Auctioning patents: Glass half-full, half-empty

From the media buzz perspective, the first public, multilateral auction of patents held in San Francisco on April 6 and 7 auction was a PR dream: extensive press coverage prior to and after the auction, from both traditonal (Wall Street Journal, San Jose Mercury News) and new media outlets (CNET, Red Herring), high-powered audience of 400 people and a broad offering from sellers such as Siemens, 3COM and Schlumberger - 78 and solid film lubricant). This was enough for James Malackowski, CEO of Ocean Tomo, to proclaim the auction a success that exceeded expectations. The next auction is scheduled for October, this time on the East Coast.

In terms of actual sales, picture is more contrasted: only 26 lots were sold on the floor for total consideration of slightly over 3 million. According to Ocean Tomo, indications of interest on an additional 22 lots for a value of about 5.6 million were received after the auction and may be closed in the next two weeks.  This would suggest that the private, bilateral negotiation remains a preferred acquisition approach for higher value patents. In the public auction, the highest price, for a patent for digital distribution of movies over networks, was 1.4 million. This may sound impressive but it was below the estimated catalog value of 2 to 5 million. This was part of broader pattern, with buyers rarely bidding above the reserve price and sellers unwilling to lower it. Ocean Tomo recognizes that sellers may have been too ambitious and is looking for alternative methods of setting the reserve price (such as third-party appraisals).

It is always risky to judge a pertinence of a given approach on a single occurrence. Nevertheless, it is far from certain that the proposed public auction format represent a breakthrough that successfully addresses the past issues of patent valuation. Price discovery process, either in terms of price dynamics or trading liquidity, does not appear to have worked. And Ocean Tomo itself recognized the need to maintain a private bilateral channel alongside the public auction.
A fundamental challenge, as I see it, is that of value sharing. Acquisition of a patent is only rarely a final step in revenue generation, often it is only a beginning. At the time of the purchase, the buyer rarely knows the full potential of revenues to be generated by the patent. He often needs further cooperation from the patent owner. Both the uncertainty and the shared nature of value creation suggest that the transfer of value should be progressive and adjustable. In other terms, it may be preferable to trade patents as derivative instruments, as options and futures, rather than as physical entities

Auctioning patents

This coming Thursday, April 6, 2006, a Chicago-based Intellectual Property company, Ocean Tomo, will proceed to auction several patents lots in a San Francisco hotel.
What makes this information newsworthy is that it is the very first public patent auction worldwide. This may sound surprising: after all, patents are a well-known economic asset, whose importance is widely recognised. It is an essential component of Intellectual Property (IP), which in the modern economy is becoming more important than the traditional Physical (Material) Property. Indeed for leading-edge sectors such as biotechnology and information technology, patent management is a critical skill and the validity of a patent is often a matter of sheer business survival. Accountants have developed various methods of evaluating the economic and financial value of patents. These methods have been codified in the new accounting standards (particularly IAS). Their validity is periodically tested in courts, which have been become ultimate adjudicators of both the ownership and the value of the patents. This was for instance the case in a highly publicized patent dispute between Blackberry owner, Research in Motion, and a small company NTP, which resulted in a settlement of over $600 million in favour of NTP.
Another trend, which should favour patent trading, is the emergence of markets for intangible assets such as telecom licences or pollution rights.
So why, outside the convoluted and ponderous legal apparatus, and despite numerous attempts, no formal market for patents has been successfully established to date?  I believe that the difficulty is due to three interrelated factors:

• Value chain integration: Owners of patents want to fully benefit from their inventions. The traditional approach to achieve this goal is exclusive ownership of patents and related licensing rights. This is particularly relevant for academic patent holders, who want to avoid a reputation risk of being associated with unethical use f their inventions.


• Information asymmetry: Patents embody only a part of knowledge used to create the invention. Thus, from a technological perspective, the owner of the patent has a sizeable information advantage over potential buyers. However, once a patent is sold, it can open a door into the related knowledge domain. As some of the buyers are existing or potential competitors, inventors often seek to minimize prior disclosure in order to preserve their advantage. In a symmetrical fashion, potential buyers may have an information advantage over inventors in terms of market potential knowledge. This is particularly the case if the patent is detained by an academic or a research entity. In order to acquire the patent cheaply, buyer may be reluctant to fully disclose his appreciation of market potential prior to its acquisition.


• Disincentive to share information: Conflicting motivation of buyers and sellers prevent them from fully sharing information, prior to the transaction. Thus, while patent trade is actually quite active, it is carried on a bilateral basis, quietly, often secretively. For instance, an ambitious patent acquisition venture, Intellectual Ventures, launched by Nathan Myhwold, ex-chief scientist of Microsoft, makes a point of not disclosing its patent portfolio.  

Ocean Tomo is apparently well-aware of those difficulties and its initial approach is quite cautious, actually old-fashioned. This will be a live auction, on a traditional Christie’s or Sotheby’s model, with a printed catalogue and social events. If successful, it will be replicated every few months. So far, no announcements were made to set up a sophisticated electronic market or to link with an existing (physical or virtual) auction site. This may be the next step.
Patent trading is a timely idea. I will monitor the results of Ocean Tomo initiative and follow its future developments. It will be interesting to see whether it triggers a trend of open, multilateral trading in patents.  

Alcatel Lucent merger: Blood, sweat and tears?

Another week, another telecom merger: on Sunday, April 2, Alcatel and Lucent, two telecom equipment suppliers, announced their union. This was not really a surprise: two companies were seen as natural partners for long-time and almost concluded a deal in May 2001. This time, the two companies came to a successful agreement. Not that they have much choice: they had to do something. Consolidation pressures that affect telco operators are even stronger among suppliers. In addition to the continuing shrinkage of traditional customer base, they face major technology shifts, which trigger waves of new entrants.  For Alcatel and Lucent, the merger is a defensive manoeuvre, crucial for their very survival. Once kings of the telecom hill, with glorious history and prestigious lineage, they have fallen on hard times recently. During the 1990s Alcatel got bogged down in the politico-economic strategies of French establishment, which transformed the company into a lumbering conglomerate and as a result largely missed the mobile opportunity. Lucent never lived up to the lofty expectations of its shareholders, who saw it as the heir of the mythical Western Electric and was unable to capitalise on the treasure trove of Bell Labs. Both companies suffered greatly in the Great Telecom Crash of the early 2000s. Their market cap is still lower than it was five years ago and they both underperformed broad market averages. It is a measure of their fall from grace that their combined market cap represents about a third of that of Nokia and is less than a quarter of that of Cisco. It is also worth noting that the merger values Lucent at a discount from its recent market price.  

Essentially defensive, the merger appears to make a lot sense, at least on paper. Geographical and product complementarity is obvious: Alcatel is strong in Europe, Midle-East and Africa; Lucent, in the US. Alcatel is a market leader in ADSL, while Lucent has considerable mobile expertise and experience. Cost synergies are considerable, estimated by the management at some $1.7 billion over the next three years. Leaders of the proposed combination, Ms. Russo and Mr Tchuruk, have impressive turn-around record.

And yet, for its advantages, it is far from clear that the how successful the merger will be.
Past experience shows that in Information Technology domain a merger of challengers rarely leads to a creation of market leader. For instance, despite having absorbed Apollo, Digital Equipment and Compaq, Hewlett Packard has not succeeded in catching up with Sun, IBM or Dell. The advantages of bringing various technologies under one umbrella appears to be largely offset by costs of co-ordination, which include not only increased in-fighting but also, more importantly, loss of focus.
In this particular case, integration challenges look formidable.
Potential for not a single but a serial cultural clash is considerable. Alcatel – Lucent operation is announced at the time when analysts are taking a hard look at DaimlerBenz-Chrysler merger (see the Economist article).  The verdict is mixed: integration was very costly and lengthy and results are only beginning to appear now, after eight years of hard slog. In the meantime, Mercedes lost its leadership position in the luxury segment and Chrysler owes its recent market success as much to the weaknesses of Ford and GM as to its own design prowess.
One of the main reasons for integration difficulties of DB-Chrysler combination was the confusion about the nature of the operation: presented as a merger of equals, it was in fact a German takeover.
A similar risk of confusion exists here.  Both in terms of revenue and market valuation, Alcatel is much bigger than Lucent. The NewCo will be listed on Euronext and the Board composition appears tilted toward Alcatel. Mr. Tchuruk might have ceded the CEO post but he remains Chairman of the Board and he has shown repeatedly that he has notoriously reticent to share decision-making. And Mrs Russo is not exactly a shrinking violet. Power struggle is bound to be endemic.
It will be compounded by the need for further strategic alignment between the two companies. Alcatel has not fully shed its conglomerate mentality: it is still trying to take over Thales, as part of its drive into satellite transmissions. On the other hand, both companies are very light on the media and consumer side. In a fast-moving environment of networking equipment, choices have to be made and made quickly. Players need to be agile and bold. The most successful suppliers won market share by making huge but focused bets: Cisco on routers, Nokia on GSM handsets, Qualcomm on CDMA. In the process, they reinvented themselves not once but two or three times.
The strategic realignment of the NewCo may also be hampered by the economic patriotism temptation, which is present in both companies (particularly if one take into account the defense business of both companies.)
David Faber, the “Brain” from CNBC network, estimates the chances of success of the merger at 50%. He may be an optimist. Not that the NewCo will go bankrupt. But rather that it will struggle mightily to find new identity and positioning.