Playing defense on patents

The idea of developing patents as a kind of asset class is still new and controversial. But there's already an interesting range of players, many of whom have worked together at one time or another, trying to capitalize on it. Last September saw the launch of one more: San Francisco-based RPX Corp., which describes itself as a defensive patent aggregator.

RPX collects subscription fees from information technology companies and then buys or licenses patents that could be wielded against them by so-called nonpracticing entities, better known as trolls. So far 13 companies -- including IBM Corp., Cisco Systems Inc., Panasonic Corp. and LG Electronics Inc. -- have signed up for the service, which costs from $35,000 to $5 million per year depending on the size of the firm. And RPX has bought more than $90 million worth of patents, concentrating on those that apply in broad areas like user-interface design or call-center management.

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RPX is backed by blue-chip venture capital firms Kleiner Perkins Caufield & Byers and Charles River Ventures Inc. The latter is also an investor in Intellectual Ventures Management LLC, the patent powerhouse founded by former Microsoft Corp. executive Nathan Myhrvold. Some observers regard IV as the biggest potential troll of all, though IV strenuously rejects the charge.

What becomes clear in a conversation with RPX co-founder and co-CEO John Amster -- himself a former Intellectual Ventures executive -- is that as this field develops, such lines are getting harder to draw. RPX is not just a rival to the NPEs but also a counterparty to them, and it has already done a couple of deals with one of the biggest, Acacia Research Corp.

Amster spoke with Corporate Dealmaker editor Kenneth Klee about RPX's progress to date, the developing secondary market for patents, and where the patent world might be headed.

What is defensive patent aggregation?

John Amster: Defensive patent aggregation just means buying patents that would otherwise be asserted against companies. We are not buying them to license them. That is a byproduct of what we do, but it's different from a typical patent-licensing model in two ways.

No. 1, we will charge substantially the same rate every year, even though we will be buying at least $100 million worth of patents a year. A typical patent-licensing model would charge more as the value of the portfolio that they're licensing increases.

Second, we won't assert patents. If you have a patent-licensing model, the ultimate reason somebody is going to take a license is because they believe that if they don't, they will end up getting sued. That's not our model.

OK. So your customers pay a subscription fee, and RPX keeps patents out of the hands of people who would use them to sue. Can you put some numbers on the costs and benefits?

It's a very low-risk proposition for companies to sign up because how much do we have to buy to justify a subscription fee of $3 million to $5 million for a large operating company? Not much. We just have to save them from one litigation. The fee can probably be justified just on the basis of the legal costs alone. And since you might have paid a license fee to settle, then it's probably one decent license fee that you avoided.

How has your business progressed since you launched in September?

In terms of revenue, we're ahead; in terms of customers, we're right on plan. We're continuing to add companies. It's been more challenging than we thought it would be because when we started our plan, the financial crisis hadn't hit yet. We've had to adapt a bit. We think that the reason that we have been able to stay on plan is because our service is really aimed at reducing people's costs.

In terms of market impact, $100 million in patent rights, our target for the year, is a big part of the market right now. If we can scale that to be $200 million, we actually should be the preferred source of liquidity for people and we should take a lot of things off the street that could otherwise end up in the hands of people who would assert them and drive up the costs for all of our member companies.

How do you choose which patents to buy? You're focused on information technology, but you still serve a variety of businesses.

We're looking for things that are either existing or imminent threats to our existing or prospective members. We're looking for patents than can be asserted, or are already being asserted.

Some portion of what we buy could apply to potentially any operating company. For example, we bought something related to speech recognition technology and the use of barge-in techniques. If you call an 800 number and you interrupt the voice prompts and it sends you where you need to go -- it recognizes that you're interrupting. That's vertical market agnostic.

Then there's going to be another portion of technology that expands across multiple vertical markets, but it's more specific. But even there, there's going to be lots of overlap.

Some companies seem to object to the basic idea of a market in patents. Former Intel Corp. chairman Andy Grove compared the trade in patents to financial derivatives, and not in a complimentary way. Are you getting these kinds of objections?

There are certainly companies taking that position, especially as it relates to lobbying for patent reform. We agree with most of the companies we're talking to on their positions on patent reform. But we take a much more practical view of what's going on.

The secondary market is real. While it's not an incredibly mature market, it's not an immature market anymore, either. We're talking about hundreds of millions of dollars, perhaps more than $1 billion a year in trading patent assets. So we take the view that it's really hard to ignore. The reality is that the market is there and you need to deal with it.

You have entities that are able to pick up a patent portfolio for $1 million and turn around and sue 20 companies. And when they sue those 20 companies, the legal costs alone combined will be well over $1 million. And many of those companies will settle.

So from a company's perspective, I think it's very important that they understand what's going on in the secondary market and they deal with it. Whether or not they think it's wrong or right is frankly irrelevant. We believe that having a financial way of dealing with it -- a market way of dealing with it -- is an important piece of the puzzle for creating lower costs.

There is a need for liquidity in the patent market. Most companies understand better than they did five years ago that the reason people sue is that they have no other means of getting liquidity. I think companies have come to understand that most who own patents and are looking for liquidity would take the option of selling their patent for a steep discount to get immediate liquidity

Where are you buying patents?

We're looking at the entire market and trying to figure out where it makes sense for us to step in. We've bought from a major corporation that was asserting patents. We've bought from small companies, individual inventors, and we've bought at the Ocean Tomo auction. We've bought some stuff from brokers. We monitor the secondary market, and we have our own proprietary dealflow. We have good relations with a lot of the NPEs to try to understand where there are deals that make sense for us and for them. We've done two deals with Acacia, for example, and we've done one deal with another contingency group.

So you're not positioning yourselves in opposition to the trolls?

No. We are a way for operating companies to lower their risks and costs in dealing with NPEs. And I don't think those two things are in opposition at all. We are trying to create a market solution to a pretty big problem. So it's not about trying to squash the NPEs. It's about trying to create a better means for them to get liquidity without litigation.

What's the current state of the secondary market in IP?

We're now seeing a lot more opportunity, which is typical in an economic downturn. More companies are turning to monetizing their IP as a way to generate cash. Smaller companies are looking to sell patents as a way of financing the company without dilution, where they otherwise would do down financing rounds. You have more companies going bankrupt. So in a downturn like this, more patents are for sale.

While there's not a lot of hard data, I think maybe prices are slightly down, but not in a major way.

I do think there are a lot more buyers. Intellectual Ventures has been talking publicly about the fact that they are getting more targeted in their buying efforts right now.

But the impact has been offset by more players coming in. There are 10 to 12 hedge funds that have been active. There's a whole generation of individual inventors and contingency lawyers who over the last 10 years have made money asserting patents that are now using their own capital to buy in the secondary market -- we're seeing that a lot.

Do NPE assertions go up in a recession?

Yes. I think last year there were around 360. Right now we're on a 390 run rate. And while that's not a big step-up, it appears that we're now at an average of about six defendants per litigation, so that number appears to be increasing. If you ask most companies, they would say there's an increase.

Do you think we'll see major patent reform anytime soon? And would it affect your business?

I don't think the fundamentals of the patent system are going to change with any reform. There's been a tendency in this debate to talk in hyperbole. I don't think that the practical patent reform to date is about eliminating the NPE issue. It's not about stripping the value out of patents entirely so that an individual inventor is unable to monetize patents through sale or litigation. I don't think anyone thinks that's the right outcome.

I think that if people stop posturing in those extremes, then there could be some very needed and important reform. One of the hottest topics is damages. People on the pro-patent side, if you will, are saying that if you have a limit on damages, then it will gut the patent system and no inventor will do any R&D. I don't think anyone's talking about gutting the system that way.

What people are really trying to get at is, let's create a system where you can't have a plaintiff and defendant walk into court and put to the jury a set of numbers on damages that are so disparate as to be irrelevant. Where you have the defendant saying the damages are $5 million and the plaintiff says they're $5 billion, that's not an efficient system.

There are certainly areas where reform can be very helpful, such as changing the way the patents are granted. I think it's about trying to find some middle ground. From everything we've been hearing about reform, it's likely to lead to good, reasonable changes that don't change the fundamentals of the patent system.

As for when it might happen, who knows? Some say there's too much already on the legislative agenda for it to happen this year. We actually don't follow it that closely. From an RPX perspective, it would not change the value proposition for our customers. They will continue to face threats and assertions from NPEs regardless.

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