The changing face of the IP value creation market
As the patent market continues to evolve companies are becoming ever more creative as they look to generate a return from their intellectual property
To say that the IP value creation market has transformed in the last decade is one axiom that is hard to dispute.
Take your pick on who to blame as the change-makers-in-chief. Perhaps it is the meddling Supreme Court justices who have rewritten vast swathes of patent jurisprudence in the United States and with it the business models of licensors everywhere. Or maybe machinating European politicians, technocrats and lawyers who – with all the aplomb of a will-they-won’t-they story line from a Hollywood romcom – have kept the world’s patent community on tenterhooks over the creation of the unitary patent and the UPC. Or maybe it is the rise of a new self-confident, well-resourced and state-sponsored patent-owning class in China that has given us new global players to consider and a domestic market that will play an increasingly important role.
Change is expected in a market that has the latest technology at its core, as innovators look to build on what has gone before or to break the model completely. Yet for some, the past few years have been a little hard to stomach. Many of the NPEs that came to define a new licensing business model – such as IPNav and Acacia Research – have beaten a hasty retreat or sought to add a few more strings to their bows in addition to straight patent licensing.
The once-mighty Intellectual Ventures – in many ways the secondary patent market in the early 2000s as it hoovered up thousands of grants – is now in full-on sales mode. RPX, another iconic brand, has just been taken private at a discount and faces questions about whether it can remain relevant in a market of diminished NPE activity. Qualcomm, one of the undoubted victors of the smartphone age as it engineered a fourth-generation LTE chip that few could match, now faces an existential fight over its licensing practices thanks to sprawling litigation with Apple.
In early 2014 IAM editor-in-chief Joff Wild published a bird’s-eye view of the market in a piece on the IAM blog entitled “The IP sales marketplace from 50,000 feet”. While the signs of a very different environment were apparent (the Supreme Court had already spent several years reshaping patent jurisprudence in the United States) it was not completely clear just how dramatic change would be and how the sector would evolve in the short term.
More than four years on, we have decided to provide another macro-analysis of what has changed and how things may continue to unfold. To do that, we divided the market into its main constituent parts and sought the views of a range of leading players. What quickly became evident is that the big names are bracing themselves for more flux.
Operating company perspective
One thing that has not changed in the last four years is that one of the toughest instructions that can be handed to the chief IP officer of a major patent-owning business is to turn an IP group from a cost centre into a profit generator.
This is particularly hard in a large operating business with myriad customer relationships and internal dynamics which may not encourage IP monetisation. This does not make it impossible, but asserting intellectual property against a business that another part of the company hopes, one day, to turn into a customer or may even already have as one, can make things tricky.
For most operating companies, deriving value from intellectual property means what it always has – a way by which to achieve freedom to operate in a particular sector. That has remained the guiding force for most businesses, but several have started to add other dimensions.
While there remain some entities – such as the owners of large SEP portfolios in the mobile space – that focus on royalty-based licensing, there are a growing band of businesses which actively see their stockpile of intellectual property as a way of supporting their interests in deals where a patent transfer or a licence might be part of a much broader agreement. Microsoft’s IP group, for instance, has evolved from straight patent licensing being a primary driver, to a position of clearly supporting the company’s focus on mobile and cloud computing.
This was clear in the software giant’s 2016 deal with Xiaomi which, among other things, saw the Chinese mobile manufacturer receive a package of 1,500 patents in return for agreeing to pre-install Microsoft applications on a range of its devices. You can also see the same principles at play in the Azure IP Advantage programme.
Others, such as GE and Boeing, have also started to reassess how they can generate a return from their intellectual property through patents-plus-technology deals or through innovative transactions in which patents are used to back new businesses. For those chief IP officers that are handed intellectual property’s toughest job, this approach seems to offer the most appealing path forward.
Redefining patent value
In the six years since the PTAB came into force, Unified Patents has been one of the most active inter partes review filers, challenging patents that are perceived to be of questionable validity and which pose a threat to its members in specific sectors such as auto, retail and the Internet of Things. “We very much grew as a company with the implementation of the [America Invents Act],” comments Unified CEO and co-founder Kevin Jakel. “Our strategy has been pretty consistent from day one that we were going to use inter partes reviews to show that too many of the patents out there being monetised were actually pretty low quality and the value of those was false to begin with,” he adds.
While Unified has championed inter partes reviews, a process that has depressed the value of patents in the eyes of many, Jakel’s position in the market has given him an interesting perspective from which to view IP value creation. He suggests that it is crucial to gain a broad overview.
“Value means very different things to different people,” he points out. “When we talk about brokers and we talk about people in the market that sell patents, value often boils down to the price of the patent. I think that’s a pretty narrow definition in many cases, there’s a lot of things that patents get used for and there’s a lot of value that can be derived from a patent portfolio absent from just the sale of assets from one company to another. While Alice and the AIA have had an impact, I think there are lots of other measures for value that are important.”
He then adds: “Once we see this tumultuous period die down we will come out on the other end with perhaps a smaller universe of highly valuable patents which is something that personally I think is the right way for intellectual property to go.”
In its relatively short existence the PTAB has generated a large amount of criticism from patent owners and other stakeholders. It has been argued that it is biased against rights holders, but Jakel claims that the debate around the review procedures is part of a much bigger question. “People should recognise that as part of our patent system we need to consider validity as part of value and there are two ways to address that in my opinion – one would be to put a tonne of money into the front end and give examiners three or four times as much time as they have today to do more prior art searching, to have access to additional tools and to put far more requirements on companies to submit prior art. We could move the cost of figuring out whether a patent is valid or not to the front end of the system before a patent is ever ranted.”
“The problem I see with that is it’s really expensive on every single patent and the truth is that of the hundreds of thousands of patents issued by the patent office, the number of those that actually see the light of day either in a licensing negotiation or in litigation is a tiny fraction of the total. I think the AIA gives a good balance so that on the back end you have a system that is designed to look at prior art that was maybe missed by the examiner on the very small number of patents that actually see a dispute between two parties. It’s very difficult to assign a value to patents just because they’ve been issued, without contemplating validity and the AIA has really highlighted that, which in the long run is very good for our patent system.”
So, in the era of inter partes reviews and a very different legal environment how does Jakel see IP value changing? “Patents will be valued more specifically in particular contexts – that means patents that are highly valid and read on specific, important technologies will ultimately bounce back significantly,” he claims. That could mean that patents that survive myriad challenges at the PTAB from the likes of Unified and its members may ultimately garner higher prices than before the AIA.
The new breed of NPEs
No part of the IP value creation market has gone through a greater existential crisis than NPEs over the last five years. In the United States, a steady downward trend in damages awards, the decline in the availability of injunctive relief, the introduction of the Patent Trial Appeal Board and inter partes reviews, a canon of jurisprudence in areas like patent eligible subject matter and a pejorative narrative around patent trolls have transformed the market for NPEs, and diminished the litigation threat faced by operating companies.
The effects have arguably been most closely felt by the public IP companies, such as Acacia, WiLAN and VirnetX, which once enjoyed valuations approaching or even exceeding $1 billion. They have seen their share prices fall markedly and, in several cases, have looked to exit the IP industry or broaden their business into other sectors.
There are exceptions to these struggles but the NPE model for success nowadays largely means private ownership, paying little money upfront for assets and having deep enough pockets or the right kind of fee agreement with outside counsel, to survive a torrent of inter partes reviews along with a traditional courtroom battle.
All of this is not to say that NPEs are not making money – the value creation model has changed but it has not gone away. In the last five years, new NPEs such as Dominion Harbor, IPEdge, BlackBird and Longhorn IP, many of them led by industry veterans from the likes of IPNav and Acacia, have emerged and raised capital to build portfolios that in some cases stretch into the thousands.
While still largely a US-based phenomenon, the new breed of NPEs is also becoming far more global in its outlook, with China’s modernised litigation system – complete with specialist IP courts – attracting growing interest. In a clear sign of the Chinese market’s growing significance as a venue for patent assertion, one new NPE – iPEL which was formed in 2017 and is backed by $100 million in investment capital – is focusing almost its entire monetisation effort on the world’s most populous country.
A shift in the licensing market
Few other major operating company licensors have gone through quite as dramatic a transformation as Nokia in the last five years. In late 2013, the Finnish telecoms giant announced the sale of its once mighty handset business to Microsoft in a move which then prompted a significant ramping up of its efforts to license a portfolio widely considered to be one of the strongest in the sector. Fast-forward five years and Nokia now has a licensing business generating more than $1 billion annually with major agreements in place with the likes of Apple, Huawei and Samsung.
While he admits that licensing conditions remain challenging, Nokia licensing head Ilkka Rahnasto believes that conditions have improved to some degree in recent years. “Ten years ago there was a little bit of a gold rush in licensing and patent monetisation but from my perspective it stopped after the  Nortel auction. There was then a period when it was almost like the market was dead because everything was so difficult but in the last few years we have seen things moving at a more constructive pace. Now we see a move away from a more assertion-based licensing approach to a solution-oriented posture adopted by licensors and licensees.”
According to Rahnasto this is occurring worldwide including in China where he points to a generation of dealmakers at major patent-owning businesses who are helping to put agreements in place. “We still have hold out in one or two cases, but we also see a tendency where companies who have been seen as holding out, now have new managers who are quite solution driven.”
The shift in the licensing market, the Nokia IP chief says, has been driven in part by a shift in the mindset of many licensees. “Some licensees have realised that they can’t just say ‘no’ to everybody, sometimes they need to take a licence because if you’re holding out there can be negative consequences,” he insists.
What does the move to a solution-drive model mean for Nokia and its licensees? “It’s a question of whether your licensing model has some built-in flexibility,” Rhanasto explains. “It’s about whether you look for ways where you can help your licensing customer, because ultimately every licensing deal is about individuals who need to justify to their respective managements why a certain deal needs to be done.”
While much of Nokia’s recent value creation success has come from licensing to mobile handset manufacturers, like many patent owners Nokia is now looking to license its intellectual property into newer industries such as automotive. This may call for a different way of doing business.
“We try to have an approach that will not disrupt a particular industry because they all have their ways of dealing with licensing issues,” Rahnasto urges. He also points to the emergence of new collective licensing platforms such as Avanci, the business headed by former Ericsson IP chief Kasim Alfalahi, as one notable trend.
Nokia is perhaps the leading SEP owner in the mobile sector which has thus far opted to not join Avanci or another platform. “We have taken the view that traditionally Nokia has not been part of a collective arrangement, we do our own bilateral discussions,” Rahnasto argues. “But at the same time this is business and we need to keep an open mind to see which direction the market is moving, so we don’t exclude anything as a matter of principle.”
Should the new platforms start to pay off then the Nokia IP chief admits they might have to reassess their traditional bilateral approach. With few other companies matching Nokia’s recent licensing return, there is certainly a sense of if it ain’t broke, don’t fix it.
Over the last decade companies have been presented with a growing number of options when it comes to defensive patent platforms. While they are largely united in their focus on drastically reducing NPE litigation risk for operating companies, they are very different beasts in how they work. Leading players RPX, Allied Security Trust (AST), Unified Patents, the Open Invention Network and the License on Transfer Network all pursue different strategies, such as looking to acquire or license patents for their members (RPX and AST) or making aggressive use of inter partes reviews (Unified) to knock out grants of questionable quality in specific sectors.
The question they now face is how to remain relevant and prosper in a market where the threat from NPE litigation has been blunted. The recent travails of RPX is a case in point. Like Intellectual Ventures before it, when it was founded in 2008 RPX seemed to capture the patent zeitgeist. Major operating companies, particularly in the high-tech sector, faced a growing threat from NPEs, causing some to run up litigation bills of hundreds of millions of dollars. RPX offered those businesses the opportunity to reduce their exposure for the price of a membership, typically costing a few million dollars.
A who’s who of Silicon Valley quickly signed up including Apple, Google and Microsoft, and a 2011 initial public offering – which valued the business at more than $1 billion – confirmed RPX’s lofty position in the market.
However, as the climate for licensors became tougher, the company’s attempts to grow beyond its core business of patent risk mitigation and move into insurance and discovery services has, at best, produced mixed results. To that end, the company’s recent acquisition by private equity investor HGGC makes a lot of sense, enabling RPX to restructure its offering away from the glare of the public markets.
RPX’s problem has been justifying the return on investment on the price of membership – the titans of Silicon Valley might have some of the deepest pockets in corporate America, but their IP functions still need to make a case for ponying up for a membership that can stretch well into seven figures.
That is less of a problem for the other defensive players such as Unified, which charges much less than an RPX membership and focuses on inter partes reviews to knock out dangerous or questionable patents that might pose a risk to its members in specific sectors. However, with patent litigation continuing to fall in the United States the likes of RPX might need to add more to their core offering to help members realise a greater return for their cash.
A trailblazer changes tack
Through the 2000s and the early part of this decade, Intellectual Ventures (IV) was the trailblazer for a large part of the IP value creation market as it amassed a patent portfolio of tens of thousands of assets. As with any entity trying to generate a return from its intellectual property, the last few years have been tough for IV: the legal climate has moved decisively against licensors and the giant NPE has stopped buying patents for its third fund and ramped up its rate of sales.
To many observers, IV’s historically lofty position is a thing of the past. But it still sits on a huge arsenal of assets and, as Mathen Ganesan, executive vice president of the Invention Investment Funds, points out, it has changed its approach. “We have 23,000 active assets in our licensing programme and our model for a long time was based around large-scale patent aggregation,” he explains. “But the way we were buying towards the end of fund three changed as the market started to change so that rather than buying large quantities we were starting to buy smaller pockets of higher impact assets, taking into account what had happened with the AIA and Alice.”
Now that the firm has stopped acquiring, Ganesan continues, it has pivoted into full-on monetisation mode: “Our core focus is how do you put that quantity of patents to work as broadly as possible in parallel and you can’t do that with a linear licensing model anymore. To really put such a large portfolio to work, you need to establish licensing and litigation partnerships, divest assets and prosecute open applications strategically and always be on the look out to solve a company’s IP challenges.”
In practice, that means more sales so that other licensing entities can look to generate a return from IV’s patents – more often than not through litigation. Since late 2016 the business has done around 50 disposals and Ganesan reveals that, off the back of that, almost 150 patents that they have sold have ended up in litigation. “For us to do that on our own would be pretty challenging,” he admits.
So do IV’s struggles show that the large-scale aggregation model is dead? “Because of the impact of all of the changes in the market, all of the case law and the legislation that has come about, the pool of patents that represent risk and are of genuine value has shrunk,” Ganesan concedes. “There’s still an aggregation play out there, but it’s a different kind of aggregation than what it might have been 10 years ago. It’s more focused on impact and genuine applicability to core technologies that underpin high-revenue products and services.”
Convergence should, in theory at least, make the patents underpinning those technologies even more valuable; and Ganesan points out that that is where the brightest prospects lie. “You’ll always have a layer of pure assertion-based licensing, but I think where the real opportunities are going to be is in plugging the IP holes through licensing and patent sales that arise from companies moving really quickly into developing new products and services and also in re-enforcing the application of existing technologies into new markets,” he comments.
Patent pool renaissance
Although patent pools have existed since the 19th century, the modern version really started with the creation of MPEG2 in the mid-1990s, administered by MPEG-LA. In the minds of many this remains the high-water mark for modern pools as it generated a return stretching into billions of dollars.
Few collective licensing platforms have come close since, but there are signs that the market is undergoing something of a renaissance. In 2016 former Ericsson chief IP officer Kasim Alfalahi established Avanci, which offers licences to 2G, 3G and 4G mobile patents owned by the likes of Qualcomm, Ericsson and InterDigital, to suppliers and manufacturers in the automotive and the Internet of Things (IoT) sectors.
Avanci is administered by a separate entity, the Marconi Group, and looks set to be one of several licensing platforms backed by the new group. Other operators such as MPEG LA, Via Licensing and Sisvel have been around longer and while pools have failed to successfully penetrate some areas (eg, the 4G mobile market), they look set to play an increasingly important role.
The new enthusiasm for collective licensing reflects the current state of the patent market and the increasing complexity of new technology. A smartphone has tens of thousands of patents that read on it, with a correspondingly large pool of patent owners, which are often clamouring for a return on their intellectual property.
This can leave licensors and licensees frustrated as they argue over the cost of a licence in disputes that often end up in court. The promise of a pool is that it makes the whole process far more efficient and transparent; but the challenge that operators face is attracting a critical mass of patent owners so that a licence covers most of the patented technology in a sector.
In the era of convergence, the complex matrix of IP owners, suppliers and device manufacturers is only going to grow. This gives patent pools a clear opportunity to help solve what would otherwise be intractable problems.
Financial institutions lack appetite and expertise for IP investment
Michael Friedman is the head of Hilco IP Merchant Banking, one of the few players in the financial sector to focus on the IP sector and patents in particular. His experience in advising on deals in the sector and on investing in IP assets gives him a particularly unique insight into how investors see the space and how it might evolve as an asset class.
How do you think the IP value creation market has changed in recent years?
IP value creation is achieved through commercialisation or alpha discovery. I am not in the commercialisation business and can’t speak to it other than to say generally that changes in IP law have had a negative effect on small-cap corporate access to capital that had been used to seed commercialisation, (ie, risk taking is down materially). The locus of commercialisation moved from innovation by small-caps to a large cap-innovation acquisition model where commercialisation opportunities come to market at scale or are killed. Innovation that comes to market today tends to facilitate large-cap long-term business plans and market control rather than the best innovation. This process has corrupted the marketplace for innovation.
The IP value creation market via alpha discovery has changed materially as IP law and the capital markets have changed, particularly since 2007. In 2007, IP law was relatively pro licensor, equity multiples were materially lower (and going lower with the 2008 market break) and interest rates were materially higher. I teach an entire course on how the dynamic interaction of these three forces has changed IP value creation over time and the specifics take more ink than we have available here. In short, as IP law has tilted in favour of licensees, equity multiples have effectively doubled and rates, driven by quantitative easing, have plummeted, IP value creation through investing morphed from relative value long/short trading of public equities and litigation outcome volatility trading to stressed/distressed public market debt trading, activism and IP-collateralised loans to the large-cap monetisation programme investing we see today.
This dynamic will continue to evolve with changes in IP law, equity multiples and interest rates. In addition, there are fields of investing that have not yet systematically come to intellectual property (eg, public market, liquid debt secured by intellectual property; royalty securitisations (other than in pharma); and IP-driven special purpose acquisition companies). It remains to be seen how or if these strategies, past implementations and never implemented, come to market.
How do you see the market changing in the next five years?
This is a long, idiosyncratic discussion based on the interplay of the factors discussed above. The answer will become clear as the direction of IP law, equities and interest rates becomes clearer. Each are at inflection points today and the degree and timing of how these changes interact will set the investing opportunity. The key is to take a special situations investing approach to IP alpha and take what the markets give you.
Will there still be a role for traditional royalty-based licensing?
Always. Top-tier intellectual property (foundational, valid and infringed) supported by clear evidence of use where reasonable royalties are asked will continue to get done, as they are today, without litigation.
Do you see more financial institutions moving into the space? What are some of the challenges they face?
Financial institutions have a lower risk appetite today than at any time since the early 1980s. IP investing is the right tail of the efficient risk and reward frontier. Financial institutions are not rewarded in today’s low interest rate environment for going there and are not incentivised to go there. Financial institutions don’t face challenges: they simply don’t have the insight, dedication or appetite for IP risk nor are they incentivised to take IP risk.
The occasional hedge or private equity fund will come into intellectual property with small allocations of their capital. There is no IP investor today that invests a material portion of their capital in intellectual property. Even large-dollar investments are rounding errors to the funds who make them. Because they are limited by their ability to pay fees on fees, their ability to give up investment discretion given their limited partnership remit and a general inexperience with IP alpha, a wave will not materialise. It’s a large gap to close and most won’t outsource alpha creation.
Few companies generate the same kind of return on their intellectual property as the owners of the largest SEP portfolios, particularly in the mobile space. The tectonic shifts in the telecoms landscape, prompted by the introduction of the smartphone, might have caused the likes of Nokia, Ericsson and Blackberry to effectively exit the handset market, but they have also left those businesses sitting on a particularly valuable stockpile of intellectual property that underpins the modern wireless sector.
Licensing these patents out has delivered annual returns of over $1 billion in some cases, but licensors have also faced some particularly challenging headwinds in the last five years. In the United States, both the courts and the Obama administration came down hard on patent owners, with antitrust laws increasingly used to police dealmaking and to guard against the risk of perceived hold-up – whereby patent owners are accused of hindering the development of a technology via unreasonable licensing demands.
However, in the last few years conditions have improved as the new US administration has put the focus on the risks of recalcitrant licensees holding out and refusing to take a licence, and courts in Europe have issued rulings that have balanced the interests of SEP owners and implementers of patented technology.
The opportunities for this band of players should also only grow with the advent of 5G mobile technology and a marked increase in the number of connected devices thanks to the IoT. China’s leading telecoms players, such as Huawei, are also likely to play an even bigger role in making technical contributions to 5G and driving the licensing market. To that end, recent comments from Huawei’s chair are worth bearing in mind. In late June he told a conference that the company “won’t seek to squeeze other companies or society as a whole. That means we will stick to the FRAND principle and make every effort to reduce licensing fees. We advocate that 5G patent holders should ensure their cumulative licensing rates are lower and more transparent than 4G.”
What that means for the bottom lines of the likes of Nokia, Ericsson and Qualcomm could be a billion-dollar question.
During the 2011 auction of the patent portfolio previously owned by Nortel – which was ultimately acquired by the Rockstar consortium for $4.5 billion – it might have seemed that intellectual property was poised to become the latest asset class to be dominated by the largest financial players on Wall Street.
However, the one-off nature of the Nortel auction and a decline in patent values has meant that intellectual property remains largely untouched by the biggest institutions. Instead, this part of the market is a patchwork of mid-market advisers (eg, Hilco and Houlihan Lokey), the odd investment giant that has hired savvy operators such as Fortress and a few private equity houses such as Vector Capital and, more recently, HGGC which have bought IP-related businesses.
The decline in patent values since the Nortel deal has also coincided with sky-high capital markets and a period of prolonged low interest rates giving investors plenty of options on where to put their cash. In this environment an IP sector which remains clouded in uncertainty thanks to the courts and meddling legislators is hardly an enticing prospect.
The question is to what extent Wall Street’s gaze will return to the sector as interest rates trend up and stock markets fall, prompting investors to look for opportunities unrelated to public equities. While recent fundraising by Fortress, which has built a standalone IP fund of almost $1 billion, shows that a smattering of money managers remain interested, the fact remains that there are few investment professionals who know how the IP market works. What seems far more likely is that the giants of Wall Street will continue to dip in and out as and when the deals demand.
In an IP market subject to wild fluctuations thanks to courts and regulators around the world, predicting how it might look in a few years is a tall order. Nonetheless, here are some of IAM’s forecasts for how things might pan out:
- Even if patent values continue to grow, a great rush from Wall Street should not be expected. Intellectual property remains an asset class that is shunned by large parts of the investment community.
- Expect a small band of SEP owners in the mobile space to grow their licensing revenues while China becomes an even more significant player in FRAND debates.
- We will see more NPEs raise capital specifically for patent assertion in China.
- Defensive patent platforms will remain relevant but a new breed that offers risk mitigation for a full range of intellectual property, not just patents, can be expected.
- We will likely see a patent pool start to follow the trail blazed by MPEG-2.
The IP value creation market has seen its fair share of challenges in recent years, but for the savviest operators there have still been considerable opportunities to profit.
- A new breed of NPEs has emerged which is privately owned and is not just focused on the United States.
- Market conditions for all licensors remain tough but there are signs that the environment is improving for owners of SEP portfolios in the mobile sector.
- A small band of savvy investors have shown that it is still possible to generate a return from IP monetisation.
- Defensive platforms have had to fight hard to justify their relevance at a time of dwindling patent litigation.
- Operating companies that use intellectual property as part of broader deals have emerged as new champions of the value creation market.