The Cheapest FANG Stock You Never Heard Of

Tired of overthinking and overpaying for the modern growth phenomena that is FANG? Afraid the next tech wreck will wreck your portfolio? Don't want to be at the mercy of a FANG member hiccup in results at these high multiples? There are FANG support stocks that are levered to this growth beast, but about all of them are well known and suffer the same over-buzzed and over-owned problems as the Fab Four. Well if you want a new, hot performing, very under-the-radar, pick-and-shovel play for FANG that's been around for over 20 years with no debt and no dilution, keep reading. It has been growing results faster than any of the FANG members the last three years, and is currently at a 1.6 multiple on sales, a 3.9 multiple on cash flow, and a TTM PE of 4.

I speak of Network-1 Technologies, Inc. (NTIP) and they chase no subscriber base, have no cost of advertising (which is one reason you've never heard of them) and have been turning roughly half their sales into EBITDA. You see, the big players (Samsung, Google, Facebook, Apple, et al) come to them for permission to play. They are a tiny $100 million market cap David that owns a wide assortment critical patents at the heart of every Goliath Amazon and Amazon want-to-be.

The Long History Of This Company

They didn't start out doing patents. They were formed in 1990 selling "prepackaged software" as their SEC business classification stated, mainly security firewalls under the name "Network-1 Security Solutions" with the ticker NSSI, going public in 1998. They are still listed by the SEC as "prepackaged software" but they are into a whole new thing business-wise.

In April, 2004 reporting 2003 results, they stated the change in focus of the company:

Network-1 discontinued its software product offering in December 2002. In November 2003 Network-1 commenced a new business consisting of the acquisition, development, licensing and protection of its intellectual property which currently consists of a portfolio of telecommunications and data networking patents. In February 2004, the Company initiated its licensing efforts relating to its patent (U.S. Patent No. 6,218,930) covering the remote delivery of power over Ethernet cables (the "Remote Power Patent"). 

Al Gore's claim about inventing the internet comes to mind, only these guys can actually claim a facsimile of that honor. So what about this pipe dream of a tiny band of highwaymen erecting a toll booth to collect patent usage bounty from FANG?  How has this worked out in real life?

There was a 2000% rise in the stock after the business model switch. But to be fair, it was from 2003, when the dot bomb had flattened the stock to near zero. As security software peddlers, their results were consistently pathetic, typically loosing over five times their sales in loss from continuing operations.

So the math had to be impressive if they just survived, and they did. What strikes me about this chart is that, after the gleam in speculators' eyes went away in 2000, the stock went into a 15 year base, and even with results now that are what the internet speculators were dreaming of in 2000 without a dime of cash flow, the stock is just barely poking its nose out of the base with a PE of 4 with no fan far. But the base breakage is accompanied by a massive increase in volume, and the ownership appears to be extremely stronghanded as evidenced by the near zero reaction by the stock to the sharp, broad selloff of early 2016. All this suggests there is much more to come.

It's also interesting in this chart that the company seemed to know that much better things would be happening soon in 2011, when they initiated their stock buyback program, and again 2014, when they uplisted their stock from OTCBB to the NYSE.

The Genius Behind The Big Change - Corey M. Horowitz

Horowitz was Chairman of the Board starting in 1996 before becoming CEO with the new vision. The November, 2003 launch of the patent business coincides with the December, 2003 start of the role of a this legal genius as CEO. He is the guiding inspiration for spotting the key patents, working deals with the inventors to monetize their work on the big stage with royalties to the inventors and licensing revenue from the big fish. It's like Shark Tank in reverse with the sharks being in the hot seat. I say "legal genius" not because he has a law degree, but because his gang, consisting of a handful employees, has been drawing the likes of Apple, Cisco, and Google, with their armies of lawyers, into court to get patent rights squared away - and winning. Legal fees are a big expense for the company. In Bloomberg's profile of Horowitz, they allude to his talent:

Mr. Horowitz was an early stage investor in Network 1 and helped transform that company into an award-winning distributed firewall vendor prior to its being taken public in 1998 ...  In 2003, as Chairman, Mr. Horowitz supervised the winding down of operations, sale of the product suite and the development of alternative business opportunities. Since 2004, he served as the Chief Executive Officer and transformed the company into a business specializing in the licensing and enforcement of intellectual property, resulting in a 25 fold appreciation in its stock price

Horowitz puts his money where his genius is, owning roughly a third of the shares. I like it when founding individuals own this kind of interest.

You can find almost nothing written or said about this company. Jeff Marston did a nice article at Seeking Alpha back in March, "Network-1 Technologies: Catalysts On The Horizon" where he explains the patent portfolio status.  And an earlier PRO article by Tom Shaughnessy from March, 2015 "Network-1 Techologies: An Undiscovered Cash Rich Company ..." discusses the patents. In lieu of the debt or dilution you'd fear with a 'net nanocap, this outfit had, as of March, 2015, laid claim to about $12 M in share buybacks on a market cap of $56M.  That's 21% of the company grabbed by the company. They now have roughly $50 M in cash and a current ratio of 22. As Shaughnessy stated:

NTIP is a uniquely financially strong microcap company which positively differentiates it from other microcaps in the space.

Is this the same company that was losing over five times their sales and needing over $40 M in paid in capital to survive in the tech boom? I think they've made a wise change in direction.  It's not that this patent brokering thing is NTIP's invention. As Marston points out, there are others doing a similar thing: RPC Corp. (RPXC) Acacia Research Corp. (ACTG) Wi-Lan Inc. (WILN) and Marathon Patent Group Inc. (MARA). But they all have had negative or spotty results with it. They just don't seem to have the flare for this sort of thing that NTIP's Horowitz has.

The Challenging World Of Patent Litigation

How these court cases turn out is very topsy turvy and are a constant battle against the expiration of the patents. The Remote Power Patent that currently has a yearly revenue stream coming to NTIP from Cisco and others expires in 2020. But expirations don't necessarily mean no revenue. For example, there is the case of the Mirror Worlds patents. In 2013, NTIP bought some patents from this company that Apple was infringing on. This was after Mirror Worlds took Apple to court and lost. Steve Jobs realized the value of these patents, saying in a Supreme Court document:

"It may be something for our future, and we may want to secure a license ASAP".  Steve Jobs stated this after seeing a New York Times article that praised Mirror Worlds' new Scopeware product. Scopeware is Dr. Gelernter's (founder of Mirror Worlds) invention for a "document stream operating system and method".

Horowitz bought the patents and got a $25 M settlement from Apple last year even though the patent had just expired. It was more of a penalty awarded by the court for Apple's infringement in the past.
These retroactive awards can apply to patents in general. From Shaughnessy's article:

The Remote Power Patent's royalties are providing a viable stream of revenue, but they can grow. For example, there are 11 infringers who have the potential to owe back damages and future royalty payments. 

NTIP can't rest on their laurels of impressive court wins (batting 1.000 so far) because patents expire and many court wins are one time settlements. They must keep a stream of license revenue and court awards coming, and they seem to be about that with actions beginning with Google and Facebook. But the future of NTIP's revenue is far from an open and shut case. The major risk with this company is the changing legal landscape for IP (Intellectual property) litigation. No one is more aware of that than Horowitz himself.

In a 2015 interview with "The Patent Investor" Horowitz predicted the massive surge in NTIP's results the following two years, but revealed some angst over the future of this patent business model:

“In the next two years, we’re going to wind up with a lot of cash on our balance sheet and then we’ll have to decide what to do next.”

For his part, Horowitz said whether he makes additional patent portfolio purchases will depend on whether the patent market gets better.

Over the past 10 years, patent holder rights have been steadily eroded by a series of court rulings that have taken away injunctive relief, reduced damages and done away with software as a patentable subject matter. In addition, the America Invents Act also established the IPR and CBM review process to give infringers an inexpensive and time-saving tool to invalidate weak patents.

“Patent holder rights have been eviscerated over the past few years and innovation in this country’s been harmed. Ambulance chasers ruined it. I’m negative on the patent business because the game keeps changing, the rules keep changing. That’s not a business for a public company.”

What Is The Attitude Of Horowitz Now, Two Years Later?

Since that discouraging word from Horowitz, the court wins have continued for Network-1, and there seems to be debate around the pendulum swinging back to patent holder rights as conveyed in this coverage of the 2016 NPE conference, attended by Horowitz:

The prevailing mood among the CEOs set a particularly sombre tone for the rest of the event. It was by no means shared by all panelists and delegates (which this blog will follow up on tomorrow), but it did contradict the claims that the pendulum is starting to swing back to stronger patent rights in the US.

As one delegate put it: “The talk at last year’s event was about turning a corner, well it’s proving to be a pretty long corner.” The reality is that while the licensing climate might be improving for some patent owners, for many NPEs it remains very challenging. If the pendulum is moving back towards the centre, it’s not taking everyone with it.

If frivolous lawsuit squashing vs patent rights is indeed a pendulum in history, we seem to be coming off a swing to the squashing, anti-patent end, a swing in which Network-1 has managed to make big hay anyway. The America Invents Act that went into effect in 2013 is generally seen as making life harder for the small inventor. The main reason for this is that it changes patent rights from first-to-invent to first-to-file. Before 2013, if you filed for a patent, someone could come along later claiming they came up with the idea first, thoroughly prove it with documentation, and steal your patent. After 2013, a patent is yours if you filed it first. This puts a lot of pressure on inventors to file before they're ready or before they pay for attorneys, giving a big advantage to bigger companies over lone wolf inventors.

To further aggravate patent rights, the US Supreme Court ruled just this May that patent court cases must be held in the district where the alleged infringement took place. This basically scatters cases away from the knowledgeable patent "specialists" of the Eastern Texas District, where some 39% of all patent cases are held and strong patent rights can be expected.

This would all seem to hurt NTIP until you think about it a little. The 2013 Act actually makes the Network-1 portfolio safer since they deal mainly with filed patents which they have paid for. The new laws prevent any of these patents from being stolen from them. It just makes it harder for those filing. Though they have been filing some patents lately with Professor Ingemar Cox as a consultant to Network-1, they are not in the business of trying to get things filed. And when they do file, they enjoy the advantages a cash rich company has over the others. As for the case location issue, Marston discusses this in his article, "What The Recent Supreme Court Decision Means For Network-1 Technologies". He points out that Network-1 has been filing in other districts, besides Eastern Texas, and they don't file a lot of frivolous lawsuits like a "patent troll" outfit does with a shotgun approach. Network-1 takes more of a smart bomb approach, doesn't go to court with weak patents and wins in any proper court.

Despite his moaning about eroding patent holder rights cited above from 2015, Horowitz is now very bullish on his stock. He still owns 33% of the shares and had this to say in a December, 2015 interview at The IP Dealmakers Forum:

“We are buying back our stock because we think it is attractive,” Horowitz said. “I have at least one trial, maybe two trials… I’m very optimistic about the next two to three years.”

He has since launched into some new litigation. And the company's rabid confidence as expressed by its stock repurchase program, initiated with $2 M worth in late 2011, continues unabated. In June, 2015, they announced another $2 M worth of approved buybacks with Horowtiz saying:

"We are pleased to announce another increase to our repurchase program to benefit shareholders at a time when we believe our stock is undervalued," said Corey M. Horowitz, Chairman and CEO of Network-1. "This, our fourth increase of our share repurchase program, reflects our confidence in the long-term potential for Network-1 and our commitment to increasing shareholder value," he added.

But he has gotten much bolder with the buybacks since then. In June, 2017, they announced another $5 M worth approved:

"We are pleased to announce another increase to our Share Repurchase Program to benefit shareholders at a time when we believe our stock is undervalued," said Corey M. Horowitz, Chairman and CEO of Network-1. "This, our fifth increase of our Share Repurchase Program, reflects our confidence in the long-term potential for Network-1 and our commitment to increasing shareholder value," he added.

This grab is aggressive:

permitting the Company to repurchase up to $5,000,000 of shares of its common stock over the next two years (for a total authorization since inception of the program of approximately $17,000,000). To date, the Company has repurchased an aggregate of 7,104,711 shares of its common stock under the Share Repurchase Program since inception of the program in August 2011 at an average price of $1.72 per share or an aggregate cost of approximately $12,214,110 (exclusive of commissions).

All this is on a market cap of just $98 M. They have bought 7.1 M shares compared to a present mutual fund ownership of 5.7 M shares (Morningstar figures). These are all huge numbers compared to a public float of only about 14 M shares. That's ultra piggish. It's almost like you're allowed to buy a private equity company while it's being made over for public consumption. If funds become very interested, it will move the stock needle. The company has been very right with their buyback buying since 2011 when their patent results began springing to life. Now they are more aggressive then ever in these buybacks. As Shaughnessy said in his article from 2015, before the massive $5 M increase this year:

We would be hard pressed to find a microcap company of this size with a comparable repurchase program.

The Patents

I don't want to go into a detailed discussion of all the patents here. Marston and Shaughnessy cover this in their articles linked above, and there is a very nice rundown of the patents on Network-1's website with up-to-date timelines on them. They presently own 28 altogether. I will however summarize the collection. These can be grouped into four batches - Power over Ethernet, Mirror Worlds, Content Monetization, and QoS.

Power over Ethernet  More commonly known as the Remote Power Patent, this is a technique where internet flows can be safely put over standard LAN lines in a local network without harming devices not able to take signal.  It has been subject to three litigations and has contributed $100 M in revenue from over 20 licencees. It expires in 2020. This summary suggests more revenue may be due once the rest of the defendents are found guilty:

So that means Network-1 has now reached settlement and license agreements with twelve of the original sixteen defendants for the licensing of its Remote Power Patent. The remaining four defendants are Avaya Inc., AXIS Communications Inc., Hewlett-Packard Company, and Juniper Networks, Inc. The litigation is currently scheduled for trial in 2017.

The patent was invented by Boris Katzenberg, who was active in the IEEE Task Force that developed the second generation Power Over Ethernet standard.

Mirror Worlds  This small company patented "technologies that enable unified search and indexing, displaying, and archiving of documents in a computer system" resulting from work in the mid 1990s (before the internet) and were later widely used in web based systems. Mirror Worlds took Apple to court and won a $208 M verdict that was not awarded due to a procedural technicality. Per Network-1's website, "Working with Dr. Gelernter, Network-1 acquired the Mirror Worlds portfolio in May 2013. Network-1 believed that under the facts of the previous case, Apple still was obligated to pursue a fair licensing agreement. Network-1 filed a patent infringement action against Apple and Microsoft on May 23, 2013." Last year, they won a $25 M settlement from Apple and $5 from Microsoft.  On May 10, 2017, Mirror Worlds, now a wholly owned subsidiary of Network-1, announced commencement of litigation against Facebook.

The patent was invented by Professor David Gelernter. He wrote a popular book titled Mirror Worlds: or the Day Software Puts the Universe in a Shoebox in 1991. It was a look into the coming of the internet. The above Facebook announcement from marketwired.com noted just how prescient Gelernter was with his amazing book:

As reported in The Economist, "Dr. Gelernter foresaw how computers would be woven into the fabric of everyday life. In his book 'Mirror Worlds,' published in 1991, he accurately described websites, blogging, virtual reality, streaming video, tablet computers, e-books, search engines and internet telephony. More importantly, he anticipated the consequences all this would have on the nature of social interaction, describing distributed online communities that work just as Facebook and Twitter do today."

Content Monetization  Otherwise know as the Cox patents, they were "12 issued patents that relate to identifying or tagging uploaded media content and taking business actions based on the identification" as the website puts it. In 2013 Network-1 bought the patents and is filing for more based on the original patents. In 2014, they began proceedings against Google, specifically against their subsidiary, YouTube, alleging they use this technology without a license. One has to wonder how many more are using it. In June, 2016, the Patent Trial and Appeals Board upheld the patentability of 119 of the 129 claims. Another objection raised by YouTube, Covered Business Method, was reviewed and ruled in favor of Network-1 in October, 2016.

These patents were invented by Professor Ingemar Cox from the University of Copenhagen. He was at Bell Labs and NEC Research Institute, holding over 40 US patents.

QoS  Then there are some "QoS" (Quality of Service) patents they've stashed away and are holding close to the vest for now.

Conclusion

There were several IP companies present at the IP Dealmakers Forum mentioned above, and they agreed that they shouldn't be judged like most companies by quarterly results as patent cases are not a smooth ride. It is difficult, in fact pointless, to project court awards into revenue. But judging from the "near miss" $208 M judgment scuttled by a technicality in one of the cases above, there appears to be even bigger money to be made with these internet defining patents than what Network-1 has done so far. The stock is not pricing any of this in. It is a fascinating speculation with a PE of 4. Network-1 keeps making precision forays into court and bringing home the bacon to inventors and shareholders.