Intellectual Property as an Asset Class
Topics addressed in this paper include:
- Patents: the invisible asset worth trillions
- The increasing visibility of patents
- Wall Street discovers patents
- Strategic patent monetization
“Capital isn't that important in business. Experience isn't that important. You can get both of these things. What is important is ideas.” -- Harvey S. Firestone
- Intellectual property as an asset class is one of the strongest pillars supporting the US economy:“Intellectual property intensive industry” was responsible for over 22 million jobs and 35% of US GDP in 2010, according to a recent Department of Commerce study.
- Roughly one-third of US IP value is the form of patents, over a third is in software and other copyrighted materials, and the balance is in trade secrets. In 2010 patents held by US companies were worth nearly $2 trillion.
- Former chairman of the Federal Reserve Alan Greenspan said that 75% of the value of companies today is in intangible assets, up from 40% in the ‘80s.
So why does the value of this important asset so often go unrecognized?
Patents: the Invisible Asset
Business owners worldwide fail to appreciate the value of their intellectual assets. As recently reported in the London Financial Times, a poll of 451 company owners found that 84 percent valued their IP at zero and only six percent valued it as anything more than 10% of their company’s worth. The World Bank calculated that royalty and license fees generated £5.25 billion in the UK in 2010 – showing the scale of potential revenue available for those who do recognize the value of IP.
For the most part, IP assets aren’t only unrecognized. They’re also largely off-balance-sheet and therefore invisible – to shareholders and potential investors as well as to company executives. Accounting practices (US GAAP in particular), which record patent value on a company’s balance sheet on a historical cost basis, don’t provide a relevant measure for the true value of patents in a business, commercialization or licensing context. Accountants and accounting practices are well behind the curve in measuring the tremendous value of these assets.
Generally speaking, research and development is expensed, not capitalized. It's easy to understand why Generally Accepted Accounting Principles (GAAP) would operate on that basis. The value of R&D is uncertain; sometimes a company can invest millions in developing technology and products that turn out to be losers (as several tablet makers have recently discovered). Sometimes a company can make a very modest investment, yet produce a blockbuster patent with a value completely out of proportion to development costs.
Also, all companies in IP-intensive industries must invest a certain amount in R&D just to stay in business. Therefore, it makes sense in an accountant’s world to treat R&D as just another cost of doing business.
However, this conservative accounting approach overlooks the fact that patents are long term assets with a life of 20 years. They’re critical infrastructure for the long term growth and value of a company.
If a company builds a new factory, it gets treated as a capital investment, and the money spent is depreciated over the life of the building. Patents have a life span as long as many buildings, and can generate revenues for decades, just as factories can. Yet the development expense for a patent gets written off completely the year it’s incurred.
Not only that, if a company develops a very successful patent – one worth far more than it cost to develop – that added value doesn’t show up on a company's balance sheet at all. An OECD report on “Business Performance and Intellectual Assets” says “despite their importance, intellectual assets remain outside mainstream discussion in business, economic and policy circles. They tend to be inadequately measured, [and] are rarely reported in financial statements….”
Patents only show up on a company's balance sheet if the company bought the patent from someone else, or if it acquired a company which owned patents that made up part of the value. Under FAS 141, intangibles, including patents that are acquired in an acquisition, must have a “fair value analysis” that establishes their worth for financial reporting purposes.
Because patents are largely invisible assets, many corporate executives haven’t paid much attention to managing their patent portfolios. Since patents don’t appear on the company’s balance sheet, investors and boards don’t know what these “hidden assets” are worth – or could be worth, if properly monetized. So managers aren’t held accountable for the under-performance of these assets.
Patents are also invisible when investors do “return on assets” calculations. So executives can take credit when patented technology yields profits and revenues, yet avoid taking the rap when the investment in IP is wasted.
However, activist investors like Carl Icahn and hedge fund Starboard aren’t willing to accept this squandering of IP assets. They’ve been pushing the companies they invest in to monetize their IP – not just leave it sitting on the shelf. This is a trend we expect to accelerate with the success Icahn enjoyed at Motorola and the success Jeff Smith and Starboard enjoyed with AOL.
The Increased Visibility of Patents as Assets
Google’s $12.5 billion acquisition of Motorola Mobility, which was finalized in May, 2012, was a thunderous wake-up call to investors on the value of patents. The purchase price was $40 per share – a 63% premium over Motorola’s previous closing price.
Motorola’s dowry included 24,500 patents and patent applications, some of which Google is using to defend its Android operating system in a global patent war against Microsoft, Apple, and Oracle.
Many factors are involved in calculating a company’s market value, but since Motorola was having trouble and losing market share when Google bought the company, the purchase price suggests that Google believed those 24,500 patents and applications are worth over $7 billion. That’s a lot of money for an “invisible” asset!
The Google-Motorola deal isn’t the only high profile financial transaction driven by patents. In April, 2012, Google rival Microsoft paid $1 billion to buy 800 patents from AOL. AOL has long been suffering financially; its revenues fell from $30 billion in 2000 to $3.2 billion by 2009. By December, 2011, AOL had a book value of $973 million; when it sold those patents, its stock went up 43% and the company’s book value doubled overnight.
Kodak has been struggling since the photography world switched from film to digital. The company hopes to net more than $2 billion by auctioning its patent portfolio -- a pretty neat trick for a company that’s bankrupt and has a negative book value.
Wall Street Discovers Patents
According to data compiled by Bloomberg, in the past 12 months patent deals have jumped to $18.8 billion – up from $450 million the year before.
Traditionally, Wall Street firms have turned up their noses at patents as a “niche asset,” unworthy of their attention. Not anymore.
With global mergers and acquisitions deals down 27% this year and patent deals up 20-fold, some under-employed investment bankers are now trying to keep busy by advising clients on patent sales.
As reported by the Financial Times, firms like Lazard, Evercore, and Barclays are getting into a field typically dominated by law firms. Not all of these new banker-backed patent deals have been successful. Both Evercore and Barclays advised InterDigital, a mobile phone design firm with more than 19,500 patents. InterDigital called off its patent auction in January when bids came in lower than expected. Lazard failed to sell 1,100 Kodak patents, which bankrupt Kodak now plans to auction.
Companies approached by investment bankers looking to do patent deals should be wary. Patents aren’t pork bellies or bonds, and patent monetization involves a combination of skill-sets that banks can’t assemble on the fly.
Strategic Patent Monetization
Patent monetization isn’t just for struggling companies such as Kodak or AOL. Industry leaders like Apple, Google, Microsoft, and Oracle are all moving aggressively to earn returns on their intellectual property through licensing deals (monetization) while at the same time locking in strategic advantages for their own products. Microsoft is already earning a lot more money on licensing its patents to Android phones than from sales of its own Windows Mobile operating system.
Smart CEOs aren’t sitting around waiting for corporate raiders to cash in on their companies’ unused IP assets – they’re busy figuring out how much their patents are worth and the best ways to liberate that value. They know that the improved financial performance that comes from a significant new revenue stream can help lift the price of a company’s stock, earn executives a nice bonus, and make management popular with investors and boards.
Patent monetization is a highly specialized field. Managing an effective patent monetization campaign can require:
- Detailed patent and product analysis
- Claims analysis
- Physically dismantling potentially infringing products
- Picking and retaining experts
- Deep knowledge of patent licensing transactions and market rates
- Strategic prosecution
- Vendor management
- Retaining legal counsel
- Money to pay for all of the above
Investment bankers simply don’t have the expertise and track record that IPNav has. Nor can law firms, patent brokers, or patent advisory firms offer the end-to-end monetization services that IPNav provides.
IPNav has invested ten years and millions of dollars to master the complex monetization process and create a Full Service Monetization Platform that no other company can match. Since 2003, we’ve done over 600 deals and earned more than half a billion dollars for our clients. No investment bank even comes close to those results.
See our white paper "Selecting an IP Monetization Service Provider" for the full story on why IPNav is the best choice for unlocking the value in your “hidden” patent assets.