Burst.com BRST
March 24, 2005 - 11:35am EST by
issambres839
2005 2006
Price: 1.70 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 68 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Burst (Pink sheets: BRST) is an intellectual property company that just received a $60 million license from Microsoft (NASDAQ: MSFT) in a patent infringement and anti-trust litigation. Right now, Burst sells for the lowly valuation net of cash of $28 million (not including the value of its remaining $25 million NOL). I believe the settlement with MSFT is just the beginning for Burst, as it can now go after dozens of other companies that are infringing on its patents. I believe that Burst is worth anywhere from $3 to $6 a share, with limited downside from current prices.

A Win against Microsoft leads to a big license fee

After nearly three years of litigation and on the eve of a very important hearing, Burst and Microsoft settled for a one time $60 million license fee, with no sub license rights for MSFT. While this was a disappointment for many bulls on BRST, this actually puts Burst on substantial footing to go after other companies using their technology. This $60 million license fee will be paid in cash in a couple of weeks and after the lawyer’s contingency fee, will represent $1 a share in cash (no taxes due to an NOL) to Burst.

A Review of Burst’s technology

Before I go into which companies could be infringing on Burst, let’s first step back and explain the importance of Burst’s technology. I recommend going to the previous recommendation on Burst for a further discussion. Here is a technology explanation by Fishbo in last year’s report:

“Burst.com patented as early as 1990 (US Patents #4,963,995, #5,164,839, and #5,995,705). The basic concept is some audio/video information is compressed and transmitted to the client in a “burst” so that it takes less time to transmit than the time it takes the original material to play. Then the client software can play the material at its leisure and reduce the effects of network transmission problems.

This is similar to streaming, a concept pioneered in 1995 by RealNetworks (NASDAQ: RNWK) (formerly Progressive Networks), which allows a computer user to view a compressed audio/video signal while it downloads continuously in the background, rather than wait for the entire file to download and be saved to the users hard drive. In streaming, the server transmits information in “real time” to the client, which is to say that it takes approximately one hour to stream one hour’s worth of video content.

It wasn’t until the advent of broadband that the difference between streaming and bursting would become apparent. In many cases a broadband user will have a much faster internet connection than is required to transfer the audio/video information in real time, so bursting allows these users to receive packets faster than they actually view them (“Faster-than-Real-Time”) and save them for later viewing. By downloading information before it is actually needed, bursting effectively insulates the user from the unexpected network problems that would cause a streamed broadcast to stutter.”

What companies could be infringing Burst?

Any type of company that is involved with faster than real time download can be assumed to be infringing. The most immediate targets are Apple (NASDAQ: AAPL) and Real Networks, through QuickTime and Real player. Burst could then go after all of the music downloading services, such as Itunes, Napster (NASDAQ: NAPS), etc.

Another big venue to go after are the TIVO/DVR related companies, meaning every set top box manufacturer and possibly cable companies for video on demand.

There are dozens of companies in all of these arenas to go after.

The Importance of Claims Construction

One of the overlooked facts going forward is how important the claims construction process was for Burst in the MSFT litigation. Judge Motz essentially ruled on the validity of Burst’s patents, that it was worthwhile to continue with the litigation.

Now that Burst is moving forward in settlement talks or potential litigation, they have two big weapons in any future trial. The first is that a major technology participant (MSFT) was willing to pay for a license. The second is that a judge in a claims construction hearing validated the patents. These are two very large weapons to have going into settlement talks or before suing someone, because these are two of the main points to prove in a patent lawsuit.

BRST’s work on MSFT patent suit should speed new lawsuits

Since Burst has spent the last two to three years working on justifying its patents and defending them against MSFT’s legal onslaught, they have substantially done most of the patent work they will need to do against every other company. So, the new patent lawsuits will be much faster than the MSFT case, simply because the wheel doesn’t have to be reinvented every time. If Burst has to go to court, the suits will move much faster, that is why I expect news of a new license/settlement within three to six months.

Revenues of Infringing Products and potential value of the patents

I estimate that the revenues in 2004 (which are growing rapidly in most cases) of Real Networks, Apple’s Itunes and Ipod, Iriver, Creative’s personal entertainment division (NASDAQ: CREAF), Tivo (NASDAQ: TIVO) and other set top box manufacturers is at least $1 billion.

There are multiple ways that you can view Burst’s potential outcome. They may end up getting an ongoing royalty stream, at anywhere from 1% to 2% depending on who the infringer is and what the circumstances are. Another alternative is a big one time royalty ala MSFT or a small one time payment for nuisance value.

Royalty Stream @1% = $10 million in income a year, or $6.5 million after tax.
@2% = $20 million, or $13 million a year/

slap a 10 to 20 multiple on that ongoing income stream and you have a value of $65 million to $260 million value.

And so on….

The other example I will use is what if there are 20 different companies that are infringing and BRST settles from anywhere from $5 to $20 million with each on average. That would place a value of $100 to $400 million in potential payments.

So, with different scenarios we can get a valuation from $65 million to $400 million.

Risk/Reward is very attractive

With $1 a share in cash soon to be on the balance sheet, a $25 million NOL left over, and a minimal cash burn of $500,000 a year, Burst is selling for $28 million for future technology settlements and litigation awards. A quick look at the downside, tells me that Burst will probably never sell below $20 million in future litigation, as there will always be some kind of litigation potential and optionality. That marks the downside at $1.50 a share for me, only $0.17 a share lower.

And at my lowest case scenario for settlements only for nuisance value at $5 million a company, I get a value of $51 million after tax and NOL. With $40 million shares outstanding that would put the value of the stock at $1 share in cash plus $1.28 in future settlements, or a stock price of $2.28 a share. That is a 35% upside from current levels.

Now with a grandslam settlement of $20 million a company the upside could be as great as $7.71 a share. Though to be conservative the most realistic scenario is probably $3 a share or a little over $100 million in future settlements. That puts the upside at almost a 100% increase.

Ampex Example

At this point I think it is important to look at prior instances of other companies pursuing this path of intellectual property enforcement. Ampex (Bulletin board: AEXCA) is probably an excellent example. They settled for a small amount or $60 million with Sony, and then within months settled with three of Sony’s competitors. The stock exploded from its post Sony settlement, to go up as high as four times its post Sony settlement price.

Now while Burst has more shares and a larger float then Ampex, the experience of beating the technology behemoth and then the other competitors falling in line is a powerful example. Why would Apple or Real Networks for example spend millions in legal expenses when they could settle for a tiny ongoing royalty or a decent one time royalty payment?

In fact, I think Burst has a strong case against Real Networks, as Burst’s initial case accused Real Networks of collusion with MSFT, before Burst decided to focus on MSFT alone to make a more focused case.

Summary

In summary, I see a technology company that has lots of upside and little downside. I also think few in the hedge fund world know or have participated in this name. I also believe that Burst is already in discussions and settlement talks with infringers. There are also some major catalysts to come in the very near future. Catalysts include a press release detailing what industries, technologies and the number of companies that are infringing on their patents. I also expect the company to hold a conference call to explain their strategy further.

Take advantage of the lull in news now, as much more news and announcements are coming in the future. And imagine what Burst does when they appear on CNBC or articles wonder if this is a technology play on the Ipod or Itunes?

Catalyst

1) New press releases detailing extensive information about which technologies, industries and number of companies infringe

2) Conference call providing light on outlook

3) Future articles on Burst

4) Settlements, or announcements of lawsuits
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