent.5 DuPont’s stock remained unchanged, while the S&P 500 Index closed 0.7 percent below its opening mark. At the time, the award was equal to about 2 percent of Monsanto’s market capitalization (roughly $46.5 billion in fiscal year 2012). By comparison, when VirnetX Holding Corp. (NYSEMKT: VHC) was awarded $368.2 million against Apple in November 2012,6 its shares bounded 28 percent above the prior day’s closing price, reflecting the relative impact on VirnetX’s financials; VirnetX posted around $400,000 in revenue with a total market capitalization just under $1.5 billion in 2012.

A Note on PIPCOs

Public intellectual property companies (PIPCOs) are entities whose core business focuses on the monetization of intellectual property assets. Investments around PIPCOs are commonly referred to as “patent pure-plays,” in reference to the absence of other business operations that might impact the companies’ stock prices. Some PIPCOs focus on licensing and the creation of secondary markets for intellectual property, whereas other business models are based solely on litigation. Remaining agnostic as to the merits of either business model, the performance of PIPCO stocks best illustrate how investors react to patent litigation events. Whereas the stock price of operating companies can be affected by a multitude of factors impacting any number of its business components, a PIPCO’s financial performance is tied directly, if not exclusively, to the litigation outcome.

Observing market reactions to litigation events involving PIPCOs is not only useful in understanding how investors perceive patent cases, but also informs one’s understanding of how the intellectual property division of other companies may contribute to the company’s financial performance.

Case Examples

Milestone events affecting the potential outcome of a case may occur at any number of times throughout the litigation. For instance, claim construction hearings are typically held early in the case and have the potential to strongly influence the case outcome. From a litigator’s perspective, having the court rule on the meaning of key patent terms often helps parties to resolve disputed issues, positioning a case for settlement or at least narrowing issues for trial. As one of the first tests of a party’s legal claims, claim construction rulings can directly impact the range of potential case outcomes, thus affecting the overall value of the case from an investment standpoint.

Figure 2

On June 15, 2012, the Eastern District of Virginia issued a claim construction ruling in Vringo’s (NASDAQ: VRNG) patent infringement lawsuit seeking $696 million in damages from Google, AOL, and others.7 The ruling was considered to favor Vringo on four of the six disputed claim terms, and Vringo’s stock gained 8 percent on elevated trading volumes (see fig. 2).

Summary judgment rulings can also trigger market-moving changes to the value of an ongoing litigation, as decisions granting or denying judgment on targeted issues directly impact the ultimate outcome of a case. Referring again to the Vringo case as an example, the defendants filed for summary judgment of noninfringement, invalidity, and laches, seeking to block or severely limit Vringo from pursuing its damages claims at trial. The court denied each of the motions on October 3, 2012,8 meaning the case was bound for trial intact. The ruling caused a flurry of trading activity, generating a 37 percent increase in Vringo’s stock (see fig. 2).

Summary judgment and claim construction can also trigger positive movements in a defendant’s stock price. At the end of 2011, Palo Alto Networks (NYSE: PANW) was sued for patent infringement by its major competitor, Juniper Networks (NYSE: JNPR).9 Founded by former Juniper employees, Palo Alto Networks was in the process of preparing for an initial public offering and being closely watched by investors. Palo Alto Networks went public in July 2012, with the Juniper litigation targeting its core business. Both parties filed summary judgment motions in August 2013.

Figure 3

On February 6, 2014, the court rejected Juniper’s bid for summary judgment on infringement, granting in part Palo Alto Network’s motions for summary judgment on noninfringement, significantly reducing the claims that Juniper could pursue against Palo Alto Networks at trial. The court also issued a claim construction ruling considered to be favorable to Palo Alto Networks. Investors responded to the reduction in claims being pursued against the company, driving Palo Alto Networks’ stock up more than 11 percent (see fig. 3).

It goes without saying that verdicts and judgments awarding monetary damages are key litigation events that could impact a company’s finances. However, a damages award does not necessarily mean that a company’s stock price will rise. Going into a trial, the market has usually accounted for an expected outcome in the company’s stock price. Results that fall short of that estimate can easily turn a trial victory to defeat in the market.

When Vringo’s case against Google went to trial, the jury returned an infringement verdict on November 6, 2012, awarding Vringo $30.5 million in damages. Given that Vringo reported adjusted revenues of roughly $100,000 in fiscal year 2012, with market capitalization around $235 million, one might have assumed that a $30 million damages award would be welcome news to investors. Vringo’s shares dropped 28 percent during intraday trading, before closing down almost 15 percent. With Vringo seeking $696 million at trial, the $30 million verdict fell well short of investors’ expectations, resulting in a devastating price slide (see fig. 2).

Figure 4

On appeal to the Federal Circuit, Google successfully argued that the underlying patents were invalid.10 The Federal Circuit issued its decision on August 15, 2014, invalidating the patents-in-suit. Vringo, whose patent licensing revenue had grown from $100,000 in 2012 to $1.4 million, saw a 72 percent decrease in its stock. The Vringo decision also prompted investors to adjust the valuation of other PIPCOs with similar business models. Patent licensing companies Spherix Inc. (NASDAQ: SPEX), Marathon Patent Group (NASDAQ: MARA), and Inventergy (NASDAQ: INVT) saw declines of 4.7 percent, 6.9 percent, and 3.9 percent, respectively, on the day of the decision.

ParkerVision’s (NASDAQ: PRKR) infringement case against Qualcomm (NASDAQ: QCOM) provides additional insight into how investor expectations impact a company’s stock price.11 Figure 4 charts ParkerVision’s stock price from just before trial through oral argument on appeal. The October 2013 trial was divided into two phases: infringement and invalidity were to be tried first, followed by a separate damages phase if Qualcomm was found to infringe the asserted patents. ParkerVision achieved a resounding victory during the first phase of the trial,12 sending share price up 64 percent in anticipation that the company would succeed in securing a large portion of the $432 million that it was seeking from Qualcomm in damages. In the second phase, the jury awarded ParkerVision $173 million, less than half of the damages sought.13 Disappointed with the result, shareholders sold off their interests, dropping the stock price 59 percent and eliminating the short-lived post-trial gains.

In post-trial motions practice, the court granted Qualcomm’s motion for judgment as a matter of law (JMOL) regarding noninfringement on June 20, 2014, finding that an insufficient evidentiary basis for the jury verdict warranted a new trial. ParkerVision’s stock dropped another 63 percent.

ParkerVision appealed the district court’s decision to the Federal Circuit.14 Oral arguments were held on May 8, 2015, during which counsel for ParkerVision faced tough questions from a skeptical three-judge panel. The company’s stock slid more than 46 percent as arguments concluded, likely fueled by intelligence provided to investors by observers in the courtroom.

Closing Remarks

Patent litigation can have a tremendous effect on a company’s financial performance and stock price. Key developments during the case can impact a company’s exposure in the litigation by affecting the potential amount at risk or likelihood of events that will have a material impact on a company’s financials. These developments alter the perceived value of the litigation, prompting investors to place trades in anticipation of or reaction to how the milestone events affect the potential outcome of the litigation.

Although this article has focused entirely on the effect that patent cases may have on public companies, market reactions to patent litigation events can provide important insight to attorneys advising clients in patent matters. Whether the client is privately held or publicly traded, understanding how investors could perceive and react to milestone litigation events can be of tremendous value when advising clients on patent litigation.

Inter Partes Review and Hedge Fund NPE

Beyond litigation, investors are showing great interest in validity challenges lodged with the USPTO, particularly activity surrounding Inter Partes Review (IPR) proceedings. Introduced by the America Invents Act in 2012 as a means for fast-tracking validity challenges to issued U.S. patents, IPR proceedings allow anyone to challenge another party’s patent in litigation before an administrative law judge at the Patent Trial and Appeals Board. IPRs focus solely on whether a patent is valid in view of prior patents and written publications and conclude within 18 months of being filed.

IPRs are most commonly used to challenge patents at-issue in ongoing litigation or enforcement campaigns, but also stand to materially impact a company’s ability to maintain competitive exclusivity. The pharmaceutical industry is particularly susceptible to IPR challenges, as marketable drugs generating billions of dollars in revenue (and into which a company may have poured billions in R&D costs) may only be protected by a handful of patents, the absence of which would allow competitors and generics to introduce identical products into the market at a fraction of the price.

While generic drug manufacturers and other pharmaceutical companies have made use of IPRs seeking to invalidate competitors’ drug patents, hedge funds and activist investors have recently begun utilizing IPR proceedings as part of what appears to be a reverse monetization strategy in which the investor challenges the validity of a company’s patents while shorting the stock or trading options contracts so as to profit from a decline in share prices.

The most widely publicized example of hedge funds making use of IPR proceedings involves petitions filed by the Coalition for Affordable Drugs—a group of limited liability companies associated with hedge fund Hayman Capital, its founder Kyle Bass, the patent monetization entity IP Navigation Group, nXn Partners, and its CEO, Erich Spangenberg. In February 2015, the Coalition filed IPRs on two of the five patents covering Acorda Therapeutics’ (NADDAQ: ACOR) multiple sclerosis drug, Ampyra, which accounts for 91% of Acorda’s revenue. Acorda’s stock dropped 9.7% after the first petition was filed February 10 and 4.8% after the second on February 27, together accounting for roughly $165 million in lost market value. Though the fund has not disclosed its investment strategy, the IPRs are thought to be are part of a reverse-monetization strategy targeting individual companies or a long-term strategy the pharmaceutical industry as a whole.

To date, the Coalition for Affordable Drugs has filed sixteen separate IPRs, challenging pharmaceutical patents held by a number companies including Celgene (NASDAQ: CELG), Cosmo Technologies (who licenses its Lialda patent to Shire Plc (NASDAQ: SHPG)), and Jazz Pharmaceuticals (NASDAQ: JAZZ).

Congress is considering proposals aimed at curbing perceived abuses of IPRs as part of the current patent litigation reform efforts. Others have requested that the SEC consider whether the practice of challenging pharmaceutical patents while short-selling the drugmaker’s stock runs afoul of insider trading and anti-manipulation laws.

Endnotes

1. Masimo Corp. v. Philips Elecs. N. Am. Corp., No. 1:09-cv-00080-LPS, ECF No. 919 (D. Del. Oct. 17, 2014) (Judgment Following Jury Trial); see also Phil Milford & Dawn McCarty, Masimo Sees Shares Surge after $466 Million Verdict, Bloomberg Bus. (Oct. 1, 2014), http://www.bloomberg.com/news/articles/2014-10-01/masimo-sees-shares-surge-after-466-million-verdict.

2. See, e.g., Finding Alpha in Event-Driven Patent-Litigation Investments, Seeking Alpha (Feb. 20, 2014), http://seekingalpha.com/article/2032861-finding-alpha-in-event-driven-patent-litigation-investments (interview with Colin Lokey, Markman Advisors).

3. Chris Barry et al., PricewaterhouseCoopers Forensic Servs., 2015 Patent Litigation Study: A Change in Patentee Fortunes 5 (May 2015), available at http://www.pwc.com/en_US/us/forensic-services/publications/assets/2015-pwc-patent-litigation-study.pdf.

4. Monsanto Co. v. E.I. du Pont de Nemours & Co., No. 4:09-cv-00686-ERW (E.D. Mo.).

5. See Andrew M. Harris & Jack Kaskey, Monsanto Awarded $1 Billion against DuPont by Jury, Bloomberg Bus. (Aug. 2, 2012), http://www.bloomberg.com/news/articles/2012-08-01/monsanto-awarded-1-billion-against-dupont-by-jury.

6. VirnetX, Inc. v. Apple, Inc., No. 6:10-cv-00417 (E.D. Tex.).

7. I/P Engine, Inc. v. AOL, Inc., No. 2:11-cv-00512-RAJ-TEM, ECF No. 171 (E.D. Va. June 15, 2012) (Memorandum Opinion and Order). Note that plaintiff I/P Engine is a wholly owned subsidiary of Vringo.

8. I/P Engine v. AOL, No. 2:11-cv-00512-RAJ-TEM, ECF No. 572 (E.D. Va. Oct. 3, 2012).

9. Juniper Networks, Inc. v. Palo Alto Networks, Inc., No. 1:11-cv-01258-SLR (D. Del.).

10. See I/P Engine, Inc. v. AOL Inc., No. 13-1307 (Fed. Cir. Aug. 15, 2014).

11. ParkerVision, Inc. v. Qualcomm Inc., No. 3:11-cv-00719-RBD-JRK (M.D. Fla.).

12. ParkerVision v. Qualcomm, No. 3:11-cv-00719-RBD-TEM, ECF No. 416 (M.D. Fla. Oct. 17, 2013) (Verdict Form (Phase One)).

13. ParkerVision v. Qualcomm, No. 3:11-cv-00719-RBD-TEM, (M.D. Fla. Oct. 28, 2013) (Verdict Form (Phase Two)).

14. ParkerVision, Inc. v. Qualcomm Inc., No. 14-1612 (Fed. Cir.).

Matthew P. Larson

Matthew P. Larson is a technology litigation analyst with Bloomberg Intelligence. He is a registered patent attorney and practiced in the patent litigation groups of two multinational law firms before joining Bloomberg.