Acacia Research ( ACTG - Nasdaq )

Acacia Research (ACTG $20.75) is the leading provider of patent enforcement services.  The company has acquired the rights to approximately 150 patent families.  It uses the legal system to enforce those rights, usually by collecting a paid-up license from an infringing party.  Those proceeds are divided between Acacia and the original patent holder.  In cases where settlements are not reached and the dispute goes to court, the company usually hires outside counsel on a contingency basis.  On average Acacia keeps 40% of any judgements won, with the original patent holder getting 40% and the law firm 20%.  In the past most of Acacia's technology partners were academics and small research organizations that could not afford to take on major corporations in court.  Infringement has become increasingly rampant as new product cycles have grown shorter, motivating manufacturers to engineer advances into new designs without engaging in a detailed patent search.  Acacia can afford to bring those infringers to account, creating a path for small inventors to earn a return on their ingenuity.

Bigger deals now are being signed.  In the first quarter Oracle paid $25 million to Acacia for the right to use all of the patents in its portfolio for the next three years.  In the September period a similar transaction with Microsoft was completed.  The Oracle deal contributed about $.50 a share in fully taxed (35% rate) earnings, before overhead.  The Microsoft arrangement is believed to be in the same ballpark.  Acacia also has signed several contracts with large patent holders, to help them enforce their intellectual property rights.  The third largest semiconductor manufacturer (based in Taiwan), a major Japanese consumer electronics company, and a Fortune 100 defense contractor all have joined forces with Acacia this year.  That inventory promises to expand the company's licensing potential in its ordinary course of business.  It also could prompt more large scale deals to be signed, possibly at higher amounts.  Other large companies are negotiating to be represented by Acacia, as well.  Most are likely to retain title to their key patents.  But a deal with Acacia promises to monetize less critical technology that might never be pursued otherwise.

Fully taxed earnings jumped to $.40 a share in the March quarter, fueled by the Oracle transaction.  No large deals were consummated in the June quarter, which led to a loss of $.04 a share.  Earnings are poised to leap again in the September period on the Microsoft license.  A growing string of small transactions promises to reinforce the momentum, and set the stage for a strong second half performance.  We estimate 2010 income will finish around $.75 a share.

Next year Acacia is hoping to land three more major deals.  Those transactions, combined with a growing volume of individual licenses, could propel earnings into the $1.15-$1.35 a share range.  In 2-3 years Acacia could build up a portfolio of 12 big licensing payors, each on the hook for a three year cycle.  Four would renew every year, laying the foundation for approximately $2.00 a share in recurring annual income.  Longer term, further expansion is possible.  Applying a P/E multiple of 20x suggests a target price of $40 a share, potential appreciation of 90% from the current quote.