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On Monday April 9, MGT Capital (MGT) experienced some unusual trading activity. The stock rocketed up over 20% on over ten times its average trading volume. The company had made no material announcements, and when NYSE sent its standard inquiry, MGT Capital promptly denied any knowledge of what might have caused the flurry of activity. Whatever it was, some investor(s) decided that they wanted in. So, what was it? Why now, on just an ordinary, sleepy spring Monday? After some quiet profit-taking on Tuesday and Wednesday, the craziness commenced anew on both Thursday the 11th and Friday the 12th. I had to take a closer look.

MGT Capital, depending on one’s point of view, may be dismissively referred to as just another patent troll, or more respectfully viewed as a defender of an inventor’s rights for his years of toil and thousands of dollars in sunk costs. I covered MGT Capital back in November 2012, just weeks after it announced a patent infringement lawsuit against some of the biggest names in the casino industry. After the market closed on Friday November 2, 2012, MGT Capital filed a complaint in a plaintiff-friendly court (U.S. District Court for the Southern District of Mississippi) alleging that casino operators Caesars Entertainment Corporation (CZR), MGM Resorts International (MGM), and Penn National Gaming (PENN), as well as slot machine gaming manufacturers WMS Industries (WMS) and Aruze Gaming America were in violation of patent rights described in patent number 7,892,088. MGT Gaming is seeking injunctive relief for continued patent infringement, as well as damages for all prior acts of infringement.

As generally happens right before announced litigation in patent cases, the plaintiff’s stock tends to get a sharp upward jolt before the drunken exuberance moderates to the stoic reality of the drudgery of a long slog through our legal system to follow. This was certainly the case when Vringo (VRNG) sued Google (GOOG) and when VirnetX (VHC) sued Apple (APPL). MGT Capital’s stock followed this playbook as well, more than doubling in the ten trading days around the lawsuit announcement. After briefly breaching $7 per share in November, MGT Capital has been seemingly lifelessly drift downward with brief drops below $3 per share in both January and February… at least until last Monday.

Suddenly, the stock was up $0.65 to $3.85 per share while trading almost 650,000 shares (versus normal activity of 45,000 shares per day). The stock gapped up at the open on both Thursday and Friday, and twice breached the $4 level before pulling back. Both of these days also traded at least ten times normal share volumes. Strange indeed.

Some Background Review

In October 2001, inventor Steven Brandstetter filed to patent his idea. He conceived of a method for linking slot machines via a giant, interactive screen whereby multiple players could compete against each other during “bonus rounds.” Mr. Brandstetter had figured out an original way for casinos to entice patrons to bet more: incentivizing more bets in order to gain access to a fun (and potentially lucrative) “bonus round” on a shared screen. The concept was so complex that the U.S. Patent and Trademark Office labored almost an entire decade to clarify the precise scope of the invention before finally, in February of 2011, issuing patent 7,892,088 entitled “Gaming Device Having a Second Separate Bonusing Event.”

Meanwhile — during the intervening ten years — Las Vegas casinos like Caesars Palace and MGM Grand might have been using the technology and methodologies defined in Mr. Brandstetter’s hard won patent. In conversations with Mr. Brandstetter, he expressed his frustration that he always felt he was on the cusp of a partnership or joint venture during these “lost years,” but the office required an extraordinary amount of time to approve his patent. In May of 2011, after years of this run-around, Mr. Brandstetter individually sued International Game Technologies (IGT) and Bally’s Gaming, Inc. (BYI) for fraud and conspiracy, alleging that these defendants used his ideas to file their own patents.

As a small inventor, Mr. Brandstetter soon discovered both the power of large corporations and their deep pockets when it came to legal matters. With large amounts of his own capital already tied up just to assert his legal rights in court, Mr. Brandstetter realized that not only was he not financially capable of pursuing on another lawsuit, but he also lacked the expertise to wage another war against billion dollar companies.

Enter stage left, MGT Capital. Mr. Brandstetter sold to MGT Capital the rights to 55% of his hard won patent 7,892,088. MGT Capital would now have a majority interest and the cash necessary to see Mr. Brandstetter’s lawsuit through to its proper end.

The Current Financials

If simplicity were a metric, MGT Capital would top the chart. Once an unprofitable medical technology company, MGT Capital has reorganized and now focuses solely on monetizing intellectual property. Its only significant operation at the current time is asserting Mr. Brandstetter’s patent against the casino industry defendants mentioned above.

Per MGT Capital’s SEC Form 10K filed on March 29, 2013, the company ended 2012 with $5.5 million cash on its balance sheet with no debt. Earlier this year, there were 3.25 million shares outstanding and 1.4 million preferred shares convertible into common stock on a one-for-one basis. In the intervening three months, 270,000 preferred shares have converted, so the common share count currently stands around 3.52 million, with approximately 1.13 million preferred shares remaining. Therefore, with 3.52 million common shares outstanding and a $3.84 per share closing price as of Friday April 12, this equates to a market cap of a paltry $13.5 million.

In other words, nearly 41% of MGT Capital’s market capitalization is cash. The balance sheet contains no debt. After the company jettisoned its medical operations, employees have been reduced down to only nine people, so the cash burn rate is extremely low.

MGT is pursuing Mr. Brandstetter’s rights in court with a tier one law firm, Nixon & Vanderhye, which has gaming industry litigation experience. The firm is handling the lawsuit on a contingency basis, meaning that it will only be paid a significant sum if it actually wins the lawsuit.

Mr. Robert Ladd is MGT Capital’s CEO and is financially and personally invested in his company. He made his first investment before he became CEO with $1 million of personal money in December 2010. It was before the company announced a reverse stock split, and he paid approximately $5 per share when adjusting for the split ratio. Mr. Ladd has since made several more open market and placement purchases, bringing his total cash invested to over $2 million. Overall, he now owns approximately 25% of current outstanding common shares at approximately $3.00 per share. As a group, insiders own over 40% of MGT Capital’s common stock. I like that the CEO and insiders have real “skin in the game.” Indeed, this is one of the first things I seek when making a small stock investment.

Finally, MGT Capital has four million warrants at an exercise price of $3.64 per share. If exercised, these warrants would add $14.5 million in cash to MGT Capital’s balance sheet, raising the previously reported $5.5 million to approximately $20 million. If all warrants and convertible preferred were exercised, MGT Capital’s fully diluted share count would be 8.6 million shares. Of interest, MGT Capital owns some residual patents from its medical imaging business. In January 2013, it retained Munich Innovation Group to sell, license or otherwise monetize these assets. Zacks Investment Research estimates the value of this portfolio at $4-5 million, but MGT Capital has not issued any guidance whatsoever as to their value.

Potential Damages

MGT Capital estimates that the present value of its patent ranges from $300 million to $4.5 billion- a large range that includes past trebled damages and future royalties. (Patents filed after June 8, 1995 have a life of twenty years from filing date. Brandstetter filed in 2001 so the patent would run until 2021 and still has a good bit of time remaining.) When considering even the low range of this spectrum, however, one can easily see how a company with a market capitalization of just $13.5 million could rally a huge amount if it won.

Of course, MGT Capital will not win 100% of the award. First, it must pay its attornies who have graciously agreed to work on contingency. MGT Capital has not specifically disclosed how much it has agreed to pay Nixon & Vanderhye, so we can only make an educated guess. Because Nixon & Vanderhye is working almost for free unless it wins, one would expect that it has a more generous payout in the event of victory. If MGT Capital pays a typical cut, it will pay approximately 1/3 of the pre-tax win to Nixon & Vanderhye.

MGT Capital holds its interest in the ’088 patent through MGT Gaming. MGT Gaming is a joint venture 55% owned by MGT Capital and 45% by J&S Gaming, which is the firm owned by Mr. Brandstetter and his early partner James Devlin. The key takeaway is that MGT Gaming receives 55% of all proceeds after the lawyers receive their cut. 55% of 66% is approximately 36%, so I estimate that MGT Capital will receive 36% of the total courtroom victory. Fortunately, MGT Gaming has an $18.7 million in allowable tax loss carry-forwards for federal tax purposes and $2.3 million in state tax loss carry-forwards, so up to $21 million in courtroom victories will be tax-free. While this alone would more than double the market capitalization of MGT Capital, if the actual award falls even toward the low end of the $330M-$4.5B spectrum, MGT’s portion may be so lucrative as to render these tax savings as little more than rounding errors.