Acacia Research ( Nasdaq - ACTG ) -- Market Leader Reinforces Position

Acacia Research (ACTG $32.75) appears on track to produce excellent Q4 results.  Acacia is the leading provider of intellectual property monetization services.  The company teams up with inventors and other patent holders to enforce their IP rights against infringing companies.  Outside legal firms are hired on a contingency basis and typically collect 15%-20% of the winnings.  Acacia and its partners divide the remainder.  Each deal is unique but the company normally keeps a little more than half of the balance.  Over the years Acacia has acquired a patent portfolio of its own.  In those situations it retains 100% of the settlement, less what it paid to outside counsel.  Targets generally are large companies that don't have time to conduct extensive patent searches when developing new products.  Before Acacia came along small inventors often were stymied by expensive and time consuming legal maneuvering.  Acacia provided the deep pockets to withstand those delays.  Over the years the company's partner list has expanded to the point where it now licenses more than 200 patent portfolios encompassing hundreds of thousands of individual patents.  That's expanded the number of companies it can sue.  It also has made it possible to sue many companies for multiple infringements, boosting its average award size.

In 2010 Acacia agreed to "structured settlements" with Oracle and Microsoft.  Those deals provided those giants with licenses to all of the patents under Acacia's control, plus all the new ones it would bring in, for a three year period.  Oracle paid $25 million; Microsoft, $40 million.  In Q1 Samsung paid the company $45 million under a similar arrangement.  A portion of that money was paid to the company's partners.  Even so, earnings jumped dramatically in each of the quarters those deals were signed.  Patent values have escalated in 2011, fueled by several major transfers in the smart phone space.  That surge has made it more difficult for Acacia to reach agreements on additional structured settlements.  Infringing companies have been waiting for the dust to settle before committing such large amounts of capital. 

The rise in patent values also has prompted many corporations to figure out ways of monetizing their own patent portfolios.  Acacia is negotiating with several companies, including the three it already made structured deals with, to license large swaths of their patent portfolios.  The arrangement could offset some or all of the money they're paying in infringement cases.  It also will hide the originating company's identity when prosecuting those rights, allowing it to do keep doing business without acrimony.  Judicial pressure might be mitigated, as well.  Acacia probably won't be accused of anti-competitive behavior. 

The lull in signing new structured deals has caused the stock price to retreat over the past few months.  Those transactions provide immediate earnings boosts which investors thrive on.  Income from stand alone settlements has been advancing sharply over the past two quarters, though.  And Q4 comparisons should be positive even if no structured deals are consummated.  Our estimates assume that scenario.  They are unchanged.  Acacia indicates it is continuing to pursue structured transactions.  It also is bringing in rafts of new patents which might take 1-2 years to prepare, but promise to bolster income growth in the future.  The company additionally is looking to buy key patents in partnership with major companies, giving them a license and then suing everyone else.  That might keep the partner off the judicial radar screen.  Earnings could follow a number of paths to sharply higher levels over the next several years.  Our 2-3 year target price is unchanged at $100 a share.

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