(ORCL) Oracle and Google Set to Settle Claims

According to a recent report from news agency Bloomberg, Oracle Corp. (ORCL) and Google Inc. (GOOG) have agreed to attend a settlement discussion over the copyright- and patent-infringement lawsuit filed by Oracle last year.

As per the order of the U.S magistrate, both the companies will be represented by their respective Chief Operating Officers (CEO). The settlement meeting is scheduled on September 19, 2011 and will be mediated by the U.S. Magistrate Judge.

The attendance of the two CEO’s, Oracle’s Larry Ellison and Google’s Larry Page in the settlement meeting was strongly recommended in the September 8 court filing by the U.S. District Judge William Alsup, who is presiding over the case. The recommendation followed Oracle’s complaint regarding the failure of its out-of-court settlement efforts due to Google’s reluctance.

In August 2010, Oracle filed a lawsuit against Google alleging violation of seven Oracle patents. The main conflict was regarding Google’s Dalvik process virtualization machine (“VM”), which was developed using Java and serves as the backbone of the Android operating system.

Oracle claimed damages worth billions of dollars and appealed for the annihilation of all the infringed products. However, Google denied any infringement and complained that Oracle’s damage claims were expansive.

Google said that Sun Microsystems (which was acquired by Oracle in early 2010) had offered to license its Java technology for $100.0 million, and Oracle overlooked this particular fact at the time of calculating its damages.

In July 2011, the U.S. District Court Judge ordered Oracle to reduce its $6.1 billion damage claim for alleged infringement of Oracle’s Java patents, citing it to be expansive and noted that the “starting point” of the damages should be approximately $100.0 million, depending on various factors.

The judge, however, dismissed Google’s claim that its advertising revenue was not related to the value of Android and should therefore not be a part of Oracle’s damages. The judge warned Google that if the company is found guilty of infringement, the court may issue a permanent injunction against the sale of Android-based devices going forward.

However, the court battle turned bitter when Oracle said that it had come across an e-mail from a Google executive to the head of Google’s Android division, which showed that Google recognized that it needed a license for Java. Google asked the judge to withdraw the e-mail, saying it was supposed to remain confidential and that Oracle wrongly revealed it. However, the judge overruled Google’s request.

Google argued that some files it copied from Java are insignificant because they are test files. Google also said that the copying was required for compatibility because there was not any other language it could use. Google claimed that there had been no infringement on Oracle’s copyright in its implementation of Android.

Based on this theory, Google requested the court to make a summary judgment citing four technicalities that were set aside by the court. Google’s motion included a request for the fixation of period of infringement from the time Oracle first gave notice of infringement to Google.

It also claimed that the Oracle engineers working at Google were not involved with the technologies under dispute, so neither they nor Google could be held responsible for any wrong doing with respect to hiring them. Google’s argument centers on the fact that it offers Android for free and so its advertising revenue should not be used to pay for damages related to sales by foreign companies in infringement of Oracle patents.

However, Oracle strongly opposed the request and asked the judge to go ahead with the trial. Oracle argued that Google took only the parts it wanted and created many other application programming interfaces (API), incompatible for Android. As a result, many programs written in Java for other platforms will not run on Android, and many programs written for Android will not run on Java platforms and devices.

Oracle also claimed that till date no court had found APIs for software like Java ineligible for copyright protection. Oracle argued that program names, even subroutine names, should have the same copyright protection as the underlying code.

Oracle also said that Google’s actions have made it impossible for the company to enter the mobile market in the future. A three-week jury trial of the case is scheduled for a hearing on October 31, 2011.

Recommendation

We believe an amicable settlement between the two giants will benefit both the companies going forward. We expect Oracle to settle for a licensing fee, while the settlement will ensure Google’s uninterrupted growth of the Android operating system (It is the hottest-selling mobile OS in the U.S. and expanding globally) over the long term.

However, if the settlement fails, we believe the stakes are high for both companies. If Google is able to defend itself successfully, the company would get off with legal hassles and expenses alone. However, if it goes in Oracle’s favor (chances are it will, since Oracle no doubt considered the matter before it acquired Sun), then Oracle would benefit immensely in terms of cash compensation.

Moreover, Oracle’s win will have far-reaching consequences for companies such as Google, which depends heavily on open source. Interoperability within different software will be practically impossible without the clear permission and royalty payments to the copyright holders. On the other hand, it would benefit companies like Oracle, Apple Inc. (AAPL) and Microsoft Corp. (MSFT) who are extremely zealous in protecting their copyrights.

We have an Outperform recommendation on Oracle over the long term and a Neutral recommendation on Google. Currently, both the companies have a Zacks #3 Rank, which implies a Hold rating in the near term.

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