Buying time in China

As they set their sights on new horizons, Chinese companies are accelerating their patent purchasing activity. For vendors and intermediaries that can get to grips with the idiosyncrasies of this market, the opportunities are abundant

China’s appetite for brands is insatiable. Visit a high-end shopping mall in any city in the country and this truth is plain to see. Acres of premium real estate and shelf space are given over to globally renowned products, from Garnier to Gucci, Chanel to Chivas Regal. As the Chinese economy has gradually opened up, the middle classes have grown – and shopping for top-end brands has quickly become a national pastime. For consumers with disposable income, a product or service that lacks the necessary pedigree (whether genuine or counterfeit, as it all too often turns out) just won’t do.

The same, it seems, can be said for patents.

Take a look back through assignment records and – where they are available – corporate press releases over the past few years, and the trend is clear: Chinese companies are buying third-party patents with increased frequency and in increased volumes, and are buying them from some of the world’s most recognised high-tech companies.

One particular transaction stands out as a landmark, for two main reasons: the prominence of the buyer and the significance of the deal to its business strategy. This breakthrough came in October 2015, when Xiaomi – the darling of China’s start-up scene – acquired a package of patents from US-Singaporean semiconductor giant Broadcom.

Mobile device maker Xiaomi is one of a few Chinese companies to have gained worldwide recognition. For anyone following this industry, it would have been difficult not to have noticed the meteoric rise of the Beijing-based outfit, which was founded in 2010 and just four years later had a valuation of $46 billion – making it the highest-valued start-up in the world (until it was dethroned by Uber’s $51 billion this year).

Pressing needs

For companies that grow so rapidly in their early days, there is an especially pressing need to keep up momentum and identify opportunities for expansion – whether new markets, new product areas or both. Pundits noted Xiaomi’s lightness in terms of patent protection and had been suggesting for some time that it would need to turn to IP transactions in order to enable it to break into jurisdictions beyond China. “Patent purchases present a quick solution for Chinese companies that are looking to strengthen their patent portfolios,” says Roger Tu, senior vice president at MiiCs, a Taipei-based firm that monetises patents for Foxconn and a number of other Chinese and Taiwanese clients. “When the development of the business demands a useful patent portfolio, the companies accelerate their purchasing activity accordingly.” A lack of patent coverage in key markets such as the United States, Europe and India would almost certainly invite attack from competitors and non-practising entities (NPEs); and while Xiaomi was engaged in commendable efforts aimed at organic portfolio growth, buying in high-quality, proven patents from external sources would provide the quickest route to operational freedom.

The Broadcom assignments represented Xiaomi’s first steps in this direction. These were soon followed up with even larger acquisitions – not least a portfolio including 332 US patent assets from Intel and around 1,500 patents from Microsoft as part of a wider licence and collaboration deal. A blog post authored by Wang Yanhui of the Mobile China Alliance claims that Xiaomi paid $40 million for the assets, though this was not verified at the time of writing. “We are finally seeing an upward slope in terms of the sophistication of Chinese companies with respect to IP in a global perspective,” says Jim Brelsford, of counsel at Skadden Arps in Hong Kong and former chief legal officer and head of licensing at Sandisk, who advised Xiaomi on its Intel purchase. “As they move beyond the Chinese market, many have not focused on building their portfolio beyond China, so they are worried that they could have issues and feel they need to bulk up. Many of these Chinese buyers are primarily looking for non-Chinese patents.”

Elvir Causevic is CEO at patent advisory firm Black Stone IP, which acted for Broadcom on the aforementioned sale to Xiaomi. At the time that deal was inked, he said that he was “thrilled” to see the increasing sophistication of Chinese players: “First, it provides much-needed liquidity in the US patent market and puts pressure on other buyers to act. Second, it’s building up the capacity and capability of Chinese firms for their global expansion, and we are happy to see new market entrants. We are definitely seeing significant interest from Chinese buyers. The most important thing we would note is the rate of change in the degree of sophistication on the part of Chinese buyers – on complexity of deals, ability to ascertain very high-quality assets, advanced negotiation strategies and ability to close meaningful deals.”

Although it was involved in probably the highest-profile of the recent string of Chinese patent purchases, Xiaomi is by no means the only high-tech player in the Middle Kingdom to have pursued such a strategy. In December 2015, Beijing-based optoelectronics outfit BOE acquired several hundred US patent assets from General Electric covering LED technology. The previous year, it purchased a portfolio including 425 US assets from Seiko Epson, as well as a smaller package of six patents from another well-known Japanese player, Casio, all relating to display technology.

Other major Chinese companies that have tapped the patent marketplace include Alibaba, which ramped up its purchases in the run-up to its 2014 US initial public offering (IPO); and Huawei, which in addition to filing a huge number of applications worldwide each year, has regularly snapped up third-party patents. Key Huawei and Xiaomi competitor Lenovo has also made a number of headline patent acquisitions, including buys from Japan’s NEC and now-dormant NPE Unwired Planet.

Table 1 provides a breakdown of several of the major patent purchases by top Chinese corporates in recent years. But speak to patent brokers and other intermediaries working on the ground in China and the consensus is that it is not just the handful of globally recognised household names that are looking to buy. “Everybody knows Huawei, ZTE, Xiaomi, Alibaba,” says Gustavo Aray, managing partner at Shanghai-based brokerage Rui Zhi Ventures. “Xiaomi is now well on its way to having a fairly large portfolio. Huawei and ZTE are already there. But then there is also this second layer of less familiar buyers that need patent coverage a little more urgently and are becoming increasingly active on the buying side. As they step outside the safe confines of the Chinese market, they are seeing that it’s pretty tough going.”

Figure 1. Types of assets targeted by Chinese outbound M&A in 2016 (% of deals announced)

Source: Baillieu Holst

Figure 2. US patent cases with at least one party from the Greater China region 2000-2013

 

China

Hong Kong

Taiwan

Dispositive judgments*

56

19

94

Win rate as patentee**

0%

60%

24%

Win rate as accused infringer

31%

50%

71%

Win rate (overall)

29%

53%

63%

*Includes default judgment, contested dismissal, summary judgment, bench or jury trial, and judgment as a matter of law **Small number of cases; high margin of error
Source: Chinese American Lawyers of the Bay Area

Team playing

All this begs the question: why now? Chinese high-tech companies have been making inroads into overseas markets for some time, yet it is only in the past two years or so that we have seen any making substantial acquisitions of foreign-issued patents.

One of the main reasons is exposure to the trials and tribulations of IP disputes outside of China (see Figure 2), says Aray. “What has happened here is that some of these guys have been sued overseas, by US and European telecoms and electronics operating companies, and NPEs in particular, and as a result are now beginning to appreciate the potential value in patents.”

The maturation of in-house teams responsible for patent transactions has also contributed to this increasing sophistication, he adds. “Huawei and ZTE already had high-class teams, but emerging companies have also stacked up or developed their IP functions to the point that they are very confident in their execution capabilities.”

Brelsford concurs: “What is spurring these Chinese companies on is that more of them are bringing in US and European-trained IP professionals, or at least people who have been exposed to those IP markets.”

Here again, Xiaomi is a pertinent example. Earlier this year, it absorbed patent consulting firm Zhigu, which had already been handling IP transactions for the company and had been operating at least one partly state-financed patent buying fund. Zhigu president (Paul) Lin Peng – an alumnus of IP licensing functions at Intellectual Ventures and Microsoft – became Xiaomi’s vice president of intellectual property. It also hired BOE’s erstwhile head of IP management, Bin Sun – who had overseen that company’s previously mentioned patent acquisitions – to become its director of IP litigation. Both Bin and Lin report to senior vice president of strategic cooperation Wang Xiang, the former head of Qualcomm’s China operations, who was himself poached from the major licensor in July 2015. “Throughout the process we were consistently impressed with the expertise, diligence and creativity shown by Paul Lin and Zhigu’s team to arrive at a mutually beneficial result,” said Ed Fish, Black Stone IP’s senior managing director, talking to IAM after the Broadcom patent sale. “This parallels a shift we have seen over the past year to an even more sophisticated approach to patent markets being demonstrated by Chinese companies emerging as global IP leaders.”

Other booming Chinese companies have made similar moves. In June this year, Internet of Things start-up LeEco announced that it had tempted senior IP counsel Joshua McGuire away from Google, where he had led Android-related patent strategy and played key roles in the company’s acquisition – and subsequent sale to LeEco’s compatriot Lenovo – of Motorola Mobility.

Figure 1. Types of assets targeted by Chinese outbound M&A in 2016 (% of deals announced)

Buyer

Seller

Seller's country of origin

Date

Details

Xiaomi

Microsoft

United States

June 2016 (announced)

Around 1,500 patents to be transferred, alongside patent licensing and software agreements. Anecdotal reports value the patent transaction at $40 million.

Intel

United States

February 2016

Assignment including at least 332 US patent assets relating to electronics, software and telecommunications, some of which were originally assigned to US chipmaker LSI.

Broadcom

Singapore/United States

October 2015

Assignment of 32 US patent assets, which were originally owned by Japan's Renesas Electronics.

Alibaba

Intel

United States

April 2016

Seven software-related US assets.

Yahoo

United States

October 2013

Alibaba disclosed in a regulatory filing that it had paid Yahoo $70 million for patents during 2013. These look likely to have been recorded as an assignment of 30 US assets to Energetic Power Investment in October 2013.

IBM

United States

September 2013

Including 22 e-commerce-related US assets.

BOE

General Electric

United States

December 2015

At least 131 US assets relating mostly to LED technology.

Casio

Japan

February 2015

Portfolio including six US assets covering various display technologies.

Seiko Epson

Japan

November 2014

Portfolio including 425 US assets relevant to LCD technology.

Huawei

Yahoo

United States

January 2016

Including 29 US assets relevant to digital media playback and storage. Yahoo previously assigned two US patents to Huawei covering internet telephony in May 2014.

Hoya

Japan

September 2015

Including 24 optics-related US assets.

NCR

United States

June 2013

Including 14 US assets relating to software and wireless networking.

Sharp

Japan

May 2013

Including 84 US assets covering telecommunications. Sharp made further assignments to Huawei in October and December 2015.

IBM

United States

December 2012

Including 16 US assets. IBM made further assignments to Huawei in July 2013, August 2014 and November 2014 - each covers a variety of technologies.

Siemens

Germany

September 2012

Seven US assets relating to telecommunications.

TCL

Mitsubishi Electric

Japan

April 2015

Including 31 US assets relating to mobile telecommunications technology.

Sanan Opto

Sharp

Japan

September 2014

Including 44 US assets relevant to semiconductor manufacturing.

Lenovo

NEC

Japan

April 2014 (announced)

Over 3,800 patent families covering 3G, LTE and various wireless device features. NEC has made multiple assignments to Lenovo since March 2014, the most recent – consisting of 16 US assets – in June 2015.

Unwired Planet

United States

March 2014 (announced)

Lenovo paid $100 million for 21 patent families covering 3G, LTE and other mobile communications technologies, alongside licences to Unwired Planet's patent portfolio.

Source: US Patent and Trademark Office

Delayed gratification

Nevertheless, Brelsford observes that it has taken some time for Chinese C-suites to recognise the need to pay good money to acquire quality patents – and likewise to invest in the people who can get the deals done. “It often takes a little while for Chinese companies to wake up to this kind of thing,” he says. “After all, it is adding cost, and nobody wants to add to a cost structure – whether they are in Shenzhen or Silicon Valley.” For Chinese mobile device makers in particular, this mindset becomes even more difficult to shift, since the domestic market is characterised by even thinner margins than its North American and European counterparts. “Sometimes it takes an event to really wake up a management team, and then they make moves and realise that IP strategy is a whole arena that a normal business executive doesn’t have enough exposure to.”

Brelsford’s perspective is that the new crop of Chinese high-tech companies present an almost irresistible proposition for many enterprising IP professionals. “People are attracted by the opportunity of these companies, by the great stories behind them,” he says. “Xiaomi, for example, started only a few years ago, but has publicly reported revenues well into the billions of dollars. There’s an excitement over what they are trying to accomplish – they’re doing a lot more than smartphones, though it is still a big part of their business. They are pre-IPO, which means that there is theoretically a good upside for new recruits in terms of stock options.” Moreover, there is the opportunity to go into a company and define its IP strategy from day one, he continues: “They will be sitting across the table from major licensors like Ericsson, Qualcomm and others, and they’ll be seeking out and closing patent acquisition deals. Values have come way down lately, so there’s an amazing market opportunity.”

Discerning buyers

The fact that we are currently in a buyers’ market, as Brelsford observes, has also likely played a big part in Chinese companies’ recent assessments as to whether to sign on the dotted line and buy patent portfolios. “It makes it an easier decision for them to implement than if patents were more expensive,” he says. Furthermore, this situation gives prospective Chinese buyers more leverage in negotiations with vendors – many of which are also leading licensors of standard-essential patents (SEPs) and are facing a tough market in terms of the licensing parts of their businesses.

“I think we may well see more deals that involve both a licence to SEPs and a patent purchase,” continues Brelsford. While there is a need for new entrants to the wireless market to take licences, there is also increasing pressure on SEP licensors to offer their patents at fair, reasonable and non-discriminatory (FRAND) rates. “The usual club of major SEP owners have built up very successful long-term licensing programmes, which at this point have profitability margins somewhere in the area of 95%,” Brelsford explains. “A lot of those companies’ value in equity markets is a function of that business.” When cracks start to appear, with events like the US Microsoft v Motorola Mobility and Ericsson v D-Link cases, the Institute of Electrical and Electronics Engineers policy update and China’s National Development and Reform Commission’s Qualcomm decision saying that current licences are not FRAND priced, those companies “need to do what they can to protect their business model”, he adds.

The lure of patent ownership can encourage Chinese companies to sign up to licences. “It gives the licensor a different lever to make a deal work,” says Brelsford. “They need to protect their licensing rate structure, but then there may be value exchanges that can go on over here on the right side of leger that overall makes it more palatable for the licensee.” In other words, the Chinese entity gets the patents it needs to ironclad its international expansion, while the vendor gets to safeguard its most important source of revenue.

Nevertheless, while this scenario appears to represent a win-win for both parties, it is crucial not to misjudge just how discerning many Chinese corporate IP teams have become. As always, the devil is in the detail – and Chinese companies are increasingly focused on the minutiae. “In my opinion, many of them are very discriminating buyers,” says Aray. “There is no such thing as an easy sale in China. Like anywhere else in the world, they want good evidence of use, they want to know about encumbrances – information like that upfront is paramount.”

Of course, another major factor that comes into play is the jurisdictional coverage offered by patent families. “The focus is very much on US, European and sometimes Chinese assets,” Aray reports. “As for Japanese and Korean assets, not so much. For Chinese patents, the motivation in acquiring them as part of a family is often just because they are in the local language and help the buyers to understand the invention they have bought.” In terms of prices paid by Chinese buyers, Tu suggests that these are largely reflective of those encountered elsewhere in the world in the current climate. “It really depends on a case-by-case basis,” he explains. “The range can typically vary from six to eight-digit US dollar values for a portfolio.”

Additionally, Chinese buyers are especially keen to know the ‘story’ behind the patents – and if at some point in their past they once belonged to a major high-tech player with a reputation for IP savvy, so much the better. “There is a big focus on pedigree,” says Aray, pointing to the transactions that Xiaomi and BOE have completed with the likes of Broadcom, Intel, Microsoft, General Electric, Seiko Epson and Casio as evidence. “Less renowned sellers will have some difficulty in the Chinese market. There is a value in the brand where the patents originated. That’s not to say that an ‘unbranded’ portfolio that has good evidence of use and is largely unencumbered isn’t going to sell; but it is going to be a tougher sell.”

Caveat venditor

Speak to people working in the Chinese patent transactions market and it becomes clear that many would-be vendors approach it with the wrong attitude. Often, they underestimate the sophistication of the companies they are targeting as potential buyers. “The mistake that I’ve seen time and again is that the seller thinks it is dealing with a non-sophisticated counterparty,” says Brelsford. That can start things off on the wrong foot, which ultimately slows down the transactional process and may well put final completion of the deal in jeopardy. “I am certainly not the first to say this, but the one major thing about doing business in China is that it’s relationship-driven,” he adds. “The Chinese term guanxi can mean many things” – the Oxford English Dictionary defines it as “the system of social networks and influential relationships which facilitate business and other dealings” – “but it is imperative that you have guanxi with a Chinese counterpart. What they might perceive as an overreaching, overaggressive, condescending or inflexible approach is not a pathway to success if you actually want to sell what you want to sell. And because it is relationship driven, sellers need to get on a plane and go there.”

Tu echoes this advice: “What is important is that the IP assets be of good quality and the case go through a solid connection. Typically, that will mean a professional broker or contact window that is well known to the buyer.”

Perhaps most importantly of all, foreign vendors looking to sell their patents in China should be prepared to be patient. “Getting deals done in China takes a long time, which can be frustrating to the counterparty, but it’s just the reality,” Brelsford concludes. “Part of it is culture; part of it is the language barrier – Chinese buyers need more processing time to get comfortable with a deal.” The bottom line is that selling patents to Chinese companies takes time. But while this might be frustrating to vendors, the rewards could well be worth it.

Action plan

With Chinese buyers upping their interest in third-party patents, there are plenty of opportunities on the horizon both for operating companies looking to monetise assets and for intermediaries that can play a role in the transactional process. Those hoping to sell patents in China should keep the following in mind:

  • Chinese companies are primarily in the market for patents for defensive purposes and in order to secure freedom to operate as they expand into foreign jurisdictions and new areas of technology.
  • Many Chinese companies have at this point assembled expert IP teams with extensive experience either working in North American and European companies or working opposite them in a dispute context.
  • Multi-faceted patent deals – for example, those that include a patent sale alongside a standard-essential patent licence – can be a win-win for buyer and seller alike.
  • Be prepared for a lengthy process, as prospective buyers will typically be new to the transactions market and will take time to get comfortable with the situation.
  • Guanxi is all-important. It will be hugely beneficial, if not necessary, to travel to China to meet with prospective buyers face to face.

Jack Ellis is contributing editor of IAM, based in Hamilton, New Zealand

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