Document Security Systems
(NYSE MKT: DSS)
Investment Highlights
Lexington Technology Group has a strong patent portfolio and management team. In October 2012, DSS entered into a merger agreement with Lexington Technology Group Inc., which is expected to be finalized in the upcoming months. Lexington is not only bringing in an experienced management team (management has been involved in obtaining over $1 billion in IP licenses, awards and settlements) and a strong cash position of $7.25 million, but also investments in companies with strong IP, such as Bascom Research and a minority interest in VirtualAgility.
Markman hearing scheduled in October 2013 against Facebook, LinkedIn, Novell, and others; a positive interpretation could lead to large share price appreciation; 4% royalty earned on settlement with first of five defendants. Lexington’s wholly owned subsidiary, Bascom Research, has received a Markman hearing date of October 2, 2013 for its litigation against Facebook, LinkedIn, Novell, Jive, and BroadVision for incorporating features crucial to social networking and modern enterprise software that Bascom owns patents for. Based upon the judge’s interpretation, the jury is called upon to determine the liability, which has a large influence on the direction the case will follow. Bascom’s “Relationships with Attributes” patent is a method of establishing relationships between two or more objects (such as user profiles) that is essential to any social networking business.
Bascom reached a settlement with the first of five defendants in April 2013. The terms of the patent license include an effective royalty rate of approximately 4% for the use of the four Bascom patents currently in litigation. Lexington will realize revenue from the settlement beginning in 2Q 2013. We believe that earning a settlement with one of the defendants early on in the case increases the probability of a successful Markman hearing; additionally, the 4% royalty rate earned on the settlement sets a benchmark that may be applied to other, larger defendants in the case.
Positive Markman hearings are often catalysts for large upward share price movement. These hearings were catalysts behind the upward price movement in ParkerVision (up over 350% in the last 14 months, 73% intraday increase on release of positive Markman ruling), and Vringo (up over 130% in the last 14 months, 36% intraday increase on release of positive Markman ruling). Given the market size for social networking companies (Facebook and LinkedIn reported a combined $6.1 billion in FY12 revenue, and a report by BIA/Kelsey projects annual social media ad revenues of $9.2 billion by 2016), a positive Markman hearing could deliver gains similar to those seen in ParkerVision and Vringo. These cases could potentially result in strong stock performance for DSS shareholders resulting from licensing agreements/royalties and/or settlements. Royalty agreements and settlements typically represent nearly pure profits for the Company (outside of taxes).
As an Innovator, DSS has advantages over other businesses that focus only on IP monetization. DSS is focused on development of its own IP and investment in and development of IP from other operating businesses that it views as having promising commercial prospects. This means it owns both “hard assets” and IP assets. If the commercial potential of the products DSS has invested in are substantial, it will have returns greater than it would from investing only in IP. Additionally, if DSS needs to enforce its portfolio, it can be expected to have a higher success rate in court, as technology companies representing their own patents in litigation have—a 34% success rate, versus a 23% success rate for non-practicing entities, according to a recent report by PricewaterhouseCoopers, titled “2012 Patent Litigation Study.”
DSS grew revenue by 28% and gross profit by 37% in FY12; launching of AuthentiGuard in FY13 expected to drive continued revenue growth and bring operations near breakeven. DSS’s revenue increased 28% from 2011 to 2012, and gross profit increased by 37% during the same time period. 4Q12 revenue growth was very strong in the packaging division (66% increase YoY). On top of this growth, DSS has introduced AuthentiGuard, a cloud-based mobile application solution for determining the authenticity of packaged products, documents, and credentials. AuthentiGuard is an exciting product with strong potential because it’s cost effective compared to traditional practices due to the ubiquity of smartphones and cloud computing; it allows site inspectors to receive real-time, accurate authentication results on their smartphone. AuthentiGuard is in beta testing trials with a major company.
Investment in VirtualAgility, Inc., which owns patents and patent pending applications that allow people to create powerful applications; patent infringement lawsuit filed against Salesforce.com, Dell, and others. LTG made an investment in VirtualAgility, with options to increase its equity holding over time. VirtualAgility holds five U.S. patents, plus additional patent pending applications, for a user-configurable platform that allows people who are not IT specialists to create sophisticated, integrated applications. Patent infringement lawsuits have been filed against Salesforce.com, Dell, Bank of America, and others. In addition to this, LTG also has a substantial pipeline of IP investments. A pipeline of opportunities gives investors additional upside beyond the Bascom Research patents and DSS product line. Following consummation of the merger, DSS has stated that they intend to acquire IP that can be used to develop new product lines in addition to performing patent litigation, giving the Company potential revenue from licensing/royalties, settlements, and operations. |
