Waiting for A Document Security Windfall

October 25th, 2012
in contributors

Investing Daily Article of the Week

by John Persinos, Managing Director, Personal Finance and Investing Daily

The litigious nature of contemporary society can be a burden for some companies, but a potential pot of gold for others. What used to be a form of document-securitySMALLlegal redress is now a business model.

This year among Internet companies, the jockeying has been heating up and shrewd investors are getting in line to profit. Case in point: Document Security Systems (NYSE MKT: DSS), a Rochester, NY-based company that specializes in digital security protection, is poised to reap a multi-billion dollar windfall from its pending lawsuit against the biggest names in social media.

Follow up:

The stock of this high-tech pioneer would likely soar if it prevails in its pending patent infringement case. However, the company’s strong products ensure long-term growth prospects, regardless of how the lawsuit turns out.

DSS creates and sells a host of security systems, including products that protect information from unauthorized scanning, copying, and digital imaging. The company signed a merger agreement in October with Bascom Research, a wholly owned subsidiary of Lexington Technology Group, a privately owned company that owns and manages intellectual property assets.

Shortly after the merger was announced this month, Bascom filed a lawsuit in the United States District Court for the Eastern District of Virginia, claiming that these five social media and business networking companies had infringed on Bascom’s patented technology: Facebook (NASDAQ: FB), LinkedIn (NYSE: LNKD), Novell (NASDAQ: NOVL), BroadVision (NASDAQ: BVSN), and Jive Software (NASDAQ: JIVE).

DSS expects to complete the merger by the first quarter of 2013, before any settlement payments are likely to be received. A court decision will probably be reached in the second half of next year.

The merged public entity would own the rights to the entire intellectual property portfolio under the unified umbrella of Lexington Technology Group, Bascom Research, and DSS.

The lawsuit claims that Bascom’s proprietary technology for online collaboration and document linking was patented as far back as 2001 (well in advance of the founding of Facebook and LinkedIn as companies). DSS’ own technology already dovetails with that of Bascom’s and the two companies are on track to be integrated as a single organization. Shares of DSS jumped on the news of the lawsuit, as investors anticipated a legal win that would line DSS’ coffers, but this fast-growing small-cap company has plenty of upside left.

There’s considerable precedent for this sort of litigation. Vringo (NYSE MKT: VRNG), a provider of software platforms for mobile social and mobile video services, is suing search behemoth Google (NASDAQ: GOOG) for infringing on its patented search technology. Sometimes pejoratively referred to as a “patent troll,” Vringo is nonetheless betting that recently acquired intellectual property will drive revenue growth—and so far, that bet has been paying off.

Investors who have bid up DSS’ stock clearly have in mind Vringo’s past successes, as well as Apple’s (NASDAQ: AAPL) historic legal victory in August against Samsung Electronics (OTC: SSNFL) for more than $1 billion, whereby Apple was able to convince a jury that Samsung had stolen basic smartphone designs from its highly popular iPhone.

DSS’ stock is riding high, but some analysts expect the stock to perhaps triple in price if DSS wins. Although the exact amount of any possible award remains unknown, it would likely run into the billions of dollars.

The Wild, Digital West

Intellectual Property (IP) lawsuits resemble the Wild West, with huge sums at stake. According to a 2011 report from the World Intellectual Property Organization, the annual global IP licensing market has mushroomed from $2.8 billion in 1970 to $180 billion in 2009, the last year for which statistics are available.

The outright pirating of technology is rampant, reminiscent of the allegations made against Mark Zuckerberg by fellow Harvard students who were his early partners in creating a social media platform that eventually morphed into Facebook.

A cottage industry of so-called patent trolls has emerged, whereby companies legally lock up certain technologies with the intention of suing companies that purposely (or inadvertently) infringe on their patents. The phenomenon is giving rise to worries that quick-draw legal shootouts are impeding innovation. No one is accusing DSS of being a patent troll, but it certainly has good company when it comes to filing lawsuits.

The newly public Facebook is expected to earn about $5 billion in 2012; if the Virginia court rules that the company is generating its earnings by exploiting Bascom’s patented technology, it would prove a huge payday for DSS, either in the form of a one-time settlement or a continual licensing fee.

Odds are favorable that DSS will win. The company has retained a highly aggressive law firm with a proven track record of obtaining access to contested “source codes” and prevailing in court.

However, DSS enjoys many inherent strengths and solid long-term prospects, regardless of how the legal battle turns out. For DSS, winning the lawsuit isn’t necessary to prosper; it would be icing on an already substantial cake.

DSS is a dominant player in the anti-counterfeiting market and holds over 50 patents and patents pending, most of which are extremely valuable. According to the technical publication Converting Quarterly, Internet fraud and counterfeiting is a worsening problem that results in an estimated $1 trillion in global losses. The magazine reports that companies spend more than $3 billion every year for online protection, an amount that’s expected to grow to over $79 billion by 2014.

The US government has mandated DSS technology to secure US Social Security cards; DSS’ technology also is used to protect iconic consumer brands from counterfeiting, including those made by Procter & Gamble (NYSE: PG), Coca-Cola (NYSE: CCE), Kellogg Company (NYSE: K), and Pfizer (NYSE: PFE).

This reliable roster of blue chip clients has helped DSS weather weak economic conditions. DSS reported second-quarter 2012 revenue of $3.7 million, a 27 percent increase over the same quarter a year ago. Revenue for the six months ended June 30, 2012 increased 35 percent from the first six months of 2011.

Gross profit for the second quarter was $1.3 million, a 65 percent increase from the year-ago quarter. Gross profit for the six months ended June 30, 2012 increased 48 percent from the first six months of 2011, largely because of higher sales and lower production costs.

The RFID Edge

DSS also plays a leadership role in radio frequency identification (RFID) tags, posing a significant long-term advantage for the company. Once considered the stuff of science fiction, RFID chips are now all around us. They’re used in tollbooths, at the gas pump, at airports, in retail stores — even on the farm to keep track of animals.

RFID tags automatically identify a “tagged” object or person by storing and remotely retrieving information from small transponders, or tags. Each tag features a built-in antenna that allows for the transmission and reception of radio waves from an RFID transceiver.

RFID is applicable anytime that a unique identification system is required. The tag can convey information as simple as the location of a product on a warehouse pallet, or as complex as instructions on how to assemble an automobile.

According to the consultancy IDTechEx, the value of the entire RFID market will be $7.46 billion by the end of 2012, up from $6.37 billion in 2011. In total, 3.98 billion tags will be sold in this year versus 2.93 billion in the previous year. DSS is in the vanguard of RFID development.

RFID chips have become a standard technology in the manufacturing and pharmaceutical industries. Even the US Defense Department mandates their use, for the provision and monitoring of spare parts and equipment in far-flung war zones.

Following the path of major retailers such as Wal-Mart Stores (NYSE: WMT), organizations in the public and private sectors are embracing RFID, a paradigm-shifting innovation that is generating operational efficiencies and enhancing corporate security. Now, RFID is the hottest trend in social media

As online marketers launch an increasing number of live events, the use of RFID tags in conjunction with Facebook is becoming more prevalent.

Online marketers staging live events use RFID to mesh the physical world of trade shows with the virtual world of social media. Combining RFID with social media enables users to interact at the time of an event.

The resulting RFID data stream gives social media marketing professionals a snapshot of a highly targeted group, with granular details that they couldn’t get any other way.

DSS also is making forays into electronic health records (EHR), providing RFID and digital security systems to hospitals to improve administrative efficiency and patient safety.

As part of the Obama administration’s American Recovery and Reinvestment Act of 2009, also known as the economic stimulus bill, the Health Information Technol­ogy for Economic and Clinical Health (HITECH) Act implemented substantial financial incen­tives for hospitals and physicians in the form of higher Medicare reimburse­ments to encourage the adoption of EHRs. The incentives total $19.2 billion and continue until 2014.

Increasing demand for DSS’ proprietary technology in the booming EHR segment will be another long-term growth driver for the company. A high-tech pioneer that faces a potential legal windfall, Document Security Systems is a buy up to 7.

What do you think of this article? Please post your feedback in the “comments” section below!

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