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Document Sample
quity Re
Eq esearch
t
August 20, 2012
Buy
B R
Rating
rice:
Pr $26.19 etX ding Co
Virne Hold on
orporatio (AMEX VHC)
X:
2-Week Range:
52 41.93-11.01
tial mes rrent ITC Situation
Potent Outcom - Cur
Av Daily Vol. (M
vg. MM): 1.78
MENT SUMM
INVESTM MARY
D
Diluted Shares (MM): 50.6
Sh
hares Short (MM
M): ~13.6
VirnetX has responded to the ITC’s requests (sea documen filed last
d s aled nts
M
Market Cap (US$ B):
B $1.34
month) and it is awa onse (30 to 90 days post VirnetX’s
aiting a respo t
In
nsiders Own: ~%20 appeal). As we have implied pre
e eviously, and based on a legal filing
St
tated Book Val./Sh: $1.27 published a few week ago, it appe there was a procedural error that
d ks ears s l
Net
N Cash/Sh.: $1.18 d
occurred and will be r e rch
rectified – we implied this in our resear on July
N Cash (M):
Net $62 hile
27th. Wh it is unkn the
nown when t ITC will r respond to VVirnetX, the
t nses
two most likely respon (in our op pinion) are:
LT EPS Growth:
T 15%
D
Dividend / Yield n/a a) The ITC simp states that it is conside
T ply t X’s
ering VirnetX appeal –
Fi
iscal Year Ends: Dec. i will e
implying it w review the company’s response (inv vestors can
12
2-mos. Target: $65 a
access an abb ion
breviated versi which was made public implying
s c),
i
it is acknowled r
dging a minor procedural e d,
error occurred and plans
Rev
R t situation
to rectify the s
$MM)
($ 2E
2012 2013E 2014E
A e ed,
b) Assuming the procedural error occurre its acknow wledged by
Mar
M $0
$ N/A N/A t ase rd,
the ITC resullting in the ca being hear but requir VirnetX
res
Ju
un $0
$ N/A N/A t ring currently scheduled
to refile causiing a potential delay (hear y
ept
Se $.5
$ N/A N/A f r y en
for September 5th) that may range betwee 6 and 18 m months
Dec
D 2.0
$2 N/A N/A
Net, examining all fac d, y by
ctors involved the history of actions b the ITC
Y
FY 2.5
$2 $18 $65 g
involving similar situa ations, we bel C
lieve the ITC will hear the case, but
G
Growth 609% 261% lly elayed for a pe
realistical it will be de eriod of time.
EPS 2E
2012 2013E 2014E No decission by the IT has any im
TC ederal “situati
mpact to the Fe ion” (Judge
d
Davis) – still scheduled for early Noovember.
70)
($0.7 $0.07 $0.51
We reiter our Buy r
rate 5
rating and $65 target.
on.
Descriptio Based in Zep phyr Cove, NV, VirnetX was inc corporated in 20005. Through
the acquisiition of certain ppatents from Sc ons l
cience Applicatio International Corporation
2 any ed
(SAIC) in 2006, the compa has develope a series of tec chnologies and cuurrently has a
patent por rtfolio (GABRIE n
EL) focused on securing real- -time communic cations – its
censing business model. The company has
intellectual property (IP) iis core to its lic s
s n nd
evolved its core encryption technology an currently poss le
sesses IP capabl of securing
communica ations transmiss t
sions over next generation net tworks (4G/LTE), a critical
Roobert V. Tango Jr.
o, ed
element to standards define by the 3rd Gen ship Project (3GP
neration Partners PP).
(212) 940-9244
rob fordsecurities.co
bert.tango@gilf om
LFORD SECU
GIL URITIES INCO ORPORATED Page 1 of 4
ease refer to page 5 of this document for importan disclosures
Ple p f nt s
VirnetX Holding Corporation
RISKS
We believe an investment in VirnetX Holding may involve the following risks:
On-going Litigation May be Lengthy – Outcome Remains Uncertain. On-going litigation will
continue for several months/quarters – the ITC hearing with AAPL officially begins on
September 5th. Despite a favorable Markman opinion and settlement by Aastra, many
variables remain. We anticipate highly sophisticated legal tactics will be utilized by
existing litigants – a very common practice with intellectual property cases. It is unclear
how the various legal systems may view the evidence, presenting a risk regarding the
potential for settlements and/or timing licensing arrangements.
Trading Risk due to the view the company is a “Concept”. Because the company is in the very
early stages of establishing a core business model (licensing agreements), investors have
limited tangible evidence of a consistent revenue/cash flow stream - thus determining
an appropriate valuation remains speculative. “Concept” models may be volatile until
some degree of confidence and understanding regarding its business is achieved.
4G/LTE deployments May be Delayed due to a Weak Macro Environment. On-going macro
concerns in has caused service providers to delay their investments in 4G/LTE
infrastructure between 2 and 4 months, in our opinion. Early stage shipments of
equipment were expected to begin by late Q4 2011/early Q1 2012 – to date
deployments have been limited (China most active) – some degree of acceleration may
occur during the 2H 2012, albeit at a moderate pace., Therefore, certain 4G/LTE
participants potentially seeking to establish a relationship with VirnetX may pause near-
term.
Royalty Rate Debate will Persist and Cause Uncertainty. Debate regarding what royalty rate
VirnetX could obtain will persist. The investment community is wary of the potential
royalty rate range that the company could obtain (1% to 2% is our assumption)
depending on the player and product/application it is providing. Despite concerns
within the investment community that the company may structure deals at a rate below
the aforementioned range, we feel this risk/concern is not material.
GILFORD SECURITIES INCORPORATED Page 2 of 4
VirnetX Holding Corporation
Valuation Analysis
Case study - QCOM's QTL division: we estimate approximately 205 customers licensing technology at royalty rates ranging between 1.5% and 4%
GS 4G/LTE estimated investment cycle (hardware and operating systems): $450b (more than 700 potential players)
Total dollar value of equipment (hardware and operating systems) shipped meeting all requirements set by the 3GPP: ~$125b
Average royalty rate: 100 bps
Potential royalty revenue stream: $1.250 b
Estimated operating margin: 75%
Estimated operating profit: $0.938 b
Estimated LT tax rate: 36%
Estimated LT net income: $0.600 m
LT diluted share count: 0.06 m
Estimated LT EPS: $10.00
Discount at 15% for 8 years: $3.27
Multiple assumption: 20
Price per share: $65
Valuation/price target excludes any potential cash settlements related to on-going litigation
GILFORD SECURITIES INCORPORATED Page 3 of 7
VirnetX Holding Corporation
VirnetX Holding Corporation (VHC)
Quarterly Earnings Model
FY Dec ember
($ in millions)
Q1 12A Q2 12A Q3 12E Q4 12E
2009A 2010A 2011A Mar-12 Jun-12 Sep-12 Dec-12 2012E 2013E 2014E 2015E 2016E 2017E
Total royalty revenues 0.026 0.068 0.021 0.000 0.036 0.500 2.000 2.536 18.000 65.000 140.000 265.000 435.000
Cost of revenues 1.800 6.500 14.000 31.800 52.200
Gross profit 16.200 58.500 126.000 233.200 382.800
Royalty expense 59.207
Researc h & development 0.864 2.412 1.464 0.256 0.274 0.300 0.450 1.280 1.440 1.625 2.100 2.385 2.610
SG&A 12.250 33.764 15.932 6.967 11.496 12.000 11.000 41.463 22.500 16.700 15.400 15.900 16.530
(Gain on settlement) (200.000)
Operating profit/(loss) (13.088) 104.685 (17.375) (7.223) (11.734) (11.800) (9.450) (40.207) (7.740) 40.175 108.500 214.915 363.660
Gain/(loss) in value of securities 0.559 (30.516) (5.595) 0.269 (2.248) 0.000 0.000 (1.979) 2.000 4.000 6.000 8.000 10.000
Interest & other inc ome, net 0.0 1.310 0.228 0.074 0.128 0.065 0.060 0.327 0.250 0.300 0.400 0.500 0.700
Pretax inc ome/(loss) (12.524) 75.479 (22.742) (6.880) (13.854) (11.735) (9.390) (41.859) (5.490) 44.475 114.900 223.415 374.360
Income taxes (benefit) 0.000 34.062 (5.480) (2.173) (3.590) 0 0 (5.763) -1.976 16.011 41.364 80.429 134.770
Net inc ome (12.524) 41.417 (17.262) (4.707) (10.264) (11.735) (9.390) (36.096) (3.514) 28.464 73.536 142.986 239.590
Earnings per share (GAAP) ($0.33) $0.84 ($0.35) ($0.09) ($0.20) ($0.23) ($0.18) ($0.70) ($0.07) $0.51 $1.27 $2.38 $3.86
GAAP EPS
Diluted shares 37.911 49.066 50.028 50.658 50.874 51.500 52.000 51.258 53.000 56.000 58.000 60.000 62.000
M argin analysis
Gross profit margin 90.0% 90.0% 90.0% 88.0% 88.0%
Researc h & development 8.0% 2.5% 1.5% 0.9% 0.6%
SG&A 85.0% 22.5% 11.0% 6.0% 3.8%
Operating margin (43.0%) 61.8% 77.5% 81.1% 83.6%
Pretax margin (30.5%) 68.4% 82.1% 84.3% 86.1%
Tax rate 36.0% 36.0% 36.0% 36.0% 36.0%
Net margin (19.5%) 43.8% 52.5% 54.0% 55.1%
Revenue analysis
YOY growth 609.8% 261.1% 115.4% 89.3% 64.2%
Sequential growth
EPS analysis
YOY growth -866.7% 149.4% 88.0% 62.2%
Sequential growth
GILFORD SECURITIES INCORPORATED Page 4 of 4
VirnetX Holding Corporation
ANALYST CERTIFICATION
I, Robert Tango, certify that all the views expressed in this research report accurately reflect my personal views of
the subject companies. I certify that I have not and will not receive compensation with respect to the issuance of
this report.
REQUIRED DISCLOSURES
In the normal course of business, Gilford Securities seeks to perform investment banking and other services for
various companies and to receive compensation in connection with such services. As such, Gilford Securities
intends to seek compensation for investment banking services from the subject company in the next three months.
The analyst owns shares in the subject company.
STOCK RATINGS
Buy: The stock should outperform its industry or peer group by 20% or greater within a 12-month timeframe.
Sell: The stock is expected to underperform its industry or peer group by 20% or greater within a 12-month
timeframe, or fundamentals have deteriorated significantly and the stock is expected to materially
depreciate.
Hold: The stock does not have enough upside or downside potential to rate it a Buy or Sell. It is either fairly
valued or carries too much uncertainty for a Buy or Sell rating.
Distribution of Gilford ratings (As of 06-27-12)
Category Coverage IB Services*
Buy 59% 6%
Hold 34% 10%
Sell 7% 0%
* Percentage of companies within this category for whom Gilford has provided
investment banking (IB) Services within the last 12 months.
ADDITIONAL INFORMATION AVAILABLE UPON REQUEST
GILFORD SECURITIES INCORPORATED Page 5 of 5
