The point of more returns

The tipping point

To borrow heavily from Frederick Forsyth’s famous opening to his 1972 novel The Odessa File (although that may not be wise in the introduction to a publication about IP rights), everyone in the IP world seems to remember with great clarity what they were doing at the precise moment they heard the results of the Nortel patent portfolio auction.

Such was the impact of the sale that it is seen by many as a pivotal moment in the history of intellectual asset management. Pretty much as soon as the Nortel portfolio went on the market, rumours abounded as to its contents and possible value. Tentative suggestions that the collection could be worth as much as $1 billion were mooted early on.

A victim of the global financial crisis, the Canadian telecoms giant filed for bankruptcy protection in 2009 and got round to the business of selling its patents in early 2010. As initial bids from interested parties were invited, speculation was rife as to the possible formation of a licensing entity to monetise the portfolio.

Heavyweights such as Research In Motion (RIM), Ericsson and Cisco were all mentioned as potential suitors; but after consulting Lazard and the Global IP Group, and failing to find an early buyer that would match the liquidators’ valuation, an auction was announced. The magic figure of $1 billion was still being bandied about, although many commentators publicly scoffed at the suggestion that such a sum was achievable. This scepticism soon infected the market, and the auction was delayed as a stalkinghorse bidder was slow to step forward and set the pace.

Billion-dollar baby
In April 2011, however, Google announced a $900 million opening offer for the portfolio, and other potential bidders were given until June to declare their intent to compete for it and thus trigger a full-scale auction. The same hats and more were thrown into the ring, but few predicted that the actual bidding process would last several days, and that the final sale price would reach a staggering $4.5 billion.

The Rockstar Consortium – comprising Apple, EMC, Ericsson, Microsoft, RIM and Sony – emerged the victor. Apple reportedly injected the lion’s share of the cash, paying $2.6 billion, while RIM confirmed a $770 million contribution and Ericsson $340 million. Google – which had fought hard and, in alliance with Intel, bid up to $4 billion – retired to lick its wounds and call for patent reform.

But it was not long before Google had returned to the fray. A matter of weeks after the auction, it was revealed that the company had purchased over 1,000 patents from IBM; and a fortnight after that came the announcement that it was to purchase Motorola Mobility – together with its 17,000- strong patent portfolio – for $12.5 billion. For good measure, the company returned to Big Blue the following month for another 1,000- plus package of patents. In early September, it emerged that Android manufacturer HTC had initiated legal action against Apple for the infringement of nine patents, all of which it had acquired from Google. The smartphone wars had taken another turn.

But the significance of the Nortel deal was felt far beyond the companies involved in and affected by the bidding. Many feel that it has changed the landscape for ever. The tsunami of media coverage that surrounded the sale and its aftermath, which splashed IP transactions onto the front pages of the international press, ensured that intellectual property was brought to the attention of both corporate executives and investors globally.

Brave new world
“Before Nortel, there had been big deals and interesting deals, but this really got a lot of board-level attention,” says Michael Lasinski, managing director of 284 Partners LLC. “It had a lot of people saying that we can no longer ignore intellectual property. There was a deal that had garnered sufficient press that people who didn’t have a day-to-day interest in IP now do. There are boardrooms out there full of people asking, ‘What are we going to do with out intellectual property?’ – and their investors are asking the same thing.”

The industry has been trying to strengthen its connection to the boardroom for some time. The fact that the Nortel deal has finally sparked interest in the C-suite should not be underestimated – not least for the effect it has had in financial circles. “I’ve been spending a lot of time travelling to New York to talk to people at financial institutions and there has been a complete sea change in attitudes,” says Robert Aronoff, managing partner at Pluritas LLC. “Nortel really piqued everybody’s curiosity, and that interest and momentum have yet to subside. People there are essentially saying that one of the first things their clients want to talk about is IP; about their own portfolios, the portfolios of M&A targets or other potentially available assets.”

As businesses become increasingly aware that there is very real revenue to be unlocked from intellectual property, more and more large companies have become interested in making assets available on the market. They realise not only that it has become standard procedure for a corporation to seek to generate value from its patents, but also that they have a duty to their shareholders not to waste what they own. But before we look more closely at the advances that have been made in the boardroom and on Wall Street, it’s worth remembering that the Nortel auction was not an isolated event.

The matrix
“While Nortel might be the seminal moment that everybody will look back to, there was a lot that went on before it that enabled it to happen,” explains Ralph Eckardt, managing director of 3LP Advisors LLC. “In some ways, it’s a 20-year overnight sensation. If the same thing had happened five years ago, I’m not sure it would have had the same effect. But the fact is, we have had a long run-up to this: we have a lot of intermediaries in the marketplace; we have a long history of major deals and other things that have led up to this to make this event possible.”

Eckardt believes that a positive spiral has occurred in the evolution of the marketplace over the last decade or so. The fact that intellectual property is such a complex asset makes it hard to transact – not least because any particular patent’s value can vary so greatly depending on a number of variables, from its validity and the usefulness of the invention it covers to the way it is used by its owner. Add to this the advanced technologies that are covered by many of the more valuable rights out there and it is no surprise that a diverse network of specialists has sprung up to facilitate their exploitation. The consequent fact that, as the market develops and grows, it drives the need for more specialists to handle that growth is what powers Eckardt’s positive loop.

The verdict
Another key development of last year was the US Supreme Court decision in the longrunning Microsoft v i4i case. This concerned the evidentiary standard for challenging the validity of patents in the United States, with Microsoft arguing that it should be changed from ‘clear and convincing evidence’ to ‘a preponderance of evidence’.

The court came down on the side of established patent practice; a decision the other way could have had an adverse effect on patent values across the board. “If Microsoft had won that Supreme Court ruling and all patents could be invalidated by a mere preponderance of evidence, there is no way that a portfolio like Nortel’s would be worth the same amount of money,” claims Mike Cannata, managing director of BOCA Advisory Services, who acted as an adviser and manager to the Northwater Intellectual Property Fund, which funded i4i in its litigation. “Obviously, there was a lot of publicity and public awareness around Nortel and the Google purchases, but I don’t know how they would have been at those premiums and would have had that kind of fanfare had the i4i decision gone the other way.”

Great expectations
In the months following the Nortel and Google/Motorola deals, some large and potentially important portfolios came onto the market and failed to sell immediately, prompting talk of bursting bubbles.

One belonged to wireless technology specialist InterDigital, which announced just weeks after the Nortel sale that it was looking for a buyer for either the company or its 19,000-plus patent portfolio. Despite reported interest from Apple, Nokia, Qualcomm and several other tech-space players, it had failed to find a suitable deal by the end of the year.

Another was a portfolio offered by Eastman Kodak, which also experienced great difficulty in attracting a buyer. It had hoped that offloading some 1,100 patents might help it to stave off bankruptcy; but having failed to make a sale, the company filed for Chapter 11 in January 2012. It has become clear that a key challenge for the evolving market is to manage the newly created expectations among top executives and investors.

“While generally the big deals of last year have changed things for the better for IP,” says Bruce Berman, CEO of Brody Berman Associates, “we have to be careful about communicating that these unusually large transactions are not typical … Our job is to bring people back down to earth. There is no doubt that many patents and portfolios out there, held by big companies and small, have significant value: but to monetise them through licence, sale or litigation – that’s another part of the calculus and it’s not always easily done.” Berman goes on to explain that there are other ways to assess intellectual property than through sale value or licensing returns. “Performance should not always be measured in transactional terms,” he explains. “There are ways that patents provide return strategically, through maintaining market share or permitting freedom of action.”

Money never sleeps
Berman has also noticed a change in the way that Wall Street thinks about intellectual property, pointing to the fact that financial analysts are starting to look in far more detail at the contents of various portfolios that come onto the market. “There was a report from a well-known investment bank that looked at RIM and they had some very good analysis of the LTE (long-term evolution) 4G patents that they did and didn’t have,” he says. “This is a real step forward in terms of equity analysis. I remember when a big firm like IBM would have been covered by one or two analysts who would just go on the number of patents in the portfolio. Now we are looking at specific patents and what they read on.”

Those close to the investment side also see that intellectual property has done a lot to make itself more attractive as an asset class; while this has been helped by the high-profile smartphone wars, other events have further served to focus financiers’ attention on intangibles.

One of the most prominent of these was the successful flotation of defensive aggregator RPX Corporation, which raised just shy of $160 million and valued the firm at around $1 billion. While the firm’s share price has since fluctuated, the fact that an IP-oriented company had developed an innovative new business model in response to the rise of nonpractising entity (NPE) activity in the marketplace drew admiring glances from venture capital and private funds alike. As did the success of Acacia, a pure-play IP-based business that has seen its market capitalisation grown from under $100 million to around $2 billion in the space of just three years.

Privateers on parade
In 2010 Acacia announced that it was increasing its focus on working with operating companies to help them to monetise their patents. Essentially, such a strategy is based on the outsourcing of enforcement – with Acacia and other NPEs either buying patents outright from, or sharing licensing proceeds with, the operating company. The latter not only gets an attractive financial boost, but also reduces its exposure to counter-suits and the costs of maintaining an internal licensing team. This so-called ‘privateer model’ has become increasingly attractive over recent years, with Round Rock Research – which manages a portfolio acquired from Micron Technologies in 2009 – another prominent example of the genre.

“For a while now, people have been exploring new avenues for accomplishing the same end: to take an asset and figure out how to monetise it in a way that minimises all of the potential downsides,” explains Tom Ewing, principal consultant at Avancept LLC. “Historically, very big companies encountered two downsides if they tried to enforce their intellectual property. First, they were open to some sort of anti-competitive claim that they were stifling competition in the marketplace; and second, their competitors and peers might think that they were being overly competitive and retaliate against them. However, as Micron claims not to have any control over the actions of Round Rock, if it were to take action against one of Micron’s peers, the operating company would be shielded from counterattack.”

The sweet smell of success
One of the most striking success stories in this area last year was that of Canadian NPE Mosaid Technologies Inc, which was the subject of an attempted hostile takeover bid by fellow Canadians Wi-LAN in August 2011, which valued the firm at C$480 million. The Mosaid board claimed that this figure was too low and suggested that shareholders hold off while it prepared a detailed response. That response was to announce, at the beginning of September, that it had acquired Core Wireless Licensing, a Luxembourg-based company established by Nokia to hold 400 patent families relating to wireless technology. This prompted an increased bid from Wi-LAN.

A little over a month later, Mosaid was acquired – not by Wi-LAN, but by US private equity firm Sterling Partners in a deal worth C$590 million. The transaction is seen as pivotal in the relationship between Wall Street and the IP markets.

“This is a seminal moment,” says Peter Holden, a partner and head of the IP investment group at Coller Capital Inc. “It’s basically a vote of confidence in the operating model of IP in the long term. In the past, we’ve seen firms such as Acacia and Wi-LAN do very well as public companies that have great returns, and there is a nice secondary market for that stock. But what is different – and what I find so exciting about the Sterling Partners deal – is that you have a reputable private equity fund buying an IP business at pretty good multiples. That’s huge. That’s more important than Nortel, because it shows that financial instruments are looking dispassionately at the situation and still coming out with a buy, as opposed to the emotional deal fever that happened at Nortel.”

The colour of money
And it’s not just the patent licensing firms that are attracting the attention of private equity. Right at the end of the year, it emerged that UK-based IP management and services company CPA Global was on the brink of a sale. Sure enough, in January 2012 it announced that it had been acquired by private equity outfit Cinven at a reported value of £950 million ($1.5 billion).

Holden is optimistic about how intellectual property is becoming such an investable commodity that the market has learned how to deal with the transactional vagaries and inherent risk involved: “Our perspective is that despite these cycles of IP boom and bust, and despite the apparent bubble in wireless, we strongly believe that there is a sustainable growth going on right now.” This is reflected, he says, in the increased quality and volume of offerings from opportunistic sellers, some of which have never sold before. Such sales, Holden suggests, could be partly driven by shareholder activism, by internal pressure to create value from intangible assets or simply by people in M&A who have been told to get creative on their deals.

“As we’ve seen,” he continues, “there are also some private equity firms, banks and hedge funds that you would call mainstream – not fringe – looking at the market very seriously. We have more supply, more demand and more liquidity: so our strong view is that while there is a bit of a bubble in wireless, prices are already coming down to more reasonable levels. What we need to look at more seriously is the fact that in any superhigh margin business, you’ll find that intellectual property is a driver of value – that’s the sustainable growth that we are chasing.”

Eurovision
And it’s not just in the United States where the IP market is flourishing – there have also been major leaps forward in Europe. “More and more people are becoming aware of intellectual property,” confirms Jackie Maguire, chief executive of Coller IP Management in the United Kingdom. “There has been an improvement across the board, although it’s been larger in some areas, perhaps. There is still a long way to go, but my conversations with board members have shown that people are at a higher point in their understanding, and as a result the conversations are becoming more fruitful. The Google, Motorola and Nortel deals were in the news and have provoked a change of attitude from financial directors. That’s helpful, because obviously financial directors are looking at the situation from a strategic finance viewpoint; so once they get it, they are very good promoters within their own company of the importance of IP.”

The smartphone wars have also ramped up activity in Europe’s busiest litigation market, Germany. Many of the disputes that have played out between the key combatants around the globe have been mirrored in the German courts. Once again, this news is filtering into the boardrooms at all levels of the industry.

“Whenever we’re in court handling these big cases, there are people from the press,” says Peter Chrocziel, a partner in the IP and IT group at Freshfields Bruckhaus Deringer in Munich. “That is something that was unheard of in Germany until now. It has created an awareness about IP that has led to companies considering their strategies more carefully. This is visible in companies of all sizes. And while start-ups tend to be quite IP conscious these days, we are also seeing more established medium-sized enterprises starting to show more interest in their intellectual property.”

Eastern promises
Further afield, the influence of Asia continues to be felt – not least because several of the players driving the events at the heart of last year’s developments are based there, and that influence is only likely to grow going forward.

The developed markets in Asia are already producing some excellent intellectual property and, according to Ron Laurie, managing director of Inflexion Point Strategy, there is more to come. “Japan is very interesting currently, as they are now a net source of good patents,” he says. “This is because many of the companies are not in great shape, as the economy is not in great shape; and yet for the last 15 or 20 years, they’ve been producing a lot of very good technology, especially on the manufacturing side, such as LCD and LED. They’re sitting on a lot of patents that are now a lot more valuable than they used to be.”

Laurie also points to the establishment of a number of rumoured patent funds that are looking to encourage innovation across the area, and the fact that China continues to pump huge resources into developing intellectual property. For the past decade or so, the Chinese government has worked very hard to encourage IP filing and innovation, and while many of the patents that are currently filed in country are likely to be worthless, it’s only a matter of time until the investment pays off. When it does, there is no telling how much valuable intellectual property could flow from the area.

Peter Holden certainly believes that Asia will add fuel to the IP fire that has been sparked among the investment community. “Not only are Asian companies and investors buying like crazy,” he says, “but in the next five to 10 years, we’ll see an increased supply from Asia. Not the lower-quality patents they’re trying to sell now, but it will be seminal stuff as the world order changes and Asia starts becoming more pre-eminent in R&D, which is inevitable in my mind.”

Korea and Japan are already world class in many technology areas, says Holden, and they are bound to be followed by China and Taiwan, as well as other countries that are beginning to show an impact on the quality of IP index. “We’re likely to see a flight to quality from China and it’s just a matter of time because they are throwing thousands of PhDs and billions in government money at it – they’ve got so much momentum on their side it will take off eventually,” Holden concludes.

Back to the future
In previous introductions to this publication, the focus has been on the need to reach into the boardroom or out to investors to achieve a greater level of understanding about intellectual property. Now, it seems, that may finally be happening. As a result, corporate appetites have been well and truly whetted.

Whether this marks a tipping point, or whether it is rather the cumulative effect of decades of work and maturation on the part of a highly specialised industry, is a moot point. The important next step is to ensure that we continue to manage not only intellectual property as effectively as possible, but also that other great intangible, the expectations of the market.