Investors learn to appreciate the value of IP
Joff Wild
Editor IP Value 2005, London
For investors operating in today’s markets, the ability to understand and analyse the intellectual property strategies of companies has never been a more important skill. The reasons for this are not hard to find. Even during the most difficult economic times the value that most companies have on stock markets, such as the NASDAQ, or the valuations private companies are given by analysts, greatly exceed their net book worth – often by a factor that is in double figures. The discrepancy between the two is largely explained by the value that is ascribed to the intangible assets these companies own, most of which are intellectual assets such as intellectual property.
Given this, it does not take a great leap of imagination to work out that if intellectual property is such a key component of corporate value, the ability to create, manage and exploit patent, trademark, copyright and other rights to maximum effect is actually a core business skill. And as a core corporate competence, IP management is something investors must understand as well.
Patents mean money
The fact is that IP rights have the potential to generate significant amounts of revenue for companies that know how to use what they own effectively. Take IBM, for example. The company endured a steep IP learning curve after developing high-temperature super-conductors in the late 1980s. Patent protection was applied for only 10 months after findings relating to its research had been published. This meant not only that IBM lost all hope for patent protection outside the US, but also that competitors were given plenty of time to do their own R&D based on IBM’s work and to file patents covering what they came up with.
Things changed at IBM during the 1990s. As a result of a strategic decision taken at the highest level, the company’s IP management programme was reworked. The effect was that instead of viewing patents as merely a defensive barrier to prevent rivals encroaching on its territory, IBM started to license out its technology. It was a strategy that had dramatic results. Having started the decade as a net importer of IP, IBM ended the 1990s with an annual IP surplus in excess of $US1 billion. Nowadays, the company generates an estimated return from licensing of over US$1.5 billion every year, more than 80 per cent of which finds its way straight to the bottom line.
But if IBM is a company that has used its intellectual property portfolio to add to profits already being generated, for Texas Instruments the priorities were completely different. It was a reassessment of the way in which it used its patents in the mid-1980s that brought the company back from the brink of collapse.
In 1985, Jerry Junkins was appointed CEO. And at that time the future seemed bleak. The company’s market share was declining rapidly, as were profits, in the face of stiff competition from a number of companies, many of which were based in Korea and Japan. Junkins decided to focus on the TI patent portfolio. What quickly became apparent was that many of its rivals’ products were underpinned by TI’s patent rights – which no-one had asked permission to use.
So Junkins hired a team of lawyers and began a campaign against a string of competitors to assert TI intellectual property rights covering the basic design of integrated circuits. Having established itself as an aggressive enforcer, TI then contacted a number of other companies to demand royalty payments for the use of TI patents. Having seen TI win cases in court, not many turned down the offer to negotiate a deal. It was a strategy that began to generate tens of millions of dollars a year: an agreement with several Japanese companies negotiated in 1986, for example, had netted TI US$1.5 billion in licensing revenues by 1993.
Although Junkins died in 1996 his strategy continued. In 1997, TI acquired a company called Amati for US$450 million. It was a surprising amount given that Amati had run up a loss of US$30 million on sales of US$13 million over the previous year. But Amati owned a portfolio of key patents relating to digital subscription lines (DSL). Something that means nowadays companies producing DSL modems pay a licence fee to TI. With one purchase the company gained a lucrative foothold in a sector worth billions of dollars a year.
Like a growing number of companies, key to everything TI does is the strategic way in which it looks at patents. This means securing protection and closely analysing the products of competitors to ascertain whether the technologies they use infringe TI IP. If they do, the company immediately asserts its rights and attempts to negotiate a licensing deal or some other form of cooperative venture. If all else fails, the company goes to court.
Not just for the big boys
Of course, not every company is in a position to generate the revenues IBM and TI do from their intellectual property. But that does not mean that IP management strategies are only for the biggest corporations. In the UK, Cambridge Display Technology (CDT) owns patents that cover cutting-edge technology relating to light-emitting polymers in display applications. But rather than build products itself the company has chosen to license others so that they can do it instead. CEO David Fyfe explains that this does not just mean licensing out CDT technology. “We have managed to negotiate deals with the likes of Seiko Epson and DuPont which give us the right to sub-license their proprietary technology,” he says. In this way, CDT is able to offer its customers a one-stop shop. “There is nothing that intimidates companies more than having to negotiate licensing agreements with many parties,” says Fyfe. So, in a sector that is dominated by multinationals and which is characterised by consolidation, the CDT patent portfolio keeps it in the game. “Our business is built on patents. They allow us to tip-toe amongst the elephants,” says Fyfe. “I have no problem getting in to see executives at the highest level of very big corporations. For me that is a clear marker for how important we are to this sector,” he adds.
The Google float
Perhaps the biggest event of 2004 for investors, in the US at least, has been the successful flotation of Google on the NASDAQ. And the company, which trades as NASDAQ: GOOG, is yet another where IP is at the very heart of ongoing potential.
With more than 750 million page hits every day and sales of US$962 million in 2003, alongside operating profits of over US$345 million, Google is one of those very rare creatures – a phenomenally successful internet-based business. Not surprisingly, the company’s success has attracted others into its market. Until February 2004, Yahoo, another NASDAQ company (trading as NASDAQ: YHOO), had used Google as the default search technology provider for its US sites. But since that time, Yahoo has provided its own solution, based on a series of technologies from Inktomi and Overture Services, two companies it has acquired since 2002.
The acquisition of Inktomi and Overture cost nearly US$1.5 billion but, in buying the companies, Yahoo got its hands on a series of important algorithmic and sponsored search patents, as well as rights owned by Alta Vista, which was previously bought by Overture, covering web crawling technologies, indexing and query processing. Applications before the USPTO related to forward-looking search technologies are also pending. In fact, Yahoo and Google are already involved in a dispute over patents on a bidding system, the money engine that powers search-related advertisements, which Yahoo obtained following the Overture acquisition.
But Yahoo is not the only potential competitor seeking to get a piece of Google’s action. A third NASDAQ company, Microsoft (NASDAQ: MSFT), holds a series of search-related patents. These include rights related to: methods for searching information in directory listings; a system for improving search area selection; and a method of concept searching that uses a Boolean or keyword search engine. The company has also hired a team of experts in natural-language information retrieval and has announced plans to develop a new web search technology. Meanwhile, yet another NASDAQ listed company, Amazon.com ( NASDAQ: AMZN), owns a patent that it believes could affect search-related advertising, while in March 2004, the online retailer was reported to have updated an application before the US Patent and Trademark Office for a method of auctioning ads that appear on a web page. Its subsidiary, Alexa Internet, has also been busy acquiring proprietary rights in the area, as has NEC. For its part, the Google portfolio encompasses, among other things, patents on method information extraction from databases and detecting duplicate and near-duplicate files.
The patent landscape in Google’s space, therefore, is becoming increasingly crowded and the possibility of litigation is something that cannot be discounted. Indeed, it is a scenario the company was careful to point out in its IPO filing. And it is something that investors will need to keep a close eye on.
It’s more than patents
But with Google there is another IP area worth monitoring. While, from a user’s perspective, it is quite probable that there will be little to set Google’s search technology apart from those of its rivals in the future, there is one attribute that will continue to offer the company a significant advantage. And that is its name. No matter what technology they develop, no matter how much money they spend on marketing it, neither Microsoft nor Yahoo will be able to tap into the extraordinary pulling power of the Google brand. That is, for as long as Google ensures that it remains protected by proprietary trademark rights.
In the intellectual property heading of the risks section in Google’s IPO filing, investors would have found the following paragraph: “We also face risks associated with our trademarks. For example, there is a risk that the word Google could become so commonly used that it becomes synonymous with the word search. If this happens, we could lose protection for this trademark, which could result in other people using the word Google to refer to their own products, thus diminishing our brand.”
For those not well versed in trademark law, such a proposition may sound ridiculous. But for those in the know, this is a threat to take very seriously indeed. Because over recent years, the Google name has begun to enter everyday usage, setting alarm bells ringing that, if the company is not careful, Google could go the way of words such as escalator, gramophone, aspirin and linoleum – all once trademarks but now merely entries in dictionaries around the world, owned by nobody and available for all to use.
If a trademark slips into common usage, it runs the risk of becoming generic. And once that happens, the trademark is worthless to its owner. Rivals will be free to use it and, in Google’s case, that would mean there would be nothing to stop the likes of Yahoo and Microsoft incorporating the name into the products they offer or using it descriptively in their marketing. And if that’s not bad enough, there is then the new expense of having to start the whole process again in order to find and then market a different name that will distinguish the company’s products from those of its rivals. All this before beginning to consider the impact on overall company value the loss of a high-profile trademark would have.
Although all this sounds alarmist, it can and does happen – especially in a world where goods and services are often sold across a variety of markets. In 2002, Sony lost the right to its registered trademark Walkman in Austria after the country’s Supreme Court ruled that the name had become synonymous with all types of hand-held portable cassette players. Sony had sued Austrian company Time Tron Corporation for describing its range of portable cassette players as Walkmans in a sales catalogue. The Court decided, however, that Sony had not taken sufficient steps to prevent the generic use of its trademark after it was found listed as a noun in a 1994 German dictionary.
All of which makes the way in which Google polices the use of its name absolutely crucial. At all times it has to be seen to be seen to be doing all it can to ensure the integrity of the trademark is preserved. This means ensuring that the word is never used as a verb or as a noun, and that when it is, those who are misusing the mark in that way are told what they have done wrong and are asked to correct their mistake. With a global brand such as Google’s, that means round-the-clock monitoring of magazines, books, TV, radio and the internet.
For Google investors, therefore, there are a number of important questions to ask of the company’s board. For example, what internal guidelines does Google have relating to the use of its trademark? What training programmes has it put in place to ensure that staff, agents and others that work on behalf of Google know what is expected of them when they use its trademarks? Does the company tolerate any use of its trademarks as verbs or nouns? What steps has the company taken to monitor the use of its name outside of the United States and has it acted when misuse has been detected?
These are not the usual questions that get asked about a public company, but then Google is not a normal company. As a web-based business, one of the key elements that sets it apart from actual and potential rivals is its name. Although the trademark becoming generic would not affect registration of the google.com domain, the company would no longer be in a position to prevent rivals launching sites such as Microsoftgoogle.com or googleyahoo.com. In the same way, advertising slogans such as “We Google Better” would be perfectly acceptable. Of course, we are a long way from anything like that happening, but if it ever finds itself on the slippery slope, Google will have a hard job clawing its way back to safety. What is certain is that companies such as Microsoft – with huge resources at their disposal – will not shirk from testing the strength of the Google name if they believe there is any chance at all it is under threat of going generic. And all Google needs to do is lose one case in court and the game is up: it essentially loses its trademark and its brand.
Onus on investors
Such scenarios show that, for investors, intellectual property is not an issue that can be ignored. As its management can have a profound effect on corporate value, shareholders, VCs, banks and other financial institutions have to be able to assess the competence of boards of directors to maximise returns on IP and to prevent the disastrously expensive mistakes that can and do happen.
Back in the 1990s, for example, a British engineering company spent several years and more than £600,000 on developing a new process for making products from metal wire. When it had come up with something it wanted to take to market, the company’s management decided to apply for patent protection. Unfortunately, the results of a patent search revealed that the company’s idea had already been thought of in the US 20 years before but had never been patented in the UK. As a result, the engineering company could not obtain any form of protection for its research and the subsequent development process. Even worse, the company could have got hold of the technology for the cost of the patent search, approximately £20. And this is not an isolated example.
However, it does seem that investors are getting the message. Work done by the law firm Howrey Simon Arnold & White in 2001 shows a growing trend in the City of London to take intellectual property management strategies into account when assessing the value of companies. In a survey of fund managers, analysts, private equity investors and venture capitalists, Howrey reported that 93 per cent of respondents believed IP rights to be crucial to the enhancement of profit, while 78 per cent stated that an effective IP strategy was fundamental to improving a company’s share price. They were findings that led the firm to conclude: “Simply protecting patents will no longer satisfy the investment community. Increasingly, companies need to develop a comprehensive and ongoing IP strategy as well as effective valuation tools in order to build investor confidence.”
The investment community, it seems, is learning to love intellectual property.