If it’s broke, fix it

In Summer 2011 Acacia Research was in its pomp. That September the company’s market capitalisation peaked at $1.75 billion as its share price reached just under $47; back in 2008 the same shares had been trading at $2. Seeking to take advantage of the firm’s standing, Acacia executives agreed what seemed like a transformational deal for the non-practising entity (NPE).

At the beginning of 2012, the business bought ADAPTIX, a failing product company which came with a portfolio of more than 200 patents. The $160 million price tag might make many wince today, but back then the market was booming following the June 2011 auction of Nortel’s patent assets, which had been snapped up by the Rockstar consortium for a staggering $4.5 billion. Compared with that, $160 million for what was deemed to be a good-quality portfolio did not look unreasonable.

Acacia had a swagger fuelled by easy access to capital, a growing portfolio of assets and a team of executives who appeared at ease with their reputation as being among the brasher players on the block. In 2012 there was no doubt who the masters of the NPE universe were.

Today, the world looks very different from Acacia’s sun-kissed Southern Californian HQ. Its share price has collapsed, with the company’s market cap hovering around the $200 million mark. Its monetisation of the ADAPTIX portfolio has largely disappointed, as the highs of two quick licensing deals inked with Microsoft and Samsung gave way to a string of courtroom losses. In December 2015, a day after Acacia suffered a defeat in the Eastern District of Texas in a case involving one of the ADAPTIX patents, Matthew Vella stood down as CEO after three years in the post. To rub salt in the wound, in March this year the business was the subject of a $189 million offer from Uniloc. Given that Acacia had around $145 million in the bank at the end of last year, Uniloc’s bid effectively valued its assets at $44 million. It was quickly rejected by the Acacia board, but the approach was a stark illustration of just how far Acacia had fallen.

Chris Donegan, principal, Fraserburgh Consulting

How the value of patents is realised is changing

Erich Spangenberg, CEO, nXn Partners

NPEs need to communicate more effectively with Wall Street

The fallen

Acacia is not alone among NPEs in seeing once-heady market valuations collapse in the face of a chilly licensing climate and unfavourable court decisions. FORM Holding – the company, previously known as Vringo, which started out selling ringtones for smartphones - pivoted its business into an NPE in March 2012; its share price peaked later that year at just under $50. Today that figure sits at around $1.50, as the company licks its wounds in the wake of a damaging 2014 court case with Google and a $21.5 million settlement with ZTE following a global litigation campaign against the Chinese tech giant.

As even the most cursory follower of the patent market can tell you, the traditional NPE business model, if not completely broken, is on life support. How NPEs get hold of their patents – through outright acquisition or privateering deals with operating companies, or sometimes even through organic creation – may have evolved, but the basic principle of licensing intellectual property with the stick of litigation has not.

And that is the problem; because the licensing environment in the United States has shifted fundamentally thanks to evolving case law, new post-issuance review procedures and a conviction among alleged infringers that if they hold out long enough, many NPEs will simply run out of cash before they can prevail in court.

Perhaps the only thing that is clear for NPEs is that simply continuing what they have been doing for the past few years will no longer cut it. They need to evolve their business models, perhaps even diversify from their licensing roots or find a way to monetise the abundant experience that their battle-hardened management teams have built up from fighting complex and increasingly multi-jurisdictional infringement lawsuits. But weaning an NPE off a typical litigation-led strategy is easier said than done. “Asking management to do anything other than hit something with a hammer is very hard,” admits Chris Donegan of Fraserburgh. Succeeding as an NPE today requires a whole new toolbox.

Jim Skippen, CEO and president, WiLAN

Access to cheap capital is now off the table for most NPEs

How the world has changed

At IAM’s NPE conference in March this year, WiLAN’s Jim Skippen gave perhaps the most cogent analysis of how the world has changed for the sector. Skippen is a no-nonsense operator who earned his licensing stripes at MOSAID Technologies (now Conversant) before joining WiLAN and becoming CEO in 2006. His approach is simple – if a deal is on the table, you should probably take it and not hold out for a jackpot damages award that in all likelihood will never come.

At MOSAID in the early 2000s, Skippen and his colleagues did some financial modelling to identify the best approach for a licensing business. “We came to the conclusion that we were better off financing our own litigation, not using contingency agreements, because the chances of success were much better,” he says. It also made sense to buy patents for cash upfront, giving the NPE 100% of any licensing revenues it reaped.

Today, explains Skippen, the same modelling yields a dramatically different outcome: “Now we are better off if we de-risk litigation and when we acquire portfolios we are much better sharing the risk.” This involves contingency deals with law firms or other arrangements that do not involve billing by the hour and, when acquiring patents, more privateering deals which include little to no cash upfront.

Alexander Poltorak of General Patent Corp, Corey Horowitz of Network-1, Mintz Levin’s Michael Renaud, Anthony Hayes of Spherix and Jim Skippen of WiLAN discuss the market at IAM’s recent NPE conference

In addition, he continues, the availability of capital for a licensing business has greatly diminished as the environment has worsened: “Fifteen or 16 years ago - even five years ago - the taps were open [for capital]. Now you just can’t get access to cheap capital and capital for any business is critical.”

This has not been helped by the fact that most NPEs’ share prices have been spiralling downwards for the last few years. Some, including Spherix and Inventergy, have been forced to go through reverse stock splits in order to remain on NASDAQ, which requires companies to maintain a share price of at least $1 to stay on the exchange. “If your stock is going up and you are doing well, then bankers are interested in you,” Skippen told conference delegates. “If your stock is down, they’re not.”

The extent to which NPEs still make sense as public companies is one of the big debates in the sector and a shift to go private might become a key trend in the next few years. As Acacia’s meteoric rise showed, it is not that long ago that investors’ heads were turned by IP businesses. The promise of blockbuster damages awards kept shareholders on the hook even as most NPEs’ quarterly revenues fluctuated wildly. “At times at WiLAN we’ve had no revenues and a $700 million valuation; and then at other times we’ve had healthy revenues and a much lower valuation,” reflects Skippen.

Cash is king

But today, investors have realised that they can no longer take punts on the promise of big courtroom pay-outs with the risk of patents being ruled invalid in inter partes reviews and of district court wins being reversed by the Court of Appeals for the Federal Circuit (CAFC). “Two years ago it was, ‘Show me a verdict and I’ll reward you,’” says Spherix CEO Anthony Hayes of how investors’ attitudes have changed. “Now it’s, ‘Show me money in the bank’ - you can’t cash a verdict.”

The issue that public IP companies (PIPCOs) now face is that while litigation has stretched out from a 12 to 18-month scrap to a protracted battle lasting several years, their parlous financial predicament is exposed for all to see thanks to the high standards of transparency that they must meet. Plus, with their share prices plummeting, they are unlikely to exact a settlement from an alleged infringer that is equivalent to a significant chunk of their value. “Potential licensees ask, ‘Why should we pay you that - it’s 50% of your market cap?”” admits David Cohen, chief legal and IP officer at what was previously known as Vringo but is now FORM Holdings.

Perhaps more than any other NPE, Vringo’s recent courtroom travails show just how challenging the litigation environment has become. In Summer 2014 it lost a suit against Google on appeal at the CAFC by a two-to-one majority, even though it had prevailed in the lower courts and proved the validity of its patents.

At the same time, the NPE was also fighting a multi-jurisdictional case against Chinese telecoms giant ZTE. After FORM Holding sued in New York district court for alleged breach of contract (the two sides had entered into a non-disclosure agreement during initial licensing negotiations, which FORM Holding claimed ZTE had breached), its opponent’s tactics came to light in court documents. Here is an excerpt from an email sent by an IP counsel at the Chinese company: “As a listed American company, FORM Holding places great importance on stock prices, plus, after every action they take, they always distribute related information; we will expand our information broadcasting activities after the release of any information that is beneficial to our company to attack the overall image of the party side, and also cast them as a notorious patent troll. This will also reduce the quality of their patents. This will further reduce their psychological expectations of the prices they think [they] will get for licensing fees from our company.”

In December the two sides settled, with FORM Holding receiving $21.5 million in return for granting ZTE a licence to the patents in dispute.

A change of tack

It is clear from the experiences of FORM Holding and others that an NPE strategy built around the traditional, litigation-led approach is increasingly challenging. So how should they adapt? Over the last year, several NPEs have started to rethink their business models in order to spread risk, diversify their revenue streams and ultimately survive in the current climate.

Most of these approaches do not deviate from the basic principle that an NPE’s revenue is driven by monetising patents. What is changing instead is how this is done, and by whom.

In March, Spherix entered into an agreement with EquitableIP – a new monetisation business set up by Dean Becker, previously CEO at ICAP Patent Brokerage – under which Equitable IP will monetise part of Spherix’s portfolio. Given that a large share of the NPE’s assets were previously owned by Nortel and were part of the portfolio acquired by Rockstar for $4.5 billion, by most measures they would be deemed pretty valuable patents. To Hayes, the motivation for bringing Equitable IP on board was simple: “The deal offloaded risk; it’s no more complicated than that.”

At a time when most NPEs are regarded as risky bets by the investment community, this would seem to be a smart move, and as a private business EquitableIP can license those assets away from the glare of the public markets. But ultimately, simply shifting the responsibility for monetising some patents does not circumvent the problems of today’s incredibly challenging licensing environment.

An alternative, which has also gained ground in recent years, has been to use patents as a form of investment in start-ups, with the NPE receiving equity in the new businesses in return. GE initially attempted to do something along these lines in Canada, but it was Spherix that was among the first NPEs to test out the model in early 2014 with the launch of an initiative called Innovate21. While this has not yet led to any deals, it is an option that remains appealing to Hayes. “It’s the logical evolution,” he suggests. “Great patents should be recycled to help seed start-up and early stage companies.”

It is also a model that WiLAN has pursued in partnership with Dominion Harbor. In May last year Dominion launched an IP bank specifically to seed patents into start-ups. Earlier this year WiLAN announced that it was transferring a portfolio of assets to the bank. “We can do it because we’re a large NPE with a large portfolio,” Skippen explains. Plus, the chance to build an early IP stockpile should be attractive to new businesses. “Start-ups are much more likely to get financing if they have a patent portfolio,” he adds.

Deals and more

WiLAN has suffered its own dark moments in the recent market turmoil, but 2015 might come to be seen as a transformational year for the NPE. Last June it announced that it was buying a portfolio of 7,000 grants and applications formerly owned by Qimonda for $33 million. The assets had been for sale for several years, but were dismissed by some potential buyers as too encumbered by existing licences. After the transaction closed, however, WiLAN immediately revealed that it had signed a licensing agreement with Samsung, and at IAM’s March event Skippen disclosed that the business is already close to breaking even on the acquisition.

Soon after the Qimonda deal, WiLAN followed up with the announcement that it was entering into a privateering deal with Freescale Semiconductor, taking 3,300 patents from the US business which was recently acquired by NXP Semiconductors.

The two deals mean that that WiLAN’s IP armoury now numbers more than 10,000 patents, making it among the largest NPEs in terms of assets. However, it has also looked to slim down part of its portfolio, selling up to 400 patents to Taiwan Semiconductor Manufacturing Company (TSMC) as well as giving the company a licence to part of its portfolio. That deal was relatively straightforward; but Skippen suggests that playing an intermediary, brokerage-type role is another way that NPEs can diversify their approach. Others have inked deals along similar lines, such as Unwired Planet’s $100 million sale of a portfolio to Lenovo in 2014 and InterDigital’s 2012 disposal of around 1,700 patents to Intel for $375 million.

According to Mike Renaud, Mintz, Levin, Cohn, Ferris, Glovsky and Popeo’s head of intellectual property, these kinds of opportunities are limited, but they do offer NPEs an alternative beyond simple licensing. “There are ways to leverage patent assets without resorting to enforcement,” he insists. “For example, you can match up a company with poor patent coverage with a portfolio that has deep relevant patent protection.”

Admittedly, any deal of this kind involves a certain degree of luck: being in the right place at the right time with the right assets. But some NPEs are ideally positioned to make their own luck. They have an in-depth knowledge of the patent market that few can match, giving them a sophisticated understanding of which assets are valuable in the current climate.

“NPEs have a lot of data which gives them great insight into the actual value of patents owned by a lot of companies which could be put to use on things like company valuations,” says Donegan. “That data and knowledge risks being wasted.”

Take FORM Holding as an example. Its campaign against ZTE was truly global, with actions in the United Kingdom, Brazil, Romania and China, among other jurisdictions. It was also waged against a company with a growing portfolio, which most people assume will soon become a key player in the global tech market. After FORM Holding settled with ZTE, David Cohen says that it was approached by other Chinese companies keen to get some insight into how they might take on one of the country’s corporate behemoths. That expertise, he suggests, could be turned into a revenue stream; but the question is how.

Changing a management team’s mindset from a pure focus on licensing to a more diverse business strategy is far from straightforward. And in the case of PIPCOs, shareholders must also be convinced that, having invested in a licensing business, they should keep their money in a company where IP monetisation is no longer the main name of the game. This challenge is greatest when an NPE is considering a move into a product business.

And now for something completely different

If you study Marathon Patent Group’s track record, there is little to suggest that it is the natural home for a subsidiary built around high-end tinted glass. But this March the NPE announced that it had acquired the technology and two executives from HP to set up 3D Nanocolor, a business that is developing a plastic film that can be placed over any piece of glass which can then change colour at the flick of a switch.

For Marathon CEO Doug Croxall, his company’s investment in the new subsidiary is relatively small and offers a low-risk opportunity to add another string to its bow. He readily admits that tinted glass is not his forte, but suggests that his team’s experience is uniquely transferable to a start-up business. “Our knowledge and appreciation of IP really set us apart from the typical path for most start-ups,” says Croxall. “The fact that we know what a patent can do and support really distinguishes us, and I’m not sure you get that from traditional VC funding.” But 3D Nanocolor is still a few years away from contributing revenue, and at a time when most NPE executives are preaching a mantra of cost control, it will still be a drag on the bottom line.

Indeed, the need to control spending was one reason why WiLAN shut down its own R&D business, which was costing between $3 million and $4 million annually. Last year WiLAN announced that it was seeking to spin this off into a standalone business, if it could attract the necessary funding. But by December it was clear that no investors were willing to back it and the NPE took the decision to close it down. “The R&D business gave us patents, but the value of patents generally kept falling and we felt it would be cheaper to go out and find patents ourselves,” explains Skippen.

Unsurprisingly, some remain sceptical of some NPEs’ attempts to back more tangible businesses. “I have heard people say, ‘Go to Europe’ or ‘Start a product business’, like they’re panaceas; but they’re not. If you are developing a product business, there has to be a cohesive transition or connection with the licensing business or it just looks like a play aimed at recycling old ideas,” insists Dominion Harbor CEO David Pridham.

In contrast to Marathon’s tie-up with 3D Nanocolor, FORM Holding’s acquisition of a product business does at least have some links to the NPE’s earlier involvement in the mobile sector. In October last year it bought wireless charging technology developer Flicharge and Group Mobile, a maker of rugged PCs, tablets and handheld computers. Together they had revenues of over $7 million in 2014, so they remain fairly small operations.

In explaining the move, FORM Holding’s Cohen highlights several benefits of developing a product business. First, having your own products that you can point to in front of a jury or judge strengthens your position as a plaintiff in an infringement lawsuit. Second, he maintains that the strongest patents are those which a company has developed itself, rather than those bought in. Third, as licensing revenues from a product business should be less episodic than those of a 100% patent licensing operation, they are better suited to the quarterly reporting of a listed business.

“We have a lot of opportunities to pursue at FORM Holding, but pure-play IP is dead,” he continues “We are now trying to find ways to use IP that spread the risk and capitalise on our deep knowledge of the space.”

The walking dead

Cohen’s assertion may sound apocalyptic; but when you look at the depressed stock prices, courtroom losses and deluge of inter partes reviews increasing time to money, it is hard to argue with. This is not to say that all NPEs in their current incarnation will go out of business in the next five years; there is a good chance that WiLAN will survive, for instance, along with leaner players such as Network-1 that have a relatively small number of patents delivering respectable licensing revenues. But many of the others are undoubtedly facing an existential crisis.

In April, for example, Unwired Planet announced that it was selling its patent business to Optis UP for up to $40 million. Despite a number of court victories in the United Kingdom and Germany, Unwired CEO Boris Teksler admitted that the cost and duration of litigation, and the way in which potential licensees were dragging out disputes, meant that the NPE simply could not afford to keep fighting. The deal still may not go through – at press time it was due to close in late June or July – but Unwired’s decision to walk away despite having more than 2,000 Ericsson-originated patents to monetise paints a particularly bleak picture of the sector.

“The problem is not that the asset class is horrible; it’s that no one has been able to communicate to Wall Street that this sector doesn’t fit the paradigm of good visibility quarter to quarter,” insists Erich Spangenberg, founder of IPNav and now head of nXn Partners. “It’s a difficult environment - certainly the most difficult anyone working in this sector has seen - but I do still think there’s value there.”

No one in the sector has pulled back as dramatically as Spangenberg: as he tells it, he went from being one of the biggest filers of infringement cases to filing a mere two in 2013, and today he has just one on the books. He also stopped buying patents in 2012; but as he senses the market starting to bottom out, he has recently been back on the acquisition trail.

For some, there are signs that the patent rights pendulum - which for several years has been arcing away from rights holders - might now be swinging back. Patent owners and NPEs in particular could receive a significant boost from the Supreme Court’s decision in Cuozzo Speed Technologies v Lee on whether the broadest reasonable interpretation standard should be used when analysing claims in post-issuance reviews. Such is the effect that reviews have had in lengthening most NPEs’ time to money that some investors suggest the case could have a considerable effect on the market. “I think Cuozzo is a game changer,” says private investor and analyst David Hoff. “I have read numerous institution decisions where the patent office has taken a very unreasonable view.”

The climate might be improving, but it is unclear whether many NPEs have sufficient capital left to ensure that they are still operational when licensing starts to pick up again. That is why developing new revenue streams and fixing a badly damaged business model has, in many cases, become crucial to their survival. “I am only really negative on the business model,” sums up Donegan. “Patents have value, but it is how you realise that value that’s changing.” And with it, so too are the tools of the trade.