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Technology Stocks : VHC - VIRNETX - Mobile internet security - Hottest technol
VHC 5.030-1.8%Sep 23 4:00 PM EDT

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From: Paul Lee4/8/2013 10:35:11 AM
   of 41
one man's opinion

Apple Says It Is Willing To Throw The Baby Out With The Bath Water Over Royalties

Apr 8 2013, 10:09 by: EXPstocktrader |

Disclosure: I am long VHC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

The phrase to "throw out the baby with the bath water" is an idiomatic expression (that means something other than the literal meanings of its individual words) used to suggest an avoidable error in which something good is eliminated when trying to get rid of something bad, or in other words, rejecting the essential along with the inessential.

The longer term valuation of VirnetX ( VHC) according to statements implied by the company are solid. Even today Kendall Larsen, CEO of VirnetX said; "We believe that VirnetX invented technologies are essential to securing the rapidly growing 4G/LTE networks." VirnetX has ientified additional 3GPP specification to ETSI and ATIS. "VirnetX remains strong and undaunted as we continue to execute on our long-term strategy to become a key provider of technology and intellectual property required for making communications secure over the 4G/LTE networks."

Look, anyone wanting to use 4G LTE technology will have to agree to a licensing agreement with the company. It all makes sense. Having a patent process and enforcement of patents is warranted here, otherwise why have a USPTO? Further, because of the validity placed on the patents like the 180 patent by the USPTO, several licensing agreements have already been made by a few companies which include: Microsoft ( MSFT), Aastra ( AATSF.PK), Mitel ( MITL), NEC (NIPNF) and Siemens. I suspect that news regarding Apple's royalty will send shares much higher despite the recent drop.

In a communication last week, Apple ( AAPL) informed its enterprise customers that it was removing the VPN On Demand feature due to a lawsuit that they lost to VirnetX. Here's the communique:

Due to a lawsuit by VirnetX, Apple will be changing the behavior of VPN On Demand for iOS devices using iOS 6.1 and later.

Essentially, the move follows a U.S. $368 million ruling against Apple, where a federal jury found the company had violated VirnetX patents. Apple went on to list a number of problems that users might experience as it essentially said that customers must manually initiate a VPN connection.

So, let me get this straight:

1) Apple is essentially now admitting that it was using VirnetX's patented technology; however in court Apple swore under oath that it wasn't? Hmmm ...

2) Apple who reported record revenue on January 23, 2013, of over $54 billion and sales of over 75 million iOS devices in a single quarter with a balance sheet of over $196 billion dollars worth of assets, would rather throw away its enterprise business rather than pay a 1% royalty rate?

Let's Be Perfectly Clear About This Move:

Apple is not providing a work around to VirnetX's technology; it is simply removing it at the expense of its enterprise customers. Also, this has absolutely NO impact on FaceTime or iMessaging. To date, Apple has NOT provided a viable work around to VirnetX's patented key technology as it pertains to FaceTime or iMessaging.

VirnetX's 1% royalty stems from arguments made in the Jury trial that concluded with a Jury siding with VirnetX and the $368 million dollars. And on top of this as determined by Judge Davis's final judgment, he apparently finds a 1% royalty as being reasonable. Running royalties can run anywhere from 1% - 7% as the judge so determines. At this point, the ongoing use of the patents is now willful infringement and could carry an even higher royalty rate if the judge sees fit.

Due to the high volume of Apple sales on accused products, Apple, facing an imposed royalty rate around 1%, could very well be on the hook for royalty payments that range anywhere from $800 million to $1.5 billion per year.

This Coming Week Will Tell More:

April 12, 2013 ends the time parameters for court ordered mediation meetings to establish a running royalty rate between Apple and VirnetX. If no agreement is made, the judge has ordered VirnetX to file a motion for him to establish an ongoing royalty rate. I wouldn't be surprised if VirnetX hasn't already written this motion with an even higher ongoing royalty rate greater than 1% now that its usage of the technology is willful.

The Walls Are Closing In On Apple:

Is Apple, who is dragging its feet here, actually going to place its fate in the hands of the judge? The same judge who has already favored VirnetX with the Markman Order ruling and has indicated that a 1% ongoing royalty rate is "reasonable" or will it try to work out an arrangement with VirnetX?

As a longer term investor in VirnetX, it appears that this stock is a good value play once again. The shares have been cut in half and the short volume is huge. At some point (as we see from time to time) the shorts will need to unwind some or all of their position and cover. When this occurs (as we have experienced many times in the past few years) the stock should spike hard. In any event, expect more short term volatility.

One last thought. If Apple continues to use VirnetX's secure patented technology, it only makes sense that it will have to pay a "reasonable running royalty rate" just like Microsoft and the other large tech companies are doing. It's like a toll road. If you use it you have to pay. I really think that Apple's announcement of removing VPN On Demand might just be a posturing maneuver in the negotiation process or possibly as a way of garnering public sympathy? We should all know how this plays out within a week. Stay tuned.

Additional disclosure: I may add more to my current position that was initiated on the recent drop in the next 72 hours
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