Are CDN Patent Lawsuits Actually a Mating Call?

Level 3's Grant van Rooyen

The content delivery network (CDN) arena isn’t just growing, it’s exploding. Demand for online video and gaming is so intense that, last year alone, CDN revenue totaled more than $990 million, according to a January 2008 report by Tier 1 Research. Meanwhile, Frost & Sullivan predicts the CDN field will rake in $2.5 billion by 2013.

Demand and forecasts for CDNs are creating an overcrowded marketplace, which is likely to result in consolidation. It’s also leading to lawsuits over intellectual property, given so much money is at stake. And some believe potential CDN consolidation and litigation may be closely intertwined.

Litigation

"I can virtually guarantee that we will continue to see an uptick in cross-licensing and patent litigation among and between service providers, as well as others in the telecommunications space," says William Wilhelm Jr., a partner at Bingham McCutchen LLP. Over the past year, he says, he worked with more investors, manufacturers, software developers and service providers than ever as unified messaging, peering, hosted VoIP and, yes, CDN, all became mainstays.

ipCapital Group's Doug Roth

VoIP lawsuits took the spotlight in 2007, and they aren’t disappearing in 2008 (see sidebar, below). But CDN is the next big battleground when it comes to telecom-industry patent infringement charges. Much of that is because new arrivals like AT&T Inc. and Level 3 Communications Inc. as well as smaller outfits are upending the CDN sector’s dynamics. Original CDN players such as Akamai Technologies, Limelight Networks Inc. and Mirror Image Internet Inc. appear ready to file lawsuits at the slightest whiff of infringement.

"New players provide reason to believe that there could be infringement on our patents," says James Hart, vice president of sales and marketing for Mirror Image. "We’re just doing work on the back end, we’re not contesting anything publicly."

Of course, it’s not always legacy CDN provider versus newcomer; these cases can go a number of directions. At press time, two CDN patent infringement cases were in play. Last month, Akamai squared off against Limelight in a Boston court; and Level 3 recently sued Limelight. Akamai did not return repeated requests for an interview, and Limelight declined to speak with xchange, citing the ongoing litigation against it.

Akamai’s fight with Limelight started in 2006; legal proceedings were scheduled to start Feb. 11, after xchange’s press time. The case could be a precedent setter. At issue is whether providers may patent a general process, not just a specific technology. "Method patents are valid," says Wilhelm, who couldn’t speak specifically to the Akamai-Limelight case. If Akamai prevails, it would have the legal wherewithal to shop its patents for licensing and earn royalties from sales a competitor made using infringed patents.

Love and War

Beyond just attempting to settle a patent issue, however, Akamai’s litigation against Limelight could signal an attempt by the former to sidle up to the latter, various sources speculate. Indeed, it wouldn’t be the first time Akamai has sued, then bought, a rival. In 2002, Akamai sued Speedera Networks, which it purchased in 2005.

"If the end game is actually to purchase a company, to gain the upper hand in the M&A negotiations by first getting them on the run through patent infringement, you might be able to buy them under much more favorable commercial terms," says Douglas Roth, senior manager of advisory firm ipCapital Group Inc.

Bingham McCutchen’s Bill Wilhelm

However, Akamai would not be the only potential suitor for Limelight. Microsoft Corp. and Level 3 — which also is suing Limelight — could be positioning to buy the CDN outfit as well. This was pure speculation on sources’ part, but such a pairing would make sense. That’s because Microsoft’s Xbox Live online gaming service is one of Limelight’s most prominent customers, so bringing those CDN assets within the fold of the software and services giant could be a good match.

For Level 3, acquiring Limelight would allow it to add some high-powered customers like Dreamworks to its CDN corral. Level 3 bought the CDN assets of SAVVIS Inc. for $132.5 million in January 2007. But CDN revenue still makes up only a small portion of Level 3’s overall income; buying Limelight, which expects to report fourth-quarter 2007 sales of $30 million, would provide the carrier’s CDN business with some instant heft.

Grant van Rooyen, senior vice president of Level 3’s content markets group, declined to comment on the potential relationship between litigation and M&A, saying the company’s legal move against Limelight is aimed squarely at protecting intellectual property.

"We took the time to identify the technologies and those who had the rights to those ideas and technologies," he says. "We think protection of those rights is critical."

Just a month after closing the deal to buy SAVVIS, Level 3 sent a letter to Limelight, informing the Tempe, Ariz.-based company that it was infringing on intellectual property. According to Level 3’s Dec. 17, 2007, court filing, Limelight "did not re-design its CDN to avoid the claims of the Level 3 patents." Level 3 is asking the court to bar Limelight from using technology that relies on its patents and to award unspecified damages. Specifically, Level 3 alleges that Limelight is infringing on two of its Internet CDN patents and one titled, "On-Demand Overlay Routing for Computer-Based Communication Networks."

Limelight, in a Dec. 31, 2007 statement, said Level 3’s allegations lack merit and pledged to "defend itself vigorously."

It wasn’t known at press time when Level 3’s suit against Limelight would be argued or whether the companies might settle out of court. Level 3 did request a jury trial.

The New Face of CDN

Mirror Image’s James Hart

This case intrigues insiders because of its implications for the CDN space, primarily because it illustrates how new entrants like Level 3 and AT&T will affect the landscape. For one thing, they can offer the same services as their rivals, at lower prices.

Companies like Akamai, Limelight and Mirror Image all offer content delivery, streaming media and more, using their own platforms but carriers’ pipes. That often translates into premium pricing. Level 3 and AT&T, on the other hand, are the networks. This means they can charge less than traditional CDN providers. To wit, Level 3 last winter cut its CDN prices, and analysts predicted this will put the squeeze on smaller companies.

Level 3 also can offer data center services and hosting, and it owns often-overlooked video streaming capabilities, says Counse Broders, research director for telecom services for Current Analysis Inc. When Level 3 bought WilTel Communications Group LLC in 2005, it also purchased a subsidiary, Vyvx LLC, which streams live video, mostly from pro sports stadiums across the country. If Level 3 plays its cards right, offering innovative services that would allow viewers to determine camera angles, for example, it will have upped the ante in the CDN market, Broders says. "Certainly for the telecom players in general, you’d be smacking your lips at the idea of that much data being sent over your network at one time," he says.

As for AT&T, although the telecom giant has not been publicizing its CDN products in the press, it told financial analysts late last year it aggressively will tackle CDN in 2008.

Barriers to Entry

Current Analysis’ Counse Broders

At the same time that these larger players are entering the CDN fray, Mirror Image’s Hart says that "word on the street is that newer, smaller players are just simply coming in to make a name for themselves and be acquired."

But although there’s a growing CDN crowd, the barriers to enter and play in this space continue to get higher.

"It’s as if you’re an airplane reaching a supersonic speed and the wings start rattling and the bolts start falling off," Wilhelm says. "At some point you need to recognize what the enterprise can withstand in terms of litigation risk and … there’s a lot of turbulence in this space."

ipCapital Group’s Roth agrees, noting, "When you have companies the size of Level 3 and a fairly fragmented patent environment, then you have companies with the resources, and, quite frankly, the stomach, to take on patent infringement activity."

Verizon, Sprint Sue VoIP Competitors

Vonage Holdings Corp. has emerged as the poster child for telecom patent infringement. Last year, the VoIP service provider lost or settled such suits leveled at it by AT&T Inc., Nortel Networks Ltd., Sprint and Verizon Communications Inc. However, VoIP patent infringement battles continue.

The latest such litigation has Verizon suing Cox Communications Inc., and Sprint filing complaints against four others.

Verizon filed its case against Cox, which now has more than 2.1 million VoIP customers, Jan. 11 in the Eastern District Court of Virginia (the same court handling Level 3’s patent infringement suit against Limelight). Of the eight patents at issue in the case, four are the same ones that Verizon in 2006 accused Vonage of illegally using. Last March, a jury decided Vonage willfully was infringing on two of those pieces of intellectual property. As a result, Vonage paid $120 million in settlement costs and provides Verizon 5.5 percent in royalties on revenue.

Verizon wouldn’t talk about this new case on the record, and a Cox spokesman declined to speak with xchange on this matter.

However, telecom insiders, speaking on background, speculated that Verizon is pursuing Cox since there’s a precedent for success. Vonage was found to be infringing on Verizon’s patents for "enhanced Internet domain name server" and "Method, server and telecommunications system for name translation on a conditional basis and/or to a telephone number." Those two counts — and two that Vonage was found not to have infringed upon — are included in the Cox suit.

Of course, Verizon didn’t sue Vonage until the latter company had signed a large number of subscribers and started posing a competitive threat to the rest of the voice industry. The same seems to be true in the case of Cox, say xchange sources, noting that Verizon, along with AT&T, is losing voice business to cable companies.

In its court filing, Verizon asked for a jury trial. It also asked that Cox be stopped from using the patents in an unauthorized manner, and that Cox pay royalties and treble damages, as well as all legal costs.

Cox isn’t the only company on the defensive. Four others became the target of infringement allegations on Jan. 24. That was the day Sprint announced it is suing four competitive providers for VoIP patent infringement. The news came as a complete surprise to those being sued: Big River Telephone Co., Broadvox Holdings LLC, NuVox Communications and PAETEC. In fact, NuVox’s press liaison hadn’t heard about the lawsuits until contacted by xchange. That’s because Sprint didn’t send letters warning the four of possible infringement.

Sprint spokesman Matthew Sullivan says there were "strategic considerations" for not giving advance notice, but he wouldn’t disclose what those were. He also says that based on previous experiences, Sprint decided not to send letters. In other patent suits, he explains, "we reached out to defendants repeatedly, and they refused to negotiate licenses." But the defendants in those situations were not Big River, Broadvox, NuVoX or PAETEC.

One telecom lawyer speaking on background says companies sometimes spring lawsuits on rivals for "maximum impact for settlement."

Sprint is filing the four cases fresh off its legal wins over Vonage and Voiceglo Communications (which no longer exists).

Sprint wants a court to award monetary damages and bar Big River, Broadvox, NuVoX and PAETEC from "ongoing infringement."

"Sprint has invested a great deal in the technology covered by its VoIP portfolio," says Harley Ball, vice president of intellectual property for Sprint. "We cannot stand by and allow others to use Sprint’s innovations and discoveries to compete with Sprint and its strategic partners."

Big River didn’t return a call for comment. Broadvox, NuVox and PAETEC all were reviewing the suits at press time and declined to comment.

Sprint last September won $69.5 million in damages from Vonage, which now licenses Sprint’s VoIP technology, and paid Sprint another $80 million for the new licensing, past use and prepayment of unspecified services. Sprint and Voiceglo didn’t disclose how much Voiceglo agreed to pay for licensing rights.

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