The list of companies that emphasize strategic IP management and tout its benefits to shareholders still isn't that long -- but it continues to grow. PE firms and hedge funds are getting better at identifying undervalued (and overvalued) IP and investing accordingly. There's even a new investment fund focused on companies with undervalued patent portfolios. So it seems opportune to ask: Are investors becoming more willing to reward good IP management?
As you'd expect, valuing what strong IP management brings to a company is hard, and the degree to which an IP portfolio can be linked to stock performance varies considerably by industry. But conversations with money managers, corporate IP strategists and other observers indicate the answer is a qualified yes: Investors do seem to be taking IP into account more often when valuing a company.
"Intellectual property is very important in terms of what kind of earnings a company is going to have, and companies that have strong intellectual property managers over time have had high returns on capital," says Robert Bartolo, co-manager of T. Rowe Price Group Inc.'s $1 billion media and telecommunications fund. As a result, he says, investors are willing to pay a higher multiple for companies with effective IP management. The link between IP and stock performance is most visible when looking at a company's patents, where quality typically trumps quantity, according to Bartolo, who adds that T. Rowe Price sometimes hires patent lawyers to value a company's portfolio.
Of course, patents matter most at companies that rely on invention, for example, drug or technology makers. Douglas Norman, Eli Lilly and Co.'s deputy general patent counsel, points out that former CEO Randall Tobias used to say, "What we really sell is intellectual property." Investors seem to agree. When a U.S. Appeals Court in August 2000 slashed Lilly's patent protection on Prozac by three years, shares dropped 31%, to $77, in one day, erasing more than $35 billion in market value.
But in the broader range of companies, the IP-stock connection is more difficult to establish, and as a result many argue that investors don't adequately value IP, or intangibles in general. In a study published in the Harvard Business Review last year, New York University finance professor Baruch Lev found that after factoring in levels of intangible capital, stocks of companies such as General Electric Co. and Pfizer Inc. were undervalued by more than 20%.
A number of companies have made strategic IP management a priority, dedicating significant financial resources as well as teams of lawyers and senior-level executives to protecting patents, exploring licensing opportunities and striking up partnerships. Some have posted impressive results. Yet it's still hard to tell whether stock price reflects the investment in IP management because so many other variables come into play.
With 40,000 patents and $1.2 billion in IP-related revenue in 2004, IBM Corp. is an undisputed leader in strategic IP management. In addition to the direct revenue patents and licensing generate, the company derives significant value from less quantifiable IP, such as the name recognition that comes with being known as an innovative company or the leverage IBM gains in patent negotiations. That's according to Jim Stallings, vice president of intellectual property and standards at IBM, who says these efforts have enhanced shareholder value because IP is a good barometer.
"A lot of things go into valuing a company. Innovation is one of them," he says. "People who analyze companies for value look at not just the current generation of products, but at the pipeline."
The impressive IP revenue number IBM posted in 2004 isn't necessarily reflected in its stock price, though. The company underperformed the S&P 500 index through most of the year and recently traded at middling price-earnings ratio of around 16.
Hewlett-Packard Co. launched a business unit in 2003 to license inventions more widely and pursue patent infringements more forcefully. The 60-employee division has since quadrupled IP value, to almost $200 million. Granted, that's just a fraction of overall revenue -- $79.9 billion in 2004 alone -- but, according to division head Joe Beyers, the income has created a new source of shareholder value, which in turn, can generate a higher stock price.
"Every time you add value to a company, it affects the stock price in some way," he says, adding that shareholder value is not only enhanced by the $200 million directly attributable to licensing or patent sales, but also by the competitive advantages Hewlett-Packard derives from better intellectual property management.
HP's stock performance since 2003 has been mixed, but generally positive. Over the past 12 months, HP stock has gained about 39% in value, outperforming the S&P 500. This comes despite major turmoil at HP over the difficult $25 billion merger with Compaq Computer Corp. and the subsequent departure of CEO Carly Fiorina. Did HP's stepped-up IP management contribute to the uptick in stock price? Put it this way: It couldn't have hurt.
But for HP and for many other companies, it's hard to say more than that, even when investors would like them to. "[IP] is hard to break out," says Rick Jones, manager of BB&T Corp.'s $700 million large-cap value fund. "It's reflected in the relative valuation through time, and it comes into play when we look at how a stock has been priced historically. It's qualitative, but we don't quantify it."
Still, it makes basic sense that good IP management should be good for share price.
Establishing that link is easiest regarding patent sales, licensing and royalties, which are easier to track because they provide distinct and quantifiable revenue streams. Less quantifiable, but often as vital to a company's overall performance, are the quality of the patent portfolio, the competitive advantage gained from IP protection efforts, even the expertise of the IP management team. For instance, a savvy patent portfolio manager minimizes patent registration costs and can reduce competition through comprehensive patent protection, says Bruce Burton, an intellectual asset management expert at Deloitte Consulting LLP. And understanding cross-licensing lets companies use IP as currency when negotiating with joint-venture partners or even suppliers.
Would investors welcome some help in quantifying or at least identifying good IP management? One says yes: "You'd think companies would be better at articulating their real intellectual property positioning rather than simply saying we hold 25 patents," complains Matthew Patsky, co-manager of the $250 million Winslow Management Co. "That doesn't mean anything."
IBM is doing its part, breaking out IP income separately in the 2004 annual report and detailing how much came from licensing, patent portfolio sales and custom product development. IBM and other IP-focused companies also view management of brands and ideas more strategically, engaging both business managers and lawyers and putting a higher premium on tracking performance.
"The legal community has traditionally managed intellectual property strategy, and it's been primarily defensive," IBM's Stallings says. "Now we're in an age where innovation is a strategic issue."
There's still ample room for improvement both in IP management and calculating and articulating its value to investors. HP, for example, doesn't break out IP revenue in financial reporting, and the company took a year before announcing it had created a dedicated IP unit. Communicating its IP efforts simply wasn't paramount, the company's Beyers says.
The lack of communication isn't surprising, considering companies often lack reliable data on their own intangible assets, says NYU's Lev, because accurately valuing brands, copyrights and employee expertise can be difficult. Companies must also be careful not to overpromise about their IP. But if they want to tell their IP story in detail, investors are eager to hear it. - Dalia Fahmy
Just settle, OK?
It's not unusual for a CEO who thinks a competitor has violated one of his company's key patents to want his day in court. But a panel of judges who made a presentation last month at the annual meeting of the Licensing Executives Society Inc. in Phoenix has some advice for such CEOs: Be careful what you wish for. The quartet of judges -- three from the U.S. and one from Canada -- compared patent litigation with a car crash. Why, they asked, would a company want to bring what is essentially a business and technology dispute before a court that is concerned only with the legality of a patent?
Irrational or not, though, more and more companies are going the litigation route. The number of patent cases filed in federal courts has risen from 2,376 in 2000 to 2,978 in 2004, according to federal judicial statistics.
Meanwhile, the judges in front of whom the litigants are coming often need to prioritize criminal cases over their civil-case workload. Criminal cases make up just 15% of those that come before Judge Dickran Tevrizian of the U.S. District Court of California. Yet those cases take up about 85% of his time, the judge said in Phoenix. So Tevrizian pushes hard for patent litigants to settle, and he's successful about 90% of the time.
Judge Joseph J. Farnan Jr., a U.S. District Court Judge in the Court of Delaware, reported that about 70% to 75% of his patent cases end up settled. It's a good thing, he says, considering resources are scarce. "It's me and my first-year associate with resources that boil down to a computer and what you tell us," says Farnan. "Personally, I wonder why anyone would bring that collision before us."
When companies don't settle, Farnan moves their cases through quickly, knowing that most litigants are unwilling to give up when they end up on the losing end of a judgment and will likely appeal anyway. And that litigation is costly, with expenses estimated at around $3 million to $4 million. Judge Randall Rader, a federal appellate judge, is doing his part. He recently began a mediation program in his court to help companies find common ground.
But if the case can't be settled, the judges offered up a couple of things that executives and their legal teams can do to make the court case easier on the judge and the company. First, don't be stingy with relevant documents. All the judges said they were frustrated by businesses in patent cases trying to make documents confidential on the grounds that making them public would hurt their competitiveness. Justice Johanne Gauthier of the Federal Court of Canada says she has seen plaintiffs try to black out information that she later found on their corporate Web site.
Second, keep the focus on the legal issues of the alleged patent infringement. The goal in coming before the court is to get an opinion on the legality of a patent and determine damages, not to dissect the technologies underlying the patent. Gauthier says, "That is a very dangerous expectation. This is not a fun day for the engineers, so don't waste time on the technical issues."
Keeping it simple and putting things in layman's terms might help hold down the expenses, and it will also make for a happier court.
-- Stacey Higginbotham
Suit and countersuit
In a case that's emblematic of the surge in patent litigation, the king of Internet retailing and a $20 billion giant in the travel and leisure industry are battling over cyberspace patents. The battle began in October 2004, when Amazon.com Inc. was sued for patent infringement by Cendant Publishing Inc., part of Cendant Corp., owners of Orbitz, Budget, Avis and Trilegiant, as well as 6,400 hotels operated under the Travelodge, Ramada Inn, Days Inn and Super 8 brands.
Cendant withdrew the suit in February after both sides agreed to settlement negotiations. Talks failed, however, and Cendant refiled its suit in June in Delaware federal court. The company is claiming that Amazon's method of providing recommendations based on a customer's purchasing history infringes on a Cendant patent. Cendant seeks a permanent injunction, damages and attorneys' fees. In its court filings, Amazon denies infringing the patent.
In July, Amazon shot back with a suit in Seattle federal court, claiming that Cendant and several affiliates were infringing four patents involving the securing of credit card transactions, customer referrals and other e-commerce methods. Amazon seeks a permanent injunction, as well as treble damages for willful infringement.
Amazon has never asserted these four patents before, and is only asserting them now because of Cendant's suit, says spokeswoman Patty Smith. Cendant spokeswoman Kelli Segal declined to comment. No word yet on how or whether Cendant's pending restructuring will affect the suits. - Katia Hetter in IP Law & Business
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