ParkerVision (PRKR) is a speculative investment with extraordinary risk reward and a near term catalyst.  To believe the risk reward is extraordinary, you need to think the upside is potentially very large, and the path to attaining it is realistic.  We think both.  The stock is a legal bet, pure and simple, and embracing it involves an understanding of patent law and process.  Ignoring the legal bet, the stock is not interesting.  The stock has rallied by 65% in the past two months driven by a ruling that drives the legal analysis.  Our argument is the ruling is so overwhelmingly positive that the shares should be much higher still; the facts underlying the legal dispute, in light of the ruling, paint a compelling picture describing the value of the claim; and this will all become clear in the next one to eight months.  The risk in the investment is nearly all of your capital.  The potential upside is greater than ten times the investment. 

The Markman ruling

Whether a patent is infringed is determined by what the patent says (how its claims are construed) and what the potentially infringing technology does.  The claim construction or Markman ruling in the QCOM dispute was overwhelmingly in PRKR’s favor.  PRKR’s base technology involves the method by which RF chipsets down convert wireless signals into digital data.  PRKR won 40 of the 44 claim disputes in the Markman order.  On the other 4, the court selected its own claim definition that was neither what PRKR nor what QCOM proposed.  On our reading, these 4 claims read more favorably for PRKR than QCOM, but even if these claims are removed from the patents at issue, the argument for infringement on the patents outside these claims remains strong.  Through our own reading and through the reading of IP attorneys we have retained on this matter, we read PRKR’s patents as being breathtakingly wide.  We think the patents read on not simply 3G and 4G technology, but on a large part of the wireless industry.  It is very difficult for any current products in the wireless industry to function without infringing.  PRKR management makes similar claims, as do IP analysts that receive no compensation from PRKR, to whom PRKR often refers in their investor materials.  The PRKR/QCOM dispute has historically amounted to a dispute about two major topics.  First, do PRKR’s patents read as widely as PRKR and others assert.  QCOM has long argued that PRKR does not teach down conversion as broadly as PRKR asserts.  After the Markman order, this question has now, for purposes of trial, been answered PRKR’s way.  The federal circuit may choose to disagree with the judge’s Markman order, that is a risk factor, but one that is more than a year away, and would only come into play after a verdict for PRKR.  In jury trials involving patent disputes, the party who wins at Markman typically wins at trial.  Some empirical studies show the success rate in this scenario is approximately 75%.  Once the claims are construed, the defenses left to overcome a Markman loss include non-infringement (what we do is not covered by the claims), invalidity of the patent based on inequitable conduct (the patent is not legal, because the patentholder did something wrong in prosecuting the patent), and invalidity based on prior art or obviousness (the patent is not legal, because its teachings were already known).  PRKR’s patents read so broadly that arguments around non-infringement are not, in our view, material to the litigation; what QCOM does infringes on what PRKR teaches, given the Markman ruling delineating PRKR’s claims.  QCOM prosecuted a series of arguments around inequitable conduct already, most of which the judge expressed skepticism about prior to the Markman ruling, and all of which have since been withdrawn. 

The second major topic in the PRKR/QCOM dispute has been prior art and obviousness.  Bears argue that PRKR is susceptible to an obviousness argument because they believe PRKR wrote claims for a technology that was already being used in circuits.  Bears assert that while PRKR may have invented a novel technology for down-converting RF signals, the claims are written much more broadly to cover additional technology that was already being used in the wireless industry.  However, we have found no prior art that, in light of the Markman ruling construing the claims in PRKR’s favor, teaches what PRKR’s patents claim.  The documents that QCOM has cited as being prior art that anticipates PRKR’s patents leverage off of the QCOM claim constructions that the judge rejected.  Since the Markman ruling says that PRKR’s claims teach what PRKR says they teach, the prior art that QCOM says teach the claims do not.  Instead, the prior art teaches the claims as construed by QCOM, which the judge has rejected as the wrong claim constructions.  Our IP consultants have performed a similar analysis and have come to the same conclusion.  In the absence of documentary evidence in the prior art that QCOM can point to, we think it will be difficult for QCOM to prove at trial to a jury that PRKR did not innovate or that its patented technologies were obvious.  QCOM’s best chance is likely going to be to attempt to reverse engineer old products that allegedly used PRKR’s energy sampling technology and prove that the teachings in PRKR’s patents are embodied in those products.  The history of attempting to accomplish this at trial to juries is poor.  Juries typically lack the sophistication required to understand the engineering behind products, and especially so when the documentary evidence that they can be pointed to does not exist or apply. 

A shorter way of making our argument: Given the absence of material issues around infringement or inequitable conduct, the Markman order largely decides the dispute.  The claims read broadly, they say what PRKR says they say, and the prior art does not say that, once you embrace the Markman definitions.  Because the upside from the dispute is so potentially large, the Markman order is very valuable. 

Upside

If PRKR wins the lawsuit against QCOM, PRKR would receive an award from the court for past damages and an ongoing royalty for the life of PRKR’s relevant IP.  The key PRKR patent (#551) was issued in May 2000 so the timeframe is 2000-2020.  There is a risk that trial is delayed, as QCOM is highly incented to play for time, but the judge has been tight in adhering to trial schedules historically and in this case.  We expect a verdict by year end.  Assuming the District Court rules in favor of PRKR by year end, PRKR will receive ongoing royalties for the period 2014-2020.  Since PRKR claims QCOM started using the company’s RF technology in 2007 and had fully incorporated its IP by 2010, the award for past damages period is 2007-2013. 

First, a license.  PRKR claims that QCOM is using its technology in the chips QCOM produces for mobile phones and other mobile devices through its QCT business segment.  QCOM receives ~$20 for every Mobile Station Modem (MSM) chip the company produces.  The MSM integrated circuits perform the core baseband modem functionality in wireless devices providing voice and data communications.  PRKR claims that its technology is a core part of QCOM’s MSM chips because it allows the chips to more effectively receive wireless data.

The key question to valuing PRKR’s upside is determining the size of the royalty per QCOM MSM chip the court would award PRKR if the company wins the lawsuit.  Compulsory licenses have typically ranged from 3-5% of the price of the device infringing patents in past cases.  There is also the potential for injunctive relief, although appellate precedent has made this potential remote in recent years.  The small prospect of injunctive relief and the resulting potential for industry disarray may incent settlement pre-trial.  Compulsory mediation in the trial occurs in May.  Ignoring the potential for injunctive relief, a compulsory license in the range of 3% ($0.60 per chip) is a realistic case in the event of a trial verdict in favor of PRKR.

Second, a settlement.  The PRKR v QCOM trial docket reveals that QCOM and PRKR engaged in licensing negotiations for PRKR’s RF transceiver technology in 1999.  One of the exhibits in Document 102 includes the following passage about the negotiations:

In these negotiations, QCOM offered a royalty structure that QCOM projected would total $636-678 million in 1999 present value. 

A settlement of $657M - the midpoint of the range that QCOM offered PRKR – in 1999 dollars would imply a present value settlement of $2.5 billion in 2014 dollars assuming a 10% cost of capital inflation.  After legal fees and taxes, the NPV of that settlement would be a $1B settlement for PRKR or $9.50/ fully diluted share, assuming the dilution laid out below, implying a royalty per chip of ~$0.30.  Of course, the projection of the value of this settlement was based on an understanding of the wireless industry as laid out in 1999.  It seems highly likely that the market has grown more than what QCOM would have projected at that time.  The QCOM litigation team made a presentation to the PRKR board in 1999 arguing for PRKR to take this settlement.  The board rejected it. 

Third, PRKR’s public statements can also be used to estimate the per chip royalty.  PRKR claims that its transceiver function in cell phones costs ~$3 to manufacture and would result in a 40-45% gross margin implying a gross profit of $1.20-1.35 (4Q10 Earnings Call).  PRKR also claims that by selling actual chips instead of collecting royalties on the technology the company would increase its revenues by 10x what the royalty revenue would be (2Q10 Earnings Call).  The two statements imply a royalty per chip of $0.12-1.35. 

Based on the information detailed above, we conclude the negotiation range for royalty per chip would be $0.12-$1.00 ($1.00 is a 5% license rate) if PRKR wins the lawsuit.

Other key assumptions needed to calculate PRKR’s NPV are:

1. Dilution: At the current monthly burn rate of $1.6M, PRKR is funded through February 2014.  PRKR’s CEO expects the Appeals Court to rule on the lawsuit by the end of 1Q15 at the latest, implying PRKR will need an additional $21M.  Assuming, PRKR is able to raise equity at $3/share, the company will need to issue an additional 7M shares, or 8% of the current total shares outstanding. 
2. Legal Fees: PRKR’s attorneys take 25% of the award for past damages and ongoing royalties.  PRKR’s legal team is working under partial contingency.
3. Deferred Tax Asset: PRKR had NOLs of $233M through 2012.  PRKR had operating losses of ~$20M in 2012.  Assuming the company has a NOL of $20M in 2013, PRKR will have a DTA of $110M at EOY 2013, resulting in the first $1.26/share of any award or settlement being tax-free.
4. QCOM Financials for 2013-2020: Bloomberg consensus estimates for 2013-2017 and assume revenues grow at 5% annually through 2020. 
5. QCT Segment Revenues for 2013-2020: 60% of total QCOM revenues, in line with 2004-2012.
6. MSM Volume for 2013-2020: QCT Revenues divided by $20 per chip, consistent with 2004-2012.

PRKR claims that all of today’s wireless devices that access 3G/4G networks use PRKR’s energy sampling technology.  The company’s primary indicator for this allegation is that only PRKR’s technology allows these phones to have the battery life that they do in the size they actually are (2Q12 Earnings Call).  QCOM has a 40% market share so assuming PRKR could use a victory in this lawsuit to force the other industry participants to license their IP, I value PRKR at $9.39/expected diluted share representing a potential return of 134% from today’s share price of ~$4/share.  We laid out below the potential claim against QCOM, as well as the potential claim against the industry.  To be clear, these numbers involve 3G and 4G only, and leave out other potentially infringing wireless technologies.

 The table below shows PRKR’s sensitivity to the size of its royalty per chip:

Risk Factor: Management

If you have read this far, you will likely know or learn that PRKR’s management team is widely reviled by investors.  PRKR has never made any money, and has barely generated any revenue historically.  PRKR management has many times promised chip orders and revenue tying back to technology they have developed, and essentially all of these promises have been proven false.  PRKR manages a cash flow deficit, and has been a consistent issuer of shares to fund itself, including its compensation to management.  It has run $10-15 million dollar annual cash flow deficits annually the past three years, including legal expenses, and has issued 30 million shares, or 38% of its shares outstanding, over that time.  If the trial or appeal timeframe is delayed, the dilution expense will increase above the numbers in the above table.  Management may misallocate capital that is raised to fight the trial, or proceeds that the trial produces.  Management owns only 3% of the shares.  The company is incorporated in Florida, making shareholder activism difficult. 

This risk factor largely explains the 17.7 million share short interest in PRKR’s stock.  This short interest represents 20% of the shares.  The short interest was just as large last October, before the Markman ruling, when the shares were below 2.00.  If the trial happens in October, and PRKR wins, the potential for short covering is large.