Show Me The Alpha - Patent Analytics 5/19/2009 11:36:58 AM
No longer a secret, much of the value of today’s Fortune 1000 companies is linked directly to intangible assets; a trend that has been on the rise for the last 20 years. While patents are only one form of intangible asset, patent analysis provides insight into technology innovation.
In our series on Patent Analytics, we began our discussion with a few simple questions: Why Use Patent Analytics? Who Uses Patent Analytics? And how do Patent Analytics deliver value? These questions can only be answered in comparison to your competitors’, customers’ and suppliers’ patent portfolios. The comparison provides perspective and insight into how technology is evolving and its impact on future competitiveness. “Patent Analytics” is a broad term used to define any metric, indicator, mathematical logic or methodology that quantifies the “value” in a patent. We have discussed the general types of patent analytics and their underlying assumptions, and today we turn to investors and how they use these tools.
WHEN INVESTORS ADD PATENT ANALYTICS TO THEIR MIX
No longer a secret, much of the value of today’s Fortune 1000 companies is linked directly to intangible assets; a trend that has been on the rise for the last 20 years. While patents are only one form of intangible asset, patent analysis provides insight into technology innovation. Patent portfolios standout as a key driver of a company’s value in many industries through their technology monopoly. Patents protect and enhance future product revenue streams which make patents not only important to the filing companies, but also to investors in those companies. Patent analytics can be focused for this constituent. An n investor wants to know how new patents will be commercialized, what patents are expiring, how the pipeline of new innovation is developing and what is the risk of infringement. Infringement settlements in excess of $100 million are becoming more frequent – as we have seen with Karlin Technology vs. Medtronics $1.35 billion settlement over spinal fusion technologies. Equally important is to understand the value of direct cash flows from patents through licensing such as IBM’s approach estimated $10 billion USD in royalties since 1993. It is not surprising that patent analytics is a critical component to any investment strategy involving technology.
Existing Indicators & Public Reporting
Investment professionals understand that information is critical to their strategies. Information from data sources such as Standard & Poor’s Compustat®, Bloomberg, Capital IQ, or Morningstar, Inc.; or industry and expert analyst opinions, and personal or contact knowledge. T here appears to be plenty of information available to investment professionals. T he problem however, is that most of these sources of information are well known, and used by most investment professionals. As a result, this information is usually already baked into the price of any investment. Patents however, are not yet transparent. While the existence of patents and applications are publically available to date, the volume and complexity makes them difficult to interpret into stock price implications. Patent analytics as they evolve provide insight into the potential future cash flows of a company. It is a deeper understanding of these cash flows via patent analytics which allows for improved insight which in turn can be wielded to maximize investment returns.
There are many types of investment vehicles in today’s world. In a broad sense, they fall into the four distinct levels of company, financial, trading and cash flow. M&A and private equity professionals typically look to acquire the entire or controlling portion of an enterprise. Mutual funds and hedge funds often take minority interests in companies via equity or debt positions that are considered a financial investment. Trading firms make short-term investments or utilize sophisticated “black-box” algorithms which generate trades, sometimes in and out of a position within seconds. And lastly, there is a group of investors which is interested in specific cash flows of the particular assets of an enterprise. Patent analytics provides an additional source of information to investment professionals utilizing these strategies and who want to remain on the cutting-edge. How can each of the types of patent analytics be used by investors?
Bibliometrics is a set of methods used to measure patents worth based on how the patents cite and are citing each other and scientific periodicals. Bibliometrics provides robust results at the patent portfolio level, making them valuable to company, financial and trading investment strategies.
When evaluating a patent portfolio, the right combination of patent metrics can identify which companies have the strongest patent portfolios among the competitors; or which patent portfolios are creating the most or best recent innovation. It could also provide insight into the age of the science within a company’s portfolio; the most prolific and collaborative inventors; and the technologies a firm is aggressively pursuing.
Mergers & Acquisition Professionals can utilize patent analytics to source deals either by identifying hot technologies protected by patents or to understand patent synergies between prospective partners. Private equity professionals can add patent analytics to their due diligence process to gain additional information regarding a small company’s technological competitive advantage and ability to protect said advantage. Large mutual funds could use patent analytics as a tool for idea generation, quickly narrowing a population of thousands of investable companies to those which own valuable intellectual assets. And finally, there is evidence that portfolio level patent analytics can drive quantitative investment models.
Patent Component Analysis
As in Bibliometrics, there have been challenges in developing investment indicators directly related to the monetary value of a patent portfolio. Patent Component Analysis uses measurement techniques to analyze specific segments of a patent specification. T he indicators include factors such as technology code, word counts, pendency duration, examiner identification, prosecuting attorney identification, the number and type of claims, and sometimes the file history of the patent to estimate the value of a patent. Patent Component Analysis assumes that the value of a patent can be modeled based on automated quantification and comparison of the components of a patent. Preliminary attempts to create indexes, such as the Ocean Tomo 300® Patent Index, a product that has generated industry wide interest from investors, businessmen, and IP attorney’s alike. Ultimately the true value will be measured by active investors and future competitive products.
Expert opinions from technology watchers are well understood by investors. E very Fortune 500 firm has a set of industry and company analysts who review performance data and forecast stock price.
These analyses are extremely sophisticated at looking for signals that could lead to a change in a company’s financial forecast. For example, new product introductions are carefully monitored to determine their impact on revenue and profits. In some cases, such as IBM, understanding patent royalty streams is critical to forecasting a firm’s value. Taking this a step further, it is normal for investment analysts to consult with Technology, Industry, or Legal Subject Matter Experts during the review of these major companies.
As the technology watchers include a review of patents and provide opinions of the relative strength of a firm’s technology position and how that position is protected with patents can add valuable insight into a firm’s value and provide insight to financial analysts. Expanding the expertise of current financial analysts, to include technology watchers is underway. T his will require opinions as to the efficacy of the patents. Expert opinions are already used when firms enter significant financial change such as acquisition or bankruptcy.
Moreover, the U .S. Securities and Exchange Commission (SEC) would like more transparent reporting about intangible assets, such as patents, enabling the investment and lending communities to make better decisions about how to allocate their capital. In the short term, this opinion will probably be delivered through some form of expert opinion. While the expert opinion will likely be delivered from an accountant or lawyer, it should include expertise from technologists and commercialization experts.
Financial Modeling requires an existing revenue stream that can be aligned to a patent or set of patents. The key assumption is that historic revenue streams are indicative of future revenues. T his type of patent analytics provides insight for executive teams, and other insiders – to understand patent values.
There are many emerging business models of companies that own IP and drive most of their revenues from licensing fees, such as Intellectual Ventures, Qualcomm, Coller IP Capital, or NTP. NTP is a Virginia-based patent holding company who aggressively enforces its patent rights, even though they do not, themselves, practice their patents. NTP filed the now infamous patent infringement case against Research In Motion Limited (RIM), the Canadian wireless device company best known as the makers of the BlackBerry® mobile email system. In March 2006, R IM agreed to pay NTP $612.5 million U SD. Intellectual Ventures is built on the belief that combining capitalism and invention will benefit the world with more and better inventions as well as create financial rewards for investors. All of these companies become vehicles to invest directly in IP. Over time the value of companies whose core activity is patent monetization can provide a financial modeling tool for all patents.
However, the insight is only possible if the companies mentioned are publically visible. An index built on the value of companies like Rambus, Qualcomm, InterDigital and UCC Capital can deliver unique insight into the value of patent portfolios.
In the meantime, the raw data to perform financial modeling is typically not available to external investors and therefore limits the effectiveness of IP financial modeling to the investor community.
Patent analytics provide investment professionals with a new form of information related to potential future cash flows of available investments. They provide a better understanding of a firm’s competitive advantage and its protection; help understand royalty streams; or funds wasted maintaining low quality patents. In any case, patents are clearly tied to the sources and uses of cash for any company in a technologically dependent industry. Until recently, investors of every type have underused the power of patent analytics and the insight they can provide regarding a firms future. They are a new source of information to investment professionals, not only providing a fresh investment perspective; but also providing information about the growing intellectual asset base of many of the most successful companies. This leads to a more thorough understanding of the underlying investment target, which is the cornerstone of alpha generation.
Originally published in Intellectual Property Today August, 2008