Update: I opened up a position in XPLT shortly after writing the below article at $0.85.
Matthew had an unexpected event come up so I apologize for the delay in getting this post up. Even though I do not currently own Xpel (XPLT, DAP.U), below is my take on the situation that surfaced yesterday with this PR issued by 3M noting that they have filed suit against Xpel for patent infringement for 3M's patented paint protection films. Xpel released its response late in the day yesterday, which, for many reasons, did not provide much comfort.
Let me first say that there are a few very strange facts surrounding all of this.
1) First is that 3M only sued Xpel, and no one else. Typically, in these type of lawsuits you see the plaintiff sue multiple parties, including manufacturers of the product. By only suing Xpel it sure seems like they are trying to accomplish one of two things; 1) drive stock price lower to attempt to acquire company; or 2) scare the hell out of Xpel to force them to negotiate a significant royalty on past and future sales. Of course, we will not know if this is 3M's intent until things progress.
2) The other interesting part of all this is that the 3M patent was original applied for in 2005, but not issued until mid-2014. This suggests to me that there were many roadblocks for 3M in obtaining the patent, including potential prior art issues, and that 3M had to spend a lot of money to get to the point of ultimate issuance of the patent, suggesting it was pretty important to them that they got this thing issued. However, with Patents it's all about the independent and dependent claims, and it's quite possible that Xpel's technology would not infringe at all. I just do not know the answer at this point.
Here are a few scenarios as to what may happen going forward:
1. Best Case Scenario: The best case scenario is that Xpel unequivocally is not infringing upon the patent. However, even if this is the case it is going to cost money to make this thing go away. However, if for some reason this is determined to be a frivolous lawsuit (which is a long-shot), Xpel could recover attorney fees.
2. Next Best Case Scenario: The 3M patent is not valid. Xpel can challenge the validity of the patent in court to have it invalidated. If Xpel, for example, used the film that the patent covers prior to 2005 when the patent was originally applied for by 3M, they would have a very strong claim that there was existing "prior art" in the marketplace and that the 3M patent should never have been issued.
3. Next Scenario (if above two do not happen): If Xpel believes they are in fact infringing after conducting their diligence with their attorneys, they will immediately seek to settle with 3M. The settlement will likely include a one-time cost and then royalty streams for all sales going forward. Of course, if this happens, it will significantly decrease Xpel's gross margins unless Xpel can pass on the cost via price increases to its customers...but that typically is not a recipe for success.
4. Next Scenario (if #3 doesn't happen): This is where things could get troubling. Let's say that 3M wants to own the market itself. Well, they could fully litigate this lawsuit, drag it out over several years by refusing to settle, and essentially force Xpel out of business (or acquire them for dirt cheap) so that they can enter the market without Xpel's competition. I would consider this a very long-shot right now, but knowing how 3M operates they typically are a bully in scenarios like these. Without knowing their ultimate intent it is hard to speculate, but this is something to be cognizant of.
There are several questions that Xpel management needs to answer as their response to all indicated that the filing of the lawsuit and the claims of infringement came as a big surprise to them. Why didn't Xpel patent their technology early on? Did Management even know that 3M was going down the road of patenting their technology? Was Xpel's technology in the market prior to the 3M applying for the Patent in 2005? We will learn the answers to these questions over the coming weeks and months.
I do know that Xpel has patents covering their manufacturing process of the film, so perhaps that is a positive. Of course, the immediate big unknown about all of this is how it will affect relationships with current customers and how it will cause distractions in the momentum Xpel currently has been building.
We will, of course, keep a close eye on any developments moving forward.
Feel free to engage with others in the comment section below. Of course, you can also email me anytime.