Patent values have increased dramatically over the past two decades. Evidence of record valuations has been demonstrated recently in the mobile phone/wireless communication industry. For example, in the second quarter of 2011, Novell’s 882 patents sold for an average value of $510,000 per patent; in Q2 2011, Nortel’s 6,000 patents were reportedly purchased at a per-patent price of $700,000; and, in Q3 2011, Motorola Mobility’s 24,500 patents went for the same $510,000 price (great multiples for patents that likely cost $20,000 to $50,000 each from filing to granting). Pundits often cite the meteoric rise of valuations in patent portfolio acquisitions such as these as evidence that patents are in the midst of a speculative bubble.
More recently, in the summer of 2012, the Kodak portfolio of 1,100 patents, which was initially predicted to sell for more than $2 billion, attracted bids of only $150 million to $250 million. Some suggested this was the first evidence that the patent bubble was ready to pop. However, the portfolio eventually sold months later for $525 million, or $480,000 per patent. While the per-patent price seems to have peaked, is this a sign that a precipitous drop is approaching, or has there simply been a market correction for an asset that had been previously undervalued?
Definition of a bubble
Many definitions of an economic/speculative bubble exist. Generally, they are based on surges in asset prices to a level significantly greater than the fundamental value of the asset. In a bubble buyers typically outnumber sellers. There is an irrational exuberance that valuations will continue to increase and the sense that asset must be acquired now for fear of missing out. The pop of a bubble is signified by a rapid sell-off of the asset as investors panic.
Although many patents (and potential sellers) exist, the transaction costs for obtaining a single patent or a few patents is quite high. Often, patents must be grouped into a larger portfolio to attract the attention of buyers. This significantly limits the supply, especially when filtered based on the technology and the quality of the patents. However, the potential buyers of such patent portfolios (especially the large portfolios described previously) are also limited, as the high costs of the purchase and ongoing maintenance of portfolios prevent many small businesses from competing.
The process of patent valuation is very difficult. Companies sometimes purchase patent portfolios to assert against competitors within a specific industry. These patents may be valued based on potential excess profits obtained by keeping competitors from using a particular invention or on estimation of litigation awards. Other patent portfolios act as a defensive strategy. These patents might be valued on the estimation of avoided or settled litigation.
Analysis of patents and bubbles
Comparing the overview of a speculative bubble and the patent landscape, there are many discrepancies. First, the number of buyers of large patent portfolios is limited. This deters the irrational behavior present in many bubbles. Second, companies are acquiring these portfolios for specific purposes (e.g. offensive or defensive). Patents are generally not being purchased as an investment to resell, and there is unlikely to be a rapid sell-off. Third, the patents have a known, finite life, and logically the value will decrease as the time to expiration decreases.
Thus, the increase in valuation may simply be a market correction of an asset that is tremendously difficult to value. The timing has coincided with the rise of patent trolls and non-practicing entities, as well as media-publicized patent litigation trials, which may have increased the estimation of litigation costs/awards. In addition, the U.S. economy has shifted over the past 25 to 30 years from a goods-based economy to an information-based economy. This is evident in data from Ocean Tomo, which shows that a majority (68 percent) of the market capitalization of the S&P 500 was composed of tangible assets in 1985, compared to a majority (80 percent) of the market capitalization being intangible assets—such as intellectual property and goodwill—in 2005 and 2010.
There are currently significant discussions in political and government circles to implement legislative change in order to deter expensive patent litigation and hopefully encourage more innovation. If there is swift, substantive change, then the valuation of patent portfolios could see a relatively rapid reduction. However, such rapid change is unlikely to happen given the entrenched economic, political and legislative systems and the potential of unknown economic side effects.