What’s Driving Patent Sales? - bswd.comIP-SIG).pdf · • Managing Director of Inflexion Point Strategy, LLC, the first intellectual ... institutional investors in bringing the

What’s Driving Patent Sales?

IEEE Consultants Network of Silicon Valley Intellectual Property SIG

February 19, 2013

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About the Speaker

• Managing Director of Inflexion Point Strategy, LLC, the first intellectual property investment bank, which he co-founded in 2004. Inflexion Point represents technology companies and institutional investors in bringing the unrealized value of high-quality IP assets to the bottom line by increasing corporate valuation in M&A transactions, by building a defensive patent shield against litigious competitors and by generating additional top-line revenue via creative exclusive field-of-use licensing programs.

• CEO of Syndicated Patent Acquisitions Corp (“SynPat”), which acquires and licenses high-value patent portfolios.

• Founding Principal of Percipience, LLC, a board-level advisory firm focused on IP strategy, competitive intelligence, focused innovation and patent valuation.

• Has worked in Silicon Valley for five decades, initially as a software engineer and then as an IP lawyer focusing on IP strategy, a subject he has taught at Stanford and Boalt (UC-Berkeley) law schools.

• Founding partner of the Silicon Valley offices of Skadden-Arps, Weil-Gotshal, and Irell & Manella law firms.

• Led IP due diligence teams in some of the largest technology deals ever done, worth over $50 billion in aggregate value.

• Inflexion Point was the first “IP Investment Bank,” launched in January 2004, with current operations in Silicon Valley, Taiwan and Singapore. • Like the more traditional i-banks, Inflexion Point focuses on both Brokerage and M&A Advisory services, but with IP (primarily patents) as the asset class, rather than corporate securities. • On the brokerage side, we focus primarily on representing technology and life science companies that are either seeking to monetize their “non-core” patents (sell-side) or to improve their competitive leverage through strategic patent acquisition (buy-side). • On the M&A side, we focus on providing specialized expertise in IP-Driven M&A transactions, where patents and know-how represent a significant part of the target’s corporate valuation. • Recently, as will be discussed, the two parts of our business have begun to merge, as corporate acquisitions are now used to acquire strategic patent portfolios.

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• Level 1 - Offensive Value

• Level 2 - Defensive Value

• Level 3 - Strategic Value

• Level 4 - Enterprise Value

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Patent Value-Extraction Levels

Level 1 - Offensive Patent Value

Level 2 - Defensive Patent Value

-------------------------

Level 3 - Strategic Patent Value

Level 4 - Enterprise Patent Value

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What’s Driving Patent Markets? Transition from Direct Financial Return to Strategic Value

• Non-exclusive patent licensing (stick model)

• Non-exclusive patent licensing plus tech transfer (carrot model)

• Exclusive field-of-use licensing in non-core markets

- with or without technology transfer

• Cross-licensing with receipt of balancing payment

• Sale

- with or without grant-back license or reservation of rights

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Level One – Offensive Patent Value

Top-Line Revenue Enhancement via Out-Licensing or Sale --

• Freedom to Operate

- Deterrence or settlement of competitor IP Infringement claims

• Cross-licensing with zero or lower net balancing payment

• Exclusive field-of-use licensing in non-core markets

- with or without technology transfer

• IP in lieu of cash as contribution to joint venture or strategic alliance

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Level Two – Defensive Patent Value

Bottom-Line Improvement via Cost Reduction in Terms of IP Cash Outflows via License Fees, Litigation Expense and Infringement Damages --

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Level Three - Strategic (Market-Related) Patent Value

• Price Premium for Products/Services with Patented Features -- depends on demand for patented feature, i.e., price cross-elasticity (licensing vs. exclusion strategies) • Market Share Protection/Expansion -- measurement issues • Share Price Support/Improvement -- measurement issues

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Level Four – Enterprise Patent Value

IP can be effectively used to enhance corporate value to potential acquirers -- -- but, how often does this actually occur? We will revisit this subject in the discussion of IP-Driven M&A.

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Patent Value Measurement Challenges

Note that as one moves from Level One to Level Four in the value hierarchy, the ability to measure IP value becomes significantly more difficult. Traditional accounting-based valuation metrics seldom reflect the economic value of a company’s IP assets, e.g., • EBITDA • P&L (Income Statement) • Balance Sheet • Fair Market Value • Fair Value • etc. Market-based valuation metrics also do not accurately reflect IP value: Share price P/E Ratios etc.

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Patent Litigation Damages as a Value Driver

In the U.S., current methodologies for calculating reasonable royalty damages for patent infringement tend to overcompensate patent owners for unlicensed use of patented inventions This results from the fact that the royalty base (to which the reasonable royalty rate is applied) often reflects the total market value of the commercial product or service containing the patented component or feature. This has the effect of imposing a tax on innovation rather than the unlicensed use of the patented subject matter. This effect in turn attracts financial investors seeking above-market (supra-normal) returns to invest in patent aggregation and enforcement.

Core Technology: Patented Inventions &

Unpatented Know-How

Productization Technology (Patented and/or Unpatented)

Royalty Base (Tax Base) – License/Litigation

Royalty Payments (Tax) - $$

Product (Cost) Digital Products (Proprietary Design Info)

Core Technology

Integration Technology

Market (Price)

Marketing, Sales, Admin, etc.

Tangible Products

Design

$$b

$$c

$$a Patent on Invention

X Invention

X

X

Innovation

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The Transition From Product Markets To Patent Markets

Effect on Patent Valuation

The current state of the law on how patent infringement damages are calculated has had three primary impacts on the ability to assign value in the emerging patent transactions marketplace:

• Lack of certainty – as to predicting future income streams from licensing and litigation and applying

appropriate risk discounts to arrive at a reliable estimate of patent value. • Lack of rationality -- as to determining the economic value contribution of patented inventions

embedded in products (and services). • Lack of transparency -- as to prevailing market prices for “comparable” patent properties.

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How do Financial Buyers Assess Patent Value?

• What is a financial patent buyer (FPB)?

• What is the standard valuation model used by FPBs?

• What is the best-case ROI scenario?

• What are the applicable risk-discount factors?

• What are the economics and deal structure options?

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Types of Financial Patent Buyers

Top-Line (Offensive) FPBs

Primary objective is revenue generation via -- » sale, » license or » litigation (settlement/award)

Defensive FPBs

Primary objective is litigation risk/cost reduction

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Types of Financial Patent Buyers (cont.)

Top-Line FPBs:

• Private Equity Aggregation Funds (Intellectual Ventures, Coller)

• European Investment Bank Funds (Deutsche Bank, Credit Suisse, Alpha Patentfonds)

• PLECs (Enforcers) (Acacia, Niro, Spangenberg, etc)

• Litigation Financiers (Altitude, Rembrandt, NW Patent, Juridica, Arca, etc.)

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Types of Financial Patent Buyers (cont.)

Top-Line FPBs (cont.):

• IP Development & Licensing Companies (Rambus, Tessera, Interdigital, MOSAID, Wi-LAN, etc)

• Operating (Product) Companies with Active “Value Licensing” Programs

(Qualcomm, IBM, Alcatel-Lucent) Note: these two categories could also be considered to be strategic

buyers

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Types of Financial Patent Buyers (cont.)

Defensive FPBs:

• Buying Collectives (anti-NPE or anti-dominant player) (AST, RPX, OIN) • OpCo’s sued by competitors for patent infringement • OpCo’s seeking to lower future cross-licensing payments

Note: the latter two categories also could be considered to be strategic buyers

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FPB Valuation Model

The valuation methodology typically used by FPBs is: Step 1 - Calculate the Risk-Adjusted Net Present Value by: • Estimating the Best-Case Return from Litigation and then • Applying Appropriate Discounts for -- Patent-Related Risks -- Cost of Capital (time value of $) Step 2 - Review Comps for order-of-magnitude sanity check It should be readily apparent that this is more art than science!

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FTB Valuation Model (cont.)

What are the Best-Case ROI Assumptions? • Current Infringement (vs. placing a bet on technology evolution) • Clear Infringement (requires bulletproof claim charts) • Large Impacted Market (requires compelling market data) • Substantial Damages (by application of reasonable royalty to impacted market over time)

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FTB Valuation Model (cont.)

What are the Applicable Discount Factors for Patent-Related Risk? (cont.)

• Infringement avoidance (design-around potential, disruptive technology)

• Infringement detection (reverse engineering, internal process details)

• Encumbrances (outstanding licenses, RAND obligations, etc.)

• Invalidity risk (uncited prior art, KSR, Bilski, etc)

• Markman risk – potential narrow (non-infringing) judicial claims construction

• Enforceability risk (inequitable conduct, terminal disclaimer, etc.)

• Claiming issues (means-plus-function, single infringer rule, etc.)

• Title defects (board/shareholder approval of prior transfers, UCC-1 general intangible security interests, joint ownership, etc.)

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FTB Valuation Model (cont.)

What are the Applicable Discount Factors for Patent-Related Risk? (cont.) • Portfolio make-up -- -- Size of portfolio/family -- Issued patents vs. pending apps -- US vs. foreign coverage -- Portfolio structure - vertical vs. horizontal relationships • Litigation history • Changing legal environment -- Case law (eBay, Bilski, entire market rule, etc.) -- Legislative reform (e.g., damages apportionment) -- Regulatory intervention (e.g., FTC def. of reasonable royalty) • Etc., etc., etc.

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FTB Valuation Model (cont.)

Use of “Comps” as a Sanity Check on NPV Calculation Limitations – • Little publicly available transaction (sale) data • Inherent difficulty of determining what is a comparable patent portfolio • Extrinsic deal factors in other transactions (e.g., cross-license, tech transfer)

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Economics

Options -- • Outright purchase (lump sum)

• Revenue share (“back-end”)

• Mixed – Front-end plus back-end

Fixed

Contingent back-end with patent reversion if financial milestones are not met

• Staged – Front-end plus fixed installment payments

Secured by Promissory Note

Patent reversion if deferred payments are not made

• Other

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Deal Structures

Options – • Joint Venture – Contractual or LLC • Conditional Assignment / Patent Mortgage • Representation Contract • Other

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Risk-Adjusted NPV Example

Note: this is the Top-Line FPB (ROI) view. The Defensive FPB will substitute counsel fees for contingency reduction, but the applicable patent risk discounts should be the same.

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The Patent Valuation Challenge

Valuation of patents and patent portfolios is difficult due to a combination of of intrinsic, contextual and structural factors:

Intrinsic – patented inventions are, by definition, unique and valuation models used for substitutable assets are not easily adapted Contextual - the value of a patent is highly dependent on who owns it and how they are using it Structural – price discovery mechanisms for “comparable” patent sale transactions are not generally available

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Tangible and Intangible Property Markets

Uniqueness Value Subjectivity Price Uncertainty LOW HIGH

Patents

Public Co. Commodities Industrial Real Classic Antiques Fine Stock Machinery Estate Cars Art

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High-Level View of the Patent Valuation Process

• Patent Quality – Technical and Legal Analysis (Evaluation stage) Validity Claims Scope Ease of Infringement Detection Clear Title • Patent Impact – Market Analysis Infringing Products/Processes – Current/Future Design-Around Alternatives Existing Licensees, Co-Owners, etc. • Patent Value ($) – Highly Contextual / Value in Use Concept For what purpose/use? – portfolio mgmt, financial reporting, tax, licensing, sale, M&A, To whom? - Owner, Buyer A, ……. Buyer n

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A Buyer’s View of Patent Value is Typically Contextual and Multi-Dimensional

The value of a patent, or a patent portfolio, to a prospective buyer often

depends on the combined effect of a number of interrelated contextual factors, including –

• What is the buyer? • Who is the buyer? • How will the buyer use the patent(s)?

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What is the Buyer? (focus is on the primary revenue model)

• “Operating” (Product/Service) Company - with or without active licensing program • Technology/IP Development & Licensing Company - with or without technology transfer (e.g., design data and know-how) Rambus, Tessera, Interdigital, MOSAID, Wi-LAN • Patent Aggregator or Licensing/Assertion Company IV, Coller, Acacia, Altitude • Patent Defense Buying Collective - anti-NPE (or anti-dominant player) counter-measures AST, RPX, OIN

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Who is the Buyer? (factors unique to a particular buyer)

What will the acquisition add to the current patent position of the buyer

relative to – • Licensing/Litigation Targets • Actual and Anticipated Attackers • Current and Prospective Competitors • Suppliers and Customers 32

How Does the Buyer Intend to Use the Patents? (the concept of multiple value streams)

The most complex patent valuation dimension of all – value in use • Financial Uses • Strategic Uses • Mixed Uses 33

Financial Uses

• Generate Top-Line Revenue via Licensing and/or Litigation • Increase Gross Margins by Reducing Operating Costs • Provide Defensive Protection to Strategic Investors, Members, or

Subscribers • Provide Attractive ROI to Financial Investors • Provide Additional Collateral for Loans to Finance Operations • Create IP-Securitized Financial Instruments 34

Strategic Uses

• Acquire/Enhance Competitive Advantage -- - Increase COGS for Competitors via License Fees or Design-Around Costs - Create Entry Barriers for New Market Players • Increase/Maintain Market Share by Excluding Competitors via Injunction (or Prospect thereof) • Increase Enterprise Valuation for Shareholders & Prospective Acquirers • Provide Non-Cash Contribution for Joint Ventures & Strategic Alliances • Support/Extend Supplier and/or Customer Relationships 35

Price Discovery Challenges

• Need to develop a taxonomy/vocabulary for cataloging the

universe of patent value contributors. • Need to identify the kinds of data necessary to make an

informed valuation decision in any particular buyer scenario. • Need to collect the data and make accessible to interested

parties. 36

High-Level View of the Patent Valuation Process The 3 Stages

• Patent Quality – Technical and Legal Analysis (Evaluation stage) Validity Claims Scope Ease of Infringement Detection Clear Title • Patent Impact – Market Analysis Infringing Products/Processes – Current/Future Design-Around Alternatives Existing Licensees, Co-Owners, etc. • Patent Value ($) – Highly Contextual Value in Use Concept For what purpose/use? – portfolio mgmt, financial reporting, tax, licensing, sale, M&A, To whom? - Owner, Buyer A, ……. Buyer n

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Syndicated Patent Acquisition

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IP-Driven M&A Using M&A as a Vehicle for Patent Acquisition –

• HP’s acquisition of Palm

• Google’s acquisition of Motorola Mobility

• Wi-LAN hostile bid for MOSAID

• Interdigital, Kodak, RIM (?), Nokia (?), etc., etc.

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THE CURRENT PATENT MARKETPLACE Winners and Losers – A Subjective View

Winners • PLECs • Aggregators • Litigation Financiers • Brokers (some) Losers • On-Line Exchanges/Bulletin Boards • Live Auctions • Securitization • Collateralization • European Patent Funds Still Evolving • Defense Collectives • “Patent Privateering” - OpCo Assertion by Proxy • Exchanges and Trading Platforms • Valuation Infomediaries

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Current Market Overview - Supply

• Supply is Up – at least 4X over 2008. • More larger corporate portfolios are hitting the market as operating

companies prune their non-core patent holdings to generate revenue and decrease prosecution/maintenance costs (e.g., HP, NEC, Philips, Verizon).

• Later-stage venture-backed companies are more willing to trade their

offensive IP position for a defensive license plus cash. • Patents are being used to finance corporate acquisitions (e.g., IV’s financing of acquisition of Transmeta by Novafora). • More bankruptcy/restructuring patent sales (e.g., Nortel, Delphi, Qimonda, Spansion). • Financial and strategic buyers are having a hard time keeping up with the offering flow.

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Current Market Overview - Demand

• Demand is Down – and the remaining buyers are much more selective. • Flight to Quality* • Smaller targeted portfolios (10-30 patent families) are preferred to larger broader (100’s or 1000’s of patents) portfolios.

• Strategic/opportunistic buyers are sitting on the sidelines due to lack of cash.

• The current market is all about economic pain – inflicting it or avoiding it. • Institutional Investors are focused on litigation - financing assertion or

defense models (e.g., IPCom [Fortress], RPX [Kleiner Perkins & Charles Rivers].

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What is a High-Quality Patent Asset?

• Current Infringement vs. placing a bet on technology evolution • Clear Infringement - no serious claim construction issues, requires bulletproof claim charts • Large Impacted Market requires compelling market data • Substantial Damages by application of reasonable royalty to impacted market over time • No Major Validity Issues e.g., uncited prior art more relevant than cited, obviousness issues • Minimal Encumbrances unrestricted (time/FOU) licenses and security interests • No Chain of Title Problems • Ease of infringement Detection

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Current Market Overview - Prices

Market Segmentation – 3 Tiers • Top End: Quality –

Definition: current infringement with significant economic impact with no serious validity, encumbrance or title issues.

Prices are holding or in rare cases increasing (e.g., standards)

• Bottom End: Commodity –

Definition: speculative - no infringement, current or prospective. Sayonara! • Mid-Market –

Definition: prospective use only, some validity/scope issues. Still selling but at significant price discounts (up to 50% or more)

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Market Effects on Seller Strategies

Combined effect of more selective buyers, increased supply and and larger portfolios ▼

• Much of the diligence burden has shifted from buyers to sellers & sell-side brokers. • This means clear and convincing claim charts and market studies. • The bottom end of the market is gone. • Sellers need to be aware of how buyers measure value.

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Date Seller Buyer(s) Technology No. of Patents & Apps Price Price /Patent

Dec. 2012 Kodak (Bk) RPX/IV-Led Buyer Syndicate Digital imaging 1100 525M $477K

Nov. 2012 MIPS ARM Networking/Mobile 580 350M $603

Oct. 2012 Alvarion Wi-LAN Wireless 150 $19M $127K

Sept. 2012 Elpida Apple Memory 259 51M $197M

Aug. 2012 Nokia Vringo Wireless 109 22M $202K

July 2012 Fujifilm Univ. Display OLED 1200 105M $87.5K

June 2012 Interdigital Intel Wireless 1700 375M $220K

June 2012 IBM Ultratech Semi Packaging 109 8M $73K

May 2012 IP Wireless Nvidia & Intellectual Ventures Wireless 500 ?

Recent High-Visibility Patent Sales & IP-Driven M&A Transactions

Date Seller Buyer(s) Technology No. of Patents & Apps Price Price /Patent

April 2012 Digitude (Altitude) RPX (10+ Member Acq. Syndicate) Consumer Elec. 500 46M $92K

April 2012 Microsoft Facebook Internet 650 $550M $845K

April 2012 AOL Microsoft Internet 925 $1.1B $1.2M

March 2012 IBM Facebook Networking, software, etc.

750 ?

Feb. 2012 MOSAID Google Optical networking 200 ?

Jan. 2012 Real Networks Intel (license back to RN) Media players, Digital Video

190 (+170 apps) + codec dev. team

$120M $632K

Jan. 2012 IBM Google Mobile phones, etc 188 (+ 29 apps) ?

Jan. 2012 Nokia Sisvel Intl. Wireless 450+ ?

Jan. 2012 Adaptix Acacia Wireless 230 100M $435K

Recent High-Visibility Patent Sales & IP-Driven M&A Transactions

Recent High-Visibility Patent Sales & IP-Driven M&A Transactions (cont.)

Date Seller Buyer(s) Technology No. of Patents & Apps Price Price

/Patent Oct. 2011 MOSAID Sterling Partners (private equity)

Trumped Wi-LAN hostile bid of $532M Wireless 5385 (1200 essential)

(M&A -stock sale) $596 M $110 K

Sept. 2011 ContentGuard Pendrell Digital Rights Mgmt. 420 (160 pending) $90.1M $215K

Sept. 2011 MOSAID Google Data compression/ encoding/search/ encryption, flash

18 $11 M $610 K

Sept. 2011 Core Wireless, Sarl. (Nokia & Microsoft)

MOSAID – M pays all licensing and litigation costs, and receives 30% of TP royalties

Wireless (from Nokia) Other (from Microsoft)

2784 (incl. apps) (1200 essential)

$200K + royalty

split

Aug. 2011 Motorola Mobility Google Wireless, handsets 17,000 plus op. bus. (1300 US “essential”)

$12.5 B $730 K

Aug. 2011 IBM Google Storage & networking 1023 ?

Aug. 2011 Google HTC Mobile phones 9 ?

Aug. 2011 Glenayre Elect. Wi-LAN Wi-Fi, Wi-Max 60 $8 M $133 K

July 2011 IBM Google Storage & networking 1030 ?

July 2011 S3 HTC Graphics 235 $300 M $1.3 M

Recent High-Visibility Patent Sales & IP-Driven M&A Transactions (cont.)

Date Seller Buyer(s) Technology No. of Patents & Apps

Price Price /Patent

July 2011 Nortel (BK) Rockstar Bidco Acq. Syndicate (Apple, EMC, Ericsson, Microsoft, RIM, Sony)

Telecom 6000* (>2700 issued US) (107 US essential)

$4.5 B $750 K

May 2011 Hynix Mosaid - related to Mosaid license to Hynix on other pats.

Semiconductor 500 ?

May 2011 IBM Google Data storage 1000 ?

April 2011 ADC Telecomm. HTC Wireless 82 (+14 apps) $75M 915 K

March 2011 Kodak Omnivision Image sensors 850 $65M 76 K

Nov. 2010 Novell CPTN Holdings Acq. Syndicate MSoft, Apple, EMC, Oracle (DOJ altered some deal terms, open source concerns)

Computer system mgmt (Linux-related)

882 $450 M $510 K

Aug. 2010 Friendster (MOL Global)

Facebook Social Networking 7 (+ 11 apps) $40M $5.7M

April 2010 Palm HP Mobile & OS >1500 + Web-OS IP $1.2B $800 K

• Shift from financial to strategic buyers at the upper end of the market is driving patent valuations to unprecedented highs.

• The Perfect Storm Effect – Combination of --

> large strategic buyers with small patent portfolios and lots of cash (e.g., Google, Facebook), and

> industry pioneers having large patent portfolios with broad coverage who have fallen on hard times (e.g., Nortel, Kodak, AOL, RIM, Nokia).

• As valuations rise, traditional investment bankers are getting into the game (e.g., Lazard, Evercore, BofA/Merril-Lynch).

• Use of average-price-per-patent in completed transactions to set market price in new deals.

• Patent acquisition as a signaling mechanism in the product market.

• Return to buying patents by the pound?

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The Patent Marketplace – 2012 Megatrends