Patents Are a Virtue
Chris Donegan on the rise and rise of intellectual property — and why investors need to take note
IN AUGUST 2011 Google paid $12.5 billion to acquire Motorola Mobility in order to capture the 17,000 patents it held on its balance sheet. The Motorola board sold its patents under pressure from the corporate activist Carl Icahn. His interest had been piqued by the prior month’s bidding war for the patent portfolio of Nortel, which resulted in the sale of 6,000 patents for $4.5 billion — a valuation that was 35 times the final market capitalisation of the bankrupt telecoms company.
The winners in the Nortel auction were a consortium including Apple, Microsoft, RIM (maker of the Blackberry) and Sony. That month Google, which had failed to buy Nortel’s assets, acquired 1,000 patents from IBM.
Hot on the heels of the Motorola deal, Wi-LAN Inc. announced it would pursue a $490 million hostile takeover of rival Mosaid Technologies. The move, Wi-LAN said, would be aimed at extracting lucrative licensing deals from technology manufacturers as patent valuations continue to soar. Both Wi-Lan and Mosaid had previously been operating companies but are now pursuing a patent monetisation business model. Within a month, Nokia closed an agreement with Mosaid to mine the value of 2,000 valuable handset patents.
In October it was reported to be the turn of Eastman Kodak and British software firm Autonomy. Eastman Kodak, once a $30 billion firm by market capitalisation, has been reduced to an equity value of less than $600 million, according to Bloomberg, but has a break-up value of $3 billion due to its patent portfolio. Autonomy, in contrast, dominates the field of meaning-based data searches, which find patterns in email and mobile phone traffic. This unique intellectual property lies at the heart of modern corporate compliance activities. Hewlett Packard paid Autonomy shareholders $7 billion for the company, which represented a 78 per cent premium to its share price, reflecting the value to HP of Autonomy’s IP.
So what is the relevance of these transactions, what is driving them and why should they be of interest to wealthy private or family office investors? The answers lie in the nature of the intangible assets being traded and specifically their strategic and competitive value to operating companies within industries that are engaged in a battle for market dominance.
Brand and IP experts estimate that over 80 per cent of the value of typical Fortune 500 companies is represented by IP. This includes brands, trademarks, trade secrets, copyrights and patents. The market value of these intangible assets is estimated by PWC at $3 trillion, although the opportunistic market value of high-quality IP may dwarf in-house estimates.
For the most part, the mainstream private equity world misses IP as an investment opportunity. Exceptions of course exist, most notably Coller Capital in the UK, which has pioneered IP investments with companies such as British Telecom and IBM.
When making an investment decision into a Fortune 500 company, traditional valuation methodologies look primarily at earnings. Analysts usually assume that management competence is stable and that operational risk is not a major factor outside of new product launches. IP is considered primarily as a risk factor and not a mainstream value driver, except in IP-centric industries such as publishing, pharmaceuticals and telecommunications (where product pipeline acts as a proxy for IP value), or where IP is critical for the business model in specific cases such as Qualcomm or ARM.
IP has been actively traded between industry participants or used as currency for mutual licensing agreements for decades. Companies have pooled patents that underpin common technologies (like MPEG) to provide industry-wide royalty collection mechanisms and easy access to core technologies to all participants for a standard fee.
Individual inventors have participated in the revenue streams arising from IP, sometimes as a result of litigation to prove their entitlement. In the pharmaceutical industry it’s normal to see young biotech companies finance growth by selling part or all of their future royalties to larger companies or specialist funds. Indeed, the pharmaceutical sector has led IP investment with a number of specialist investors who acquire royalty streams for a discount on future cash flow. This approach has also crossed over into other worlds.
PERHAPS THE MOST well known sale of royalty rights was the issue of ten-year bonds to the Prudential Corporation by David Bowie in 1997. Bowie raised $55 million on the sale of his rights in 25 albums, which started a trend for music artists to monetise their back catalogues for up-front cash. These IP-based assets have become the basis for generating billions of dollars in revenue for Time Warner, DC Entertainment, Walt Disney and Marvel Entertainment as they create movies, digital online content and downloads, merchandising and the comic books. Marvel emerged from bankruptcy in 2001, only to be acquired by Walt Disney in 2009 for $4.24 billion due to the quality of the IP underpinning the Marvel catalogue.
For wealthy investors the opportunity now exists to participate in IP investing by working with specialist advisers in pooled IP strategies or to create custom, sector or situation-specific investment choices.
Ray Reusser, a former IP head at ATT Bell Labs, has charted the growth of the IP asset class for more than twenty years. He believes the rapid leap in technology in smart phones and broadband has created an unparalleled opportunity for investors: ‘We’re witnessing the restructuring of an industry and the formation of a number of winning companies whose technology will become ubiquitous. Owning rights to fundamental IP is like receiving a cent for every text message received across the globe.’
It’s possible that the IP ‘pixie dust’ that underpins all modern technology will prove inaccessible as an asset class to all but the most sophisticated investors. However it’s more likely that IP is now entering the mainstream. In our 2010 study of 51 family offices and alternative investment professionals, almost 70 per cent expressed a strong interest in IP, with more than half of these confirming that they had some form of IP investment within their portfolios. The real challenge for any investor interested in this asset class is to find the right IP-based investment firms to work and invest with.
With most economists predicting difficult markets for the foreseeable future, investing in the intangible assets of the world’s most successful companies may be an investment strategy whose time has come.
Cartoon by George Leigh
Dr Chris Donegan is CEO of Fraserburgh