|Shares Out. (in M):||47||P/E||n/a||n/a|
|Market Cap (in $M):||5||P/FCF||n/a||n/a|
|Net Debt (in $M):||-4||EBIT||-1||0|
Graphon Corp is a crappy software company. Management does not communicate well with their shareholder base. Its software business is a no growth business that will never throw off large amounts of cash flow. However, it is also a company which happens to have acquired some potentially valuable patents in an acquisition a few years ago which is just now starting to pay dividends for Graphon with a catalyst that should occur shortly.
(As you can see from a market cap of just over 5mm, this is mainly a PA investment only. Average trading volume is miniscule but you with patience you can acquire a decent sized position.)
My trading thesis is simple - I think the patents are worth significantly more than the market value of the company. And I believe the catalyst will be the 10Q that comes out in August will detail the results of recent settlements from companies such as CareerBuilder, LLC and Classified Ventures, LLC, and Google for a patent which brought in over $6mm in 2007 from a settlement with Autotrader. Without getting too bogged down in details, the company received strong results in a Markman hearing in the Autotrader suit. Rather than continue to fight, Autotrader paid a settlement. Graphon continued to press other companies for infringement and, to my surprise, none have fought back with any force. Either the defendants find Graphon's case to be strong, or they simply think it's less costly to settle than to fight. Either way, as long as management doesn't screw this up, it can be a cash machine for Graphon.
Here is the language in the most recent 10Q that I think is the most relevant (the Google settlement was a press release and hasn't been in a 10Q yet):
On March 10, 2008, we initiated a proceeding against Classified Ventures, LLC;
IAC/InterActiveCorp; Match.com (an operating business of IAC/InterActiveCorp);
Yahoo! Inc.; eHarmony.com; and CareerBuilder, LLC in the United States District
Court in the Eastern District of Texas alleging infringement of four of our
patents, namely; U.S. Patent Nos. 6,324,538, 6,850,940, 7,028,034 and 7,269,591,
which protect our unique method of maintaining an automated and
network-accessible database. The suit alleges that the named companies infringe
our patents on each of their Web sites. The suit seeks permanent injunctive
relief along with unspecified damages. During late April and early May 2008, the
opposing parties in the proceeding filed their Answers and Counterclaims seeking
a declaratory judgment that they do not infringe the patents in the suit and
that each of the patents in the suit are invalid and unenforceable. On June 5,
2008, we filed our answers to each of the opposing parties' counterclaims. On
August 13, 2008, the opposing parties filed their respective motions for early
hearing on inequitable conduct. Responses and replies were filed during August
and September 2008 addressing this motion. On August 21, 2008, IAC/interactive
Corp. was dismissed from the lawsuit without prejudice. On December 2, 2008 the
court issued a Docket Control Order setting the dates of April 27, 2011 for the
Markman Hearing and November 7, 2011 for jury selection.
During April 2009 we entered into settlement and licensing agreements with
CareerBuilder, LLC and Classified Ventures, LLC, which resolved all legal
disputes between us and them. The aggregate financial effect of these agreements
will be reported in our operating results for the three and six-month periods
ending June 30, 2009.
Not only will these patents bring cash in now, but I also think that each settlement strengthens the chances of obtaining future settlements. Because this is a broad patent, I think there are many companies they could chase for a settlement including some very large companies where the settlement amounts could be multiples of the current market cap.
Additionally, they have other patents that they are trying to enforce against Juniper, which Graphon alleges which protects their fundamental network security and firewall technologies. I have spoken informally to IP lawyers who have said the patents are broad and encompassing, but were granted recently enough that they would have had to withstand fair strict tests in the patent office. I don't feel I have any edge as to whether Graphon is likely to succeed in this suit, so I just write it off as a zero. To be fair, it could actually be a cash drain as they could spend money to fight, and ultimately come out with nothing to show for their trouble. (You can follow the case via Pacer.)
The software business is straightforward and easy to understand. It usually sells around 5mm-6mm of software annually, and costs are in that same range. It's not a great business, and as a standalone company, is virtually worthless. To a strategic acquirer, you might be able to get 1-2x sales, but if anyone was interested, that would have happened a long time ago. I know this isn't much detail, but I don't really think there is much to say but I'm happy to answer questions in the Q&A if there's interest.
Graphon had 3.6mm in the bank as of last quarter. Assuming their cash burn remained steady from that quarter, it would put them at 3.45mm of cash.
The Autotrader settlement was 6.25mm. Although we won't know until the 10Q comes out in a few weeks, I doubt they would have been able to repeat their Autotrader settlement. In fact, I'd be content if the recent settlements amounted to 6.25mm in aggregate.
While I think the market may award a premium to cash value at some point in the future, I think a conservative valuation of the company would be cash value which I believe is more than the current stock price. (Figure as a ballpark estimate that they will keep 2/3 of whatever the settlements bring in.) Assuming they were able to pull in 6.25mm from these three settlements, that would indicate a current value of $0.15-$0.20, which would not take into account future settlements. Downside should be limited as the stock hasn't reacted much, if at all, to the recent settlements. If the settlements are better than expected and the market takes notice, it would be very easy for this kind of stock to be a multibagger. It's not hard to imagine the market putting future settlements values at $20mm+, which would value the shares at $0.40 or higher. In the hands of an acquirer who had deeper pockets, this scenario could be realized. As a side note, the company had discussed monetizing patents before, but I haven't heard it within the last year so I'm not expecting anything like that to materialize in the near future. Over time, I think this solution makes a lot of sense for the company, and especially the large shareholders who are limited in options to monetize their investments.
The risks here are great. Aside from the obvious, ie they go to court and lose and/or settlement amounts are too small to matter, there are risks with management. They are terrible about communicating with shareholders. As a result, I'm unclear what they would do with the money in the case of future settlements. Personally, I'd like to see them dividend out the cash received from settlements - to make sure they don't reinvest in the software business.
Liquidity is poor. Even if the results prove to be encouraging, it's unclear whether the share price will react given the other risks.
There is legal risk with the company itself. Other companies can counter-sue and engage the company in a lengthy cash burning legal case, and force the company to raise money at distressed prices.
Catalyst: Graphon's soon to be reported 10Q + any legal updates from the company and/or Pacer.
|Entry||08/02/2009 01:51 PM|
Thanks for the write-up. When do the key patents expire? Also, given recent cash flow performance shouldn't you put a negative DCF value on the software business and deduct that from your estimates of IP value?
|Entry||08/14/2009 09:05 PM|
on first glance, settlements are around ~2mm in aggregate, which is less than i anticipated.
the company has about 4mm in cash, so at the current prices, gojo is trading slightly above cash per share.
i'm going to read the 10Q in more detail this weekend, and intend to speak with the company sometime in the next two weeks.
if anyone has any questions that they want answered specifically, i will pose those questions to the company.