In the week since it was announced that Microsoft has agreed to pay AOL just over $1 billion for a porftfolio of 800 patents, as well as the right to license 300 more, there has been a lot of commentary about the deal. Over on the IP CloseUp blog, Bruce Berman quotes one experienced IP dealmaker who believes that AOL could have got more. “Based on the patents that I examined I thought the entire AOL patent portfolio could be worth as much as $1.79B, the entire market cap of the company,” Rob Aronoff of Pluritas, LLC tells Berman.

“At least several fundamental patents were included in the core portfolio, and my informal assessment indicated that full portfolio value of all AOL’s 1,100 patents without the business operations was probably in the area of $1.4B,” Aronoff states. “Had there been more time for a marketing effort by Evercore Partners instead of a rush to sale the AOL may have gotten closer to the full $1.79B company value.” Aronoff concludes: “This transaction appears to have been rushed into the marketplace on a relative basis when compared to other major patent sales like Nortel and Motorola Mobility … The beneficiary appears to be Microsoft. The approximately one-month sales process does not appear to have been played out to the benefit of the all shareholders.”

In a similar vein, under a headline entitled “Microsoft AOL Patent Theater” the I, Cringely blog claims that AOL manufactured an auction process to appease possibly restive shareholders but always intended to sell the patents in question to Microsoft:

The reason there was an auction at all was probably because of AOL’s concern about adversarial shareholders. Had AOL simply sold the patents to Microsoft in a private transaction the company might have been at risk for shareholder lawsuits claiming the price was too low. A public auction was the best defense against such lawsuits.

Only the auction wasn’t real. No company but Microsoft was ever going to buy those patents.

Cringely goes on to explain that the other bidders in the process were Facebook and Goldman Sachs, neither of whom were actually interested in buying them. Microsoft, on the other hand, wanted them because they helped the company out of a potential litigation problem relating to an anti-trust suit brought against the company by AOL and others back in 2003:

The 2003 settlement with AOL didn’t cover patent infringement. Even back then Time Warner lawyers felt that there was another $500 million to be recovered from Microsoft for patent infringement. Yet for some reason they never went back for the money.

So Microsoft has had that potential litigation hanging over its corporate head for almost a decade. Not only was there infringement, but that infringement could be easily documented as willful with a decade of litigation leaving a clear paper trail of causation. Microsoft couldn’t claim they were unaware of the AOL patents. And since they were aware they could be subject to treble damages. That’s a potential $1.5 billion hit to earnings.

Much better to cut the present deal, paying just over $1 billion as an asset purchase.

Microsoft paid too much for the patents, says Cringely, but less than it might otherwise have had to have paid. Hmmmm.

Both Aronoff and Cringely seem to have a problem with the speed with which everything was done. But the reality may well be that there was nothing hasty about the deal at all. According to AOL CEO Tim Armstrong the company’s board signed-off on the idea of a patent sale as far back as last autumn, while he had personally contacted Steve Ballmer of Microsoft at that time to give him a heads up as to their availability.

It’s worth remembering that when the portfolio first came to mainstream attention, after the stinging letter sent to the AOL board by activist shareholder Starboard Value in February, the response from the board was: “We have a valuable patent portfolio and several months ago, prior to Starboard’s first letter, the AOL Board of Directors authorized the start of a process, and hired advisors, to realize the value of these non-strategic assets.” Furthermore, on completion of the deal, Microsoft general counsel Brad Smith stated: “This is a valuable portfolio that we have been following for years and analyzing in detail for several months.” There does not seem to be anything rushed about that.

The problem here seems to be the Starboard intervention. Given that this is what brought the potential divestment of the portfolio into the public domain people may be assuming that the sales process began then too. But, as the statements from both AOL and Microsoft make clear, that does not seem to be the case. Whichever way you look at it, $1 billion is a lot of money and it is hard to believe that a company such as Microsoft, which has an exceptionally well-oiled IP machine, would just release that amount of cash without being sure of what it was getting its hands on. That certainly does imply extensive due diligence – something that for 800 patents cannot be done in a matter of days. If you take the Starboard letter out of the equation, however, what you have is a process that lasted for six months or so. And that does make sense.

So has Microsoft overpaid for the patents? Again, bearing in mind the operation there, it is difficult to believe that is the case. They know what they are doing in Redmond. But I am not an expert, so I thought I would ask Art Monk, who is, what he thinks. Art, the VP of the patent brokerage at UBM TechInsights, came back to me with this:

• Per patent the $1.06 billion paid represents $1.3 million/patent which is well above the rate paid by Google for the Motorola portfolio at $735K/patent. Thus, one would hope that the quality of the assets was high with few encumbrances.

• Based on the rule of thumb that roughly 3% of a bulk portfolio represents assets that are truly valuable, there might only be 24 valuable jewels in the pile.

• If we tie all the value to just the jewels, then Microsoft paid $44.2 million for each of them. Although this number seems high it is not far off what the Rockstar Consortium paid per essential family if you base all the Nortel value on the standards essential patent families within it.

• Since the true unit of transaction in such matters is patent families and not just patents generally, one might find there were only around 100 to 150 patent families in the portfolio. We’ll have to see once the assignment records; if it records in a visible way.

This situation was an interesting strategic scenario in which Microsoft was faced with the “cost of doing nothing” versus the cost of acquiring the portfolio. If they did nothing and the patents fell into the hands of a non-practicing entity, they could have faced many millions of dollars in litigation expense and royalties paid out over the life of the patents. After paying all such costs they at best would have just a license to the patents and a significant liability to pay royalties into the future.

Contrast this with putting out money now, acquiring the patents and then using them defensively and possibly assertively (more Android-like assertions) to recoup the expense … and not only that, acquiring a license to the rest of AOL’s holdings as an insurance policy that protects them no matter what happens to the rest of AOL’s IP assets.

This looks like a thoughtful move on Microsoft’s part. When Microsoft’s other shoe drops … the label on the bottom will likely read “assertion.”

What Art says here ties in quite nicely with parts of Rob Aronoff’s assessment reported by Berman in IP CloseUp and also with those provided by other IP market makers, such as Erin-Michael Gill of MDB Capital. For me, therefore, the real issue is not whether Microsoft overpaid, but whether AOL could have got a higher price. We are never going to know the answer to that, but in retrospect perhaps Starboard Value may have been better advised to bite its tongue back in February. Had that happened, AOL is unlikely to have got less from Microsoft, but it might have received quite a bit more.

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