Cochlear has "head in the sand" over A$378 million legal bill

Is the Cochlear (ASX:COH) share price heading for trouble?

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The Cochlear Ltd (ASX: COH) share price is up around 3% over the last week to $174.46 on the back of a reported broker upgrade to a "buy" status from Citi, although there are still mixed views as to its future liabilities.

For the six month period ending December 31 2018 Cochlear reported net profit of $128.6 million on sales of $711.9 million, while maintaining full year guidance for net profit to be up 8%-12% to between $265 million to $275 million.

It will also pay an interim dividend of $1.55 per share on earnings of $2.23 per share on a payout ratio of 70%, with the dividend up 11% on the prior corresponding period.

However, Cochlear and some of its investors are still being accused by some of brushing over the likelihood of it being forced to pay the US$268 million (c.$A378m) in damages awarded against it to the U.S. based Alfred Mann Foundation for patent infringements.

Analysts at Goldman Sachs are also reporting the plaintiffs have asked for US$123m (c.A$172m) in pre-judgement interest, with Cochlear having to arrange and finance a legal insurance bond to stay the judgement pending its appeal.

The damages awarded of c.A$378 million at around 1.35x forecast full year net profit are a material amount and you also have to factor in potentially substantial legal costs and time associated in dealing with the case.

The original claim quantum was based on the ruling that Cochlear had infringed on two patents across four claims, with an original US$131 million in damages being calculated as 7.5% in lost royalties on base sales of US$1.8 billion.

Cochlear's board reportedly believes a successful appeal to the latest judgement is "probable", although external lawyers will always tell a board that more fee-earning work for them is the correct decision.

While the Alfred Mann Foundation insists Cochlear has its "head in the sand" over the legal process and now cannot escape having to pay substantial compensation.

For investors the outcome is of course uncertain, although it's fair to say the market is probably not currently pricing in a US$268 million legal bill into Cochlear's valuation.

This potential liability and Cochlear's existing valuation are a couple of reasons I wouldn't buy Cochlear shares today.

I'd much prefer CSL Limited (ASX: CSL) in the blue-chip healthcare space, or even ResMed Inc. (ASX: RMD) now it has resolved its multiple patent infringement cases with rival Fisher & Paykel Health Care Limited (ASX: FPH).

Motley Fool contributor Tom Richardson owns shares of Cochlear Ltd., CSL Ltd., and ResMed Inc. You can find Tom on Twitter @tommyr345 The Motley Fool Australia has recommended Cochlear Ltd. and ResMed Inc. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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