Will Facebook's VR Efforts Be Derailed by ZeniMax?

By Leo Sun Markets Fool.com

Facebook (NASDAQ: FB) and video game publisher ZeniMax Mediaare clashing in court over allegations that the social network's Oculus VR subsidiary stole ZeniMax's intellectual property prior to being acquired by Facebook in 2014. The case revolves around John Carmack, who co-founded ZeniMax subsidiary id Software and serves as CTO of Oculus.

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The Oculus Rift. Image source: Oculus VR.

ZeniMax acquired id Software in 2009, which made Carmack a ZeniMax employee. Carmack took the CTO job at Oculus in Aug. 2013, and attempted to convince ZeniMax to add support for the Oculus Rift to its games. When ZeniMax reportedly refused, Carmack leftthe company in Nov. 2013 to work full-time at Oculus. Facebook's takeover then made Carmack its employee.

A tangled web is woven

That's where things get messy. ZeniMax claims that the Oculus Rift was a "primitive" device until Carmack modified the prototype "based upon years of prior research at ZeniMax." ZeniMax also claims that some of its employees aided Carmack, and the improvements to the Oculus Rift were based on its intellectual property. Furthermore, ZeniMax alleges that Oculus co-founder Palmer Luckey founded his company just three days after a gaming convention at which ZeniMax demonstrated the technology that powered the Rift headset.

During his recent cross examination at a Dallas Federal Court, Facebook CEO Mark Zuckerberg called the accusations "false," denied that he was aware of Carmack's possession of code and documents from ZeniMax, and refused to discipline Carmack on grounds that "it would be wrong to discipline employees for claims that we believe are wrong." Zuckerberg also noted that IP lawsuits were "pretty common" after big deals were made, and that "all kinds of people come out of the woodwork and make claims."

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The potential impact

ZeniMax is seeking a whopping $2 billion indamages, which is equivalent to the amount Facebook initially said that it was paying for Oculus. The actual amount, which was recently revealed through Zuckerberg's testimony, was $3 billion -- including an additional $700 million it set aside to retain key employees and $300 million in milestone payments.

If ZeniMax somehow wins the case and is awarded the full amount, Oculus could become a money pit, since initial headset sales have been very low. Last October, research firm SuperData estimated that Sony's (NYSE: SNE) PlayStation VR would be the best selling deviceof the year with 2.6 million units sold, followed by Samsung's (NASDAQOTH: SSNLF) Galaxy Gear at 2.3 million, and Alphabet's new Daydream devices at450,000 units.

Sony's PlayStation VR. Image source: Sony.

HTC's Vive came in fourth with an estimate of 420,000 units, and the Oculus Rift came in fifth at 355,000 units. To make matters worse, Steam's most recent survey figures indicates that just 0.23% of its PC gamers own a Vive, and0.12% own the commercial version of the Rift.

The main headwinds

A key problem with the Vive and Rift is that they're both expensive (the Vive costs $800, and the Rift costs $600) and require high-end PCs that can easily cost over $1,000. Sony's PSVR only costs $400 and requires a $300 PS4, and the Gear VR costs $99 and works with flagship handsets that cost between $300 and $700.

Back when Facebook closed the Oculus deal, Zuckerberg declared that the company had tosell 50 million to 100 million Rifts to make it an important computing platform. Oculus has since laid down the foundations of that "platform" with its Oculus Home ecosystem, Oculus Story Studio VR films, and social games which allow users to interact with each other in virtual space. From there, it isn't a stretch to see Facebook launching a VR version of its social network that lets users visit each other in virtual reality.

But for now, it seems like smartphone and gaming console tethered headsets are gaining more mainstream traction with their lower price tags and superior mobility. As a result, Facebook could struggle to establish itself as the leader of the VR headset market, although its commercial launch of the Oculus Rift arguably set off a land grab across the VR market.

Should Facebook investors worry about ZeniMax?

ZeniMax initially accused Oculus and Facebook of stealing its intellectual property in 2014, and thecurrent trial will likely drag on for a very long time. Even if Facebook is found guilty, the company will likely appeal the ruling -- which means that the case will probably remain unresolved for years. It's also possible that Facebook could settle with ZeniMax with royalty payments instead of a flat $2 billion fine.

Regardless of what happens, the ZeniMax case reveals how acqui-hires can result in messy claims over intellectual property. Facebook investors shouldn't fret over the case for now, but they should keep an eye on its progress, especially if Rift sales accelerate over the next few years.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Facebook. The Motley Fool has a disclosure policy.