Monday, December 12, 2005


THE NEXT BUBBLE: STOCKS? REAL ESTATE? . . . PATENTS? In this interesting article from Dominique Patton, a question has been raised whether the current slew of high profile patent ligitation is causing excessive valuations to permeate the IP portfolios of technology companies. It has been recently reported that intangible assets now make up two thirds to three quarters of corporate market value in the US for both old and ‘new-economy' businesses, and in many cases, intellectual property lies at the core of these assets - biotech firms around the world are claiming that intellectual property typically accounts for some 60 per cent of their market value.

One of the biggest problems with intangible assets (and especially patents), is that there are few fundamental accounting norms for actually calculating a patent's "value." While accountants, actuaries and the like can be called in as experts during trial to calculate damages (i.e., lost profits/Panduit test, reasonable royalty, price erosion, non-infringing alternatives, etc.), these types of exercises do little to inform the market on the real value of any specific (non-litigated) patent during a given time period.

Experts have long warned about the inadequacy of existing accounting norms in capturing the monetary worth of patents. Those that are generating licensing revenue and royalties can be valued on a discounted cash-flow basis. A further slice is deemed valuable because of the competitive threat it prevents.

In the food, pharmaceutical and biotech industries, for instance, where it is now commonplace to seek to block out an entire market space with a patent barricade, some 11 per cent of the patents filed are subsequently contested. A patent battle, alone, is the first mark of real value, according to some commentators.

Elsewhere, within some companies, the monetary value of patents are deduced by looking at what it would cost to license in the same notional technology. This provides a theoretical basis, but little real data to work with.

Yet the most striking fundamental of patent valuation, overall, is how few fundamentals there are. Companies themselves struggle to evaluate their own intellectual property.

And this problem at the level of book valuations is multiplied manyfold in market values. Specialists at the Inno-Tech institute in Munich's Ludwig Maximillian university have shown that the ratio of book value to market value for companies' intangible assets has declined dramatically from 1:1 in 1978 to 1:7 in 2000.

This means that any misplaced value on the books is now getting amplified by a factor of 7 in market valuation, and rising.

2 Comentários:

Anonymous said...

IMHO, it should be cautioned that the difference between market value and book value of stocks is not solely attributable to a company's intangible assets, much less the value of its patent portfolio.

As such, it really cannot be said w/ any authority that patent valuations are a driving factor behind market value-book value divergence.

Primarily that divergence is driven by steadily-declining discount rates on future cashflows. Declines in long-term interest rates from 1978 to 2000 (and beyond to 2005), combined with a drop in the risk premiums demanded by investors, are much more explanatory of the market-book value divergence in stocks than patent litigation activity.

The decline in interest rates over this period is self apparent. Less obvious is the subtle decline in required risk premiums that has resulted from a larger demand for stocks over the past 30 yrs. Dramatically increased allocations of investment portfolios into equity, out of fixed income, over the past 30 years has reduced risk premiums and driven market values higher. More money bidding on a relative static supply of shares has significantly bid up share prices, changing what constitutes a "reasonable" value in today's context.

Stock markets are auction markets - more bids drive an auction higher to its efficient max. Rather than 7:1 being an overvaluation, it is more correct to conceptualize the 1:1 ratio dominant in the 1970s and before as an undervaluation of the market-book spread, driven by illiquidity and a degree of risk aversion towards equity since lost to history.

The rising pro forma valuation of patent portfolios, per se, is really only a small and insignificant piece of the overall market-book valuation gap.

A patent establishes (1) a right to sue for infringement of its claims, and (2) an exclusion of others from making identical claims that confers upon the holder a very nominal picket defense from infringement suits.

Because of design arounds and the fact that most revenue-generating products consist of multiple patentable components, the existence of one or even a few patents in a portfolio effectively minimizes the defensive value of a patent. Thus in practical terms, a patent's primary value rests on its offensive properties, the right to sue.

As such, the value of a patent per se is nothing more than the risk-adjusted value of litigation damages, or of royalties that can be coerced from others in avoidance of litigation.

Given the speculative risks of patent litigation (i.e. invalidation, countersuit, etc.), risk-adjusted values of patents are extremely low and not a meaningful component of a firm's overall market value until & unless realized through successful litigation or licensing.

More broadly, however, it is true that the value of underlying technologies and business methods (patented or not) is indeed climbing steadily in value, inflating the market-book value gap exponentially.

But this is much more correctly described as being due to increased appetite for & acceptance of risk in equity markets over the past 30 years, not as a consequence of patent litigation trends.

LDM

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