Acacia Research ( Nasdaq - ACTG ) -- Return of the Jedi

Acacia Research (ACTG $25.00) suffered a steep sell off following its publication of Q2 results.  Those financial measures were excellent.  Earnings advanced 162% to $.21 a share on revenues of $50.5 million (+27%).  But they coincided with a series of external events that caused dismay among investors.  Legislation was introduced in Congress ("Shield Act") to reduce the value of software patents.  Apple Computer and several other hardware manufacturers promoted the effort, to minimize their exposure to lawsuits.  Product development cycles have become so short in the electronics industry that companies have no time to investigate possible infringement beforehand.  In the past they were able to settle claims for small amounts or wear down their opponents altogether, because the patent owners didn't have the financial resources to stay the course.  When advocates like Acacia Research arrived on the scene, that strategy no longer worked.  And judgements escalated in value. 

Apple Computer and its cronies hope to escape that liability now by changing the law.  Software industry stalwarts like Oracle and Microsoft have fought back because the scope of the proposed legislation encompasses far more than cell phone technology.  Modifications to the law are possible despite that, of course.  But the effort has stalled for the moment.  The outlook for sweeping change has grown slim for the time being.

Eastman Kodak put its patent portfolio up for sale over the summer, as well.  That company bandied about huge sums initially ($2.0 billion).  The bidding has proved less enthusiastic than hoped, though ($500 million).  The final round ended with Kodak avoiding a decision, to extend the process.  The poor result may have caused investors to fear that patent values in general are peaking and perhaps headed lower.  Many experts think the shortfall is specific to Kodak, that its patents largely have been exploited already and that their potential is diminished.

The Apple versus Samsung court case has contributed further tension.  Samsung is a "structured transaction" customer of Acacia Research's.  The patents involved in that deal aren't connected to the Apple donnybrook.  But the showdown between the two cell phone giants has generated concern that Acacia Research will suffer collateral damage if its customer loses. 

That's unlikely.  Earlier in 2012 Acacia Research purchased an expensive portfolio of wireless patents ("Adaptix").  If Apple prevails in its lawsuit with Samsung the Adaptix technology is likely to become easier to assert in an upcoming court case Acacia is scheduled to fight with Apple itself.  In addition, the methodology Apple is using in its Samsung case could be used without alteration to contemplate damages of $1.0 billion or more.  That's Acacia Research's thinking anyway.  However the Apple v. Samsung matter is resolved the result could be a positive for the company.

Short sellers have increased their position by over 400,000 shares.  At the same time Acacia Research has expanded its patent portfolio at the fastest pace in its history.  It also has diversified its technology base into several new areas, especially medical technology.  Cash remains at high levels despite the acquisition spree.  And Acacia Research is believed to have half a dozen or more Fortune 500 companies in "inventory," ready to sign massive structured transactions if only Acacia Research lets them do it.  The company has been holding off on those deals while the patent market was going up, and its portfolio was being expanded, to extract maximum value. 

The company has the ability to report gigantic financial results any time it wants.  Now that patent valuations are leveling off and the stock is under pressure, Acacia Research has plenty of incentive to pull the trigger.  Our earnings estimate (which is fully taxed) excludes any further structured transactions this year.  Income could surge far beyond our target if even a small number of deals are consummated.  That would provide a windfall for Acacia's patent partners, too, who share in the license income at a 50-50 rate.  It also could reward shareholders with a substantially higher stock price, and blow the short sellers' death star to bits.

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