Patents as an asset class: the law of unintended consequences

On various occasions I have written about the precarious position in which intellectual property finds itself when described as an asset class. Whatever truth was living in that classification has now evaporated.

Attending IPBC Global 2015 last week, I was surprised at the sanguine nature of the discussion about the state of the market. There was the usual grumbling about Congress and Google, but no one really seemed in a state of panic. It is almost as if the audience had moved from the first Kubler Ross state of grief (denial) directly to the last stage (acceptance) without transitioning through the intermediate phases of anger, bargaining and depression.

My attention in San Francisco was gripped by the plenary panel entitled “End of an Era” and the inventor panel featuring, among others, Chuck Hull, the inventor of 3D printing. I also listened carefully to coffee-break discussions about inter partes review and the impact of everyone’s favourite enfant terrible at Hayman Capital.

My take-homes were significant.

Legislation in the United States and the courts' interpretation of it has stopped dead patents' journey from legal right to traded asset. Simply put, patents are not an asset class if they can be invalidated at will by patent offices. Imagine if this could happen to stocks or bonds. Financial chaos would result.

The inter partes review statistics speak for themselves, with the most recent numbers showing an 85% cancellation rate. 

This is not a good thing for patent owners, which face reduced liquidity and value for their expensively produced patents, with concomitant reduction in utility for licensing and financing. For financial investors which have identified patent litigation as an attractive niche, it is worrisome; as it is for lenders which have dipped their toes in the nascent patent 'asset-backed' market. As in all investment strategies, the opportunity starts to move as soon as money starts to enter the market. In this case it is not supply/demand, but a regulatory catalyst that is driving change.

Just as the market for buying royalties rewarded the first movers with well-priced deals and a healthy supply of inventory, so the patent litigation market has had its best days for investors. The America Invents Act had some intended and unintended consequences - the latter being a reduction in liquidity, demand and value for patents across the board.

One consequence of this state of affairs is a migration of money across the Atlantic based on the yet-to-be proven assumption that European courts (particularly German courts) will breathe life into European patents and provide the big stick of injunctions as a matter of course. This remains to be seen - as does the propensity of inter partes review to cross the Atlantic. The knock-on effect of US regulation on European markets has been beneficial for creating industries in the past, and it could be that way again. If this is the case, the impact on the stock prices of Eurocentric companies will be interesting to observe, since they will benefit from stronger IP protection and in theory should increase in value where their revenues derive from European sales.

For financial investors in intellectual property, the best risk/reward is now to be found in patents that can affect European sales or be directly tied to products, technologies or services. Of course, this value is not confined to patents and will likely also include trade secrets, data or codified processes or procedures that generate an operational advantage for the inventor. 

This intimate reconnecting of intellectual property to the business that it supports is a radical change of direction that will fundamentally restructure an IP industry that has grown bloated on patent monetisation revenues. As I have written before, it will challenge non-practising entities in particular to find new business models.

Ironically for agnostic investors, the hostile legal and regulatory environment may make intellectual property more attractive as an asset (if not an asset class). The reason is one of understanding.

Fundamental intellecual property that is integrated to design, research and manufacturing is something that can be understood intuitively by investors, trustees and turnaround specialists. It is less esoteric than the disembodied notion of patents that have a life of their own outside of the operating company context.

Consequently, the America Invents Act may indeed achieve some worthy aims. By forcing companies to more explicitly link their intellectual property to their products and inventions, it may reduce over-patenting, reconnect the legal department with the business, remind CEOs where the real value drivers for margins and market share lie, invigorate the capital investment case for intellectual property and marginalise litigation finance.   

The IP pendulum is swinging back to the real economy of products, services and value creation. Now that truly is an unexpected and unintended consequence.