(Editors' Note: This article discusses a micro-cap stock. Please be aware of the risks associated with these stocks.)
When it comes to patents, the most frequent question we get asked by investors (big and small) is how much they are worth. Our typical answer? "Whatever someone is willing to pay for it." In other words, it is usually an impossible answer to give with any accuracy absent other information. When researching a company's financial statements, investors (rightly) won't find any numbers reflecting the true value of these intangible assets. Indeed, when a company develops its own patents, the only numbers investors would see are costs, namely the legal and filing expenses. Clearly, those are not numbers indicative of a patent's real worth.
If a company purchases a patent, the purchase price (cost allocation to the patent) is recorded as an intangible asset on the balance sheet of the purchasing company. To facilitate the purchase, companies retain economists, IP valuation gurus and patent experts who perform due diligence and come up with a number. Does this type of hypothetical estimate get us closer to the true value? Not quite.
Why is this such a difficult exercise? Because economists and financial experts usually have specific models they use in valuing patents -- models that vary from one expert to another. The models and methods used are thus subjective, and as a result are often fundamentally flawed from a patent monetization perspective.
What types of models are out there? We will provide some examples, but will keep the discussion simple in the interests of brevity. One is a cost-based approach, which seeks to capture the value of a patent by estimating the cost of replacing the patented technology with another technology. By calculating the total costs of developing the patented technology economists usually arrive at a very limited value, one that is exclusively based on a single factor - cost. Second, some valuation experts use a market-based approach that values a patent by comparing it with other transactions that involve similar patents. However, if no similar transactions are available, this approach is of little use. In a third model, use of an income-based approach values a patent on the basis of the future income derived from utilizing the patented technology. Essentially the present value of a patent is derived from future income, taking into account the net cash flow (extra cash earned due to patented technology), the duration of income, and the discount rate, factoring in inflation, risk, interest rates, etc. Finally, the option-based approach is based on the option pricing theory developed for use in pricing financial options. It takes into account the value of the options involved in the R&D projects that lead to patents, the choices made in the prosecution of the patent, as well as in the post-grant phase of patent commercialization. Essentially you can think of the patent filing process or commercialization of the underlying invention as a series of call options (the right to buy at a future date) and abandoning the patent or terminating the R&D project as a put option. Needless to say, this is an extremely complicated method for valuing patents and in many ways is unrealistic.
The takeaway is that such valuation methods are based on the success of the underlying protected technology. They don't take into account the fundamental meaning of a patent -not the affirmative right to practice (e.g., make, use or sell) the protected invention, but the right (derived from Article 1, Section 8, Clause 8 of the U.S. Constitution) to exclude others from practicing the patented invention. This exclusion concept of patents is what differentiates patents from a frequently compared-to real property right, where the right to exclude ensures the right to use.
It is not surprising then, that the only effective way of unlocking the true current value of a patent is to enforce it against an infringer in a court of law or sell it outright to a willing buyer. Companies may speculate as to what their patent portfolios are worth by going through the valuation process, similar to valuing what your 100-year old stamp collection is worth, but at the end of the day, it will come down to what others are willing to pay for it - whether in litigation or on the open market.
This is where the concept of patent monetization comes in. Whether you are a university seeking licensing revenues from an industry utilizing your inventions, a startup company leveraging your inventions by clearing a pathway in a highly competitive market, an individual inventor seeking to obtain quantifiable recognition, a successful company looking to build a patent arsenal to fend off other competitor companies' potential infringement actions, a struggling company finding an alternative way to generate cash flow, a bankrupt company rewarding its debtors by auctioning off its most valuable form of assets (i.e., patents) or simply a patent assertion company deriving revenues from acquired patents - you are in the business of monetizing patents. You can call them trolls, orcs, elfves or hydras, but the fact remains the same -- patents are valuable and they are here to stay because they "promote the progress of science." Some of the recent patent acquisitions by technology giants further underscore this point:
- Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT) acquire Nortel Networks Patents for $4.5 billion.
- Facebook (NASDAQ:FB) acquires AOL Patents from Microsoft for $550 Million.
- Google (NASDAQ:GOOG) buys Motorola for $12.5 Billion For Patent Parts.
- Microsoft acquires AOL patents for $1 Billion.
- Kodak patents sold to Microsoft, Amazon (NASDAQ:AMZN), Facebook and RIM (RIMM) for $527 million.
- Intel (NASDAQ:INTC) acquires InterDigital patents for $375 million.
When it comes to investing in non-practicing entities, and more specifically, to companies exclusively dedicated to monetization of patents (sometimes referred to as "patent plays,") there are a few alternative business models investors can choose from. One model is the "boom or bust" strategy of acquiring one key patent and aggressively enforcing it against the biggest companies in the industry hoping to get to the trial stage where the damages may be on the order of hundreds of millions, if not billions. This is a highly speculative model and may not suit the needs of longer term risk-averse value investors. (See Vringo (VRNG) cases v. Google, MSFT)
Another model is the steady accumulation of patent portfolios spread across multiple industries with a licensing strategy in mind and a conscious effort to avoid high litigation costs. These companies start with what they call a "carrot licensing" strategy (negotiate without threats of litigation) and move on to the "stick licensing" approach (threaten litigation by filing the complaint) frequently ending up with an early settlement recovery from multiple defendants, helping them fund ongoing litigation activities. (See Acacia (NASDAQ:ACTG)) The licensed patents are rarely tested for validity and infringement issues because it's cost-prohibitive for defendants to fight to that stage. Many such cases don't even reach the Markman hearing where the parties can get a clearer picture as to the meaning of the asserted claims.
As a result, neither strategy, if employed by a publicly-traded company, gets the investor closer to an accurate valuation of the company's assets because the damages and settlement figures are very speculative. That is why there emerged yet another alternative model - a publicly-traded company built on the acquisition and enforcement of proven revenue generating patents.
Marathon Patent Group (NASDAQ:MARA) is one such company that aims to extract maximum value out of battle tested cash flow generating patent portfolios. In effect, Marathon's approach adds some predictability to the future potential value of the company.
MARA has already acquired 5 patent portfolios in a span of 3 months -- portfolios that have already generated (prior to acquisition) over 130 licensing agreements for about 55 million in revenues. Marathon continues to enforce these same patents against a plethora of new targets, hoping to secure continuing settlements that will boost the company's cash flow. The reason Marathon is able to acquire such highly valuable assets is because of its partnership with IP Nav -- a monetization company that has generated over $600 million in licensing revenues for its clients, and continues to put together lucrative acquisition deals for Marathon. Notably, IP Nav's founder, Erich Spangenberg, is the largest shareholder of Marathon through his TechDev holding company and has actually added to his personal holdings very recently at the tune of 625,000 shares acquired in the open market at 0.40/share.
We will cover the company in greater detail in our future articles, but for starters here is a brief synopsis of its current holdings and activities:
(ED Texas) Portfolio
Relay IP (Delaware) Portfolio
Bismarck IP (Siemens Portfolio)
U.S. PAT. NO. 5,734,832
1. Sony Computer Entertainment America LLC,
2. Siemens Energy, Inc.,
3. CB Apex Realtors, d/b/a Coldwell Banker Apex Realtors,
4. Blue Cross and Blue Shield Association,
5. Juniper Networks, Inc.,
6. Winn Dixie Stores, Inc.,
7. Dell, Inc.
8. E*Trade Financial Corporate Services Inc.,
9. Liberty Mutual Group Inc.,
10. Aetna Inc.,
11. Avon Products Inc.,
12. Starbucks Corporation,
13. Yum! Brands Inc.,
14. Hewlett-Packard Company,
15. Alcatel-Lucent USA Inc.
16. Ambit Energy Holdings, LLC,
17. BMC Software Inc.,
18. HomeAway, Inc.,
19. Hoover's Inc.
20. Ristken Software.
1. Sprint Nextel Corporation,
2. Juniper Networks,
3. Cisco Systems,
4. Bloomberg L.P.,
5. Hitachi Cable America,
6. D-Link Corporation,
8. Hewlett-Packard Company,
9. Enterasys Networks,
10. Extreme Networks,
11. TIBCO Software,
12. BT Group,
13. SAVVIS Inc.,
14. Zhone Technologies,
15. Huawei Technologies,
16. Allied Telesis,
18. Thomson Reuters Finance Company, Thomson Reuters Finance Investments Inc., Thomson Reuters USA Inc., Thomson Reuters US LLC .
19. Securities Industry Automation Corporation
- 10 more defendants on June 18, 2013:
CBOE Holdings, Inc., The Nasdaq OMX Group, Inc., ActiveTick LLC, BATS Trading Inc., Lek Securities Corporation, Direct Edge ECN LLC
33 license agreements ($16 million)
16 named defendants, including Federal Express, Mitsubishi, Toshiba, Nintendo, ZTE, Siemens, Alcatel-Lucent and UPS among others.
97 settlements and licensing agreements to date and $39 million in gross recoveries
Not yet asserted
Not only is the company, together with IP Nav, successful in efficiently settling its cases, but it's been successful on a litigation front as well. A recent Markman hearing in the TQP line of cases resulted in a favorable claim construction order, which should further increase its settlement negotiation leverage, usually resulting in quick exit strategies by multiple defendants. Using the most conservative numbers, settlements from the remaining TQP defendants alone could result in at least $15 million in additional revenues for MARA, effectively doubling MARA's current market cap. To help finance the patent purchases, such as the TQP portfolio, MARA recently received $6.0 million in subscriptions for units, where each unit was offered in a privately subscribed offering at $0.40 per unit, with each unit consisting of one share of common stock and three year warrant to purchase one-half of one share of common stock at an exercise price of $0.50 per share.
While there is a lot more to cover about this particular "patent play," it's important for investors to know that there are different business models at work in the patent monetization space and each one presents different value depending on your preferred level of risk. For those interested in steady returns and minimized risk, MARA may be an option worth exploring.
Disclosure: I am long MARA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.