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What The Patent Frenzy Means for Investors

The market for patents is real and it is growing, but describing it to outsiders is like trying to describe financial derivatives in 1982. Notwithstanding, here's an attempt...

If you run a large institutional investor that invests in the high-tech industry, you are forgiven for scratching your head about the recent frenzy of patent-related activity. It seems that high-tech companies are buying and selling patents like never before! 

For example, there’s news out this morning about Microsoft buying some AOL patents for $1.1 billion. Google recently spent $12.5 billion on Motorola Mobility for patents, and it has indicated that it plans to further ramp its patent acquisitions. Intel bought RealNetwork’s patents last week. Facebook reportedly bought 750 IBM patents not long ago. And there was the Nortel Networks auction that raised everybody’s eyebrows a few months back. And that’s just scratching the surface!

What’s going on here? Why do your high-tech portfolio companies seem to have an insatiable appetite for patents? There are two fundamental things driving this buying spree:

  1. If a company is infringing a patent, even if they aren’t aware of it, their business can be shut down in a number of ways either by a federal circuit court injunction or by an International Trade Commission stop order. And if they are aware of the infringement, the eventual punishment if they are found guilty is tripled due to ‘willful infringement’. In short, the stakes are very, very high.
  2. The technologies that all of these companies are producing are so complex that no firm – no matter how hard they try – can be certain that a product they are making is not infringing any other patents. So these companies are spending billions in R&D without real confidence that what they’re building is not infringing another firm’s intellectual property. That can be risky.

The combination of these two phenomena can place tech companies in a vulnerable position. And this is what’s driving the increasingly high-profile market for patents.

But, in actuality, that explanation only scratches the surface of what’s going on with these companies. As I wrote in a paper back in 2008, “The market for patents is real and it is growing, but describing it to outsiders is like trying to describe financial derivatives in 1982.” And that’s still true even four years later. What’s changed, however, is the number of high-profile transactions we can now point to that fit the changing corporate strategy of high-tech firms. Indeed, these companies are increasingly adopting a cold war style corporate strategy based on the notion of mutual deterrence. Here are some insights:

“...if two firms have patents aimed at each other’s products, neither will seek to assert or litigate for fear that the other firm will do the same...” OR they may have gone through a series of patent altercations in the past and have established détente through a cross-licensing agreement.

And so what do companies do?

“...they seek to acquire patents that read on the technologies at the core of the profit centers of other firms. Thus, firms acquire patents that may have almost nothing to do with their business in order to be able to attack the most profitable segments of their such, the big high tech firms in the US and abroad are apparently in the process of buying up patents that ‘read’ on their competitor’s products for the simple purpose of avoiding costly litigation and increasing clout during negotiations...”

And this is why young companies like Google and Facebook have been so aggressive on the patent market; they don’t have the deep pool of patents to draw from (cf IBM and HP).

Take the Facebook-Yahoo case as an interesting example of what’s going on. Yahoo asserts its patents on Facebook. Then, rather than calling its lawyers, Facebook first looks to its own patent portfolio. Luckily, it had just acquired a bunch of IBM patents. So Facebook then looked to counter-assert some of its new patents on Yahoo. Why? So that the real negotiations could begin. The court process is just a backdrop to the negotiations so that if the negotiations fail ... a resolution will be determined, albeit an expensive one, in court.

This is what some are now calling “balanced counter assertion”. It’s all about coming to terms with patent adversaries using tactics similar to mutually assured destruction.

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