A handful of public companies have found an inventive way to make money from patents.
They're not the ones that had the brainstorms that resulted in the legal rights to make and market new products. Instead, they acquire the patents from individuals or small companies, with the aim of turning the intellectual property into a stream of cash.
As recent lawsuits between Apple and Samsung demonstrate, the battles over patent rights are becoming increasingly contentious. Patents have also become a major factor in valuing BlackBerry Ltd. Some analysts say the smartphone maker's patents are worth $1-billion; others say it's more like $5-billion.
As those examples suggest, intellectual property is hard to value. And determining who holds the rights to a given innovation can often involve litigation.
Acacia Research Corp. of Newport Beach, Calif., is the largest of the publicly traded patent companies. It licenses the patents it acquires to other companies; it also pursues lawsuits that request cash damages for alleged infringements of its patents. The original patent holders get cash or royalty payments from Acacia as the money rolls in.
Companies such as Acacia are sometimes referred to as "patent trolls" because they use the courts to enforce patents on inventions they had no hand in creating. This, opponents argue, stifles innovation thanks to a plethora of nuisance actions. A more polite term for such firms is "non-practising entities," since they don't actually practise the business covered by the patent.
Non-practising, however, does not mean non-moneymaking. Acacia has roughly 275 patent portfolios across a wide range of technologies and has signed more than 1,200 licensing agreements. In the past 12 months, it has booked $200-million (U.S.) in revenue. ("Sales" doesn't really seem like the right word, does it?)
Revenue and, importantly, earnings can be inconsistent, however. In the first quarter of 2012, the company recorded $99-million in revenue and a $50-million profit; in the most recent quarter, it recorded $23-million in revenue and a net loss of $12.5-million. This helps explain why the company's shares reached nearly $45 early last year, but now trade for half as much, with a forward price-to-earnings ratio of just over 13.
Here's the positive spin on the disappointing results: Analyst Darrin Peller of Barclays Research believes the company is acquiring "increasingly more valuable" patent portfolios, which "result in more complex negotiations with prospective licensees."
The underwhelming second-quarter results – the company missed revenue expectations by, um, nearly 70 per cent – prompted Mr. Peller to cut his target price from $28 to $23, just above its current trading levels. Despite that, however, he says the company is "well-positioned to benefit from the secular growth trends within the patent licensing industry longer-term." He says the shares could reach $40 if things break perfectly.
When Mr. Peller speaks of "secular growth trends" in the patent industry, he includes proceeds from litigation. If you'd like to play the other side of this coin, there's always RPX Corp. of San Francisco.
RPX's business model is the direct opposite of Acacia's: Instead of representing the small inventors and companies alleging infringement, RPX assists the bigger companies that get accused of violating the patents.
It goes out and acquires the patents that a company such as Acacia might use against its clients. Through this "defensive patent aggregation," as RPX calls it, the company's clients then license the patents from RPX. The company also sells patent-infringement insurance.
RPX says it has identified more than 1,000 different plaintiffs in patent-infringement lawsuits since 2005.
"We have never initiated patent infringement litigation, and our clients receive guarantees that we will never assert patents against them," RPX explains in its annual report. "We consider this guarantee to be of paramount importance in establishing trust with our clients."
In contrast to Acacia, RPX's results have been relatively consistent. The shares, at around $16, are up nearly 80 per cent this year, although they're still barely above half their 2011 highs and have a price-to-earnings multiple of about 17.5.
Mr. Peller of Barclays has an "overweight" rating on RPX with an $18 price target. Jeffrey Meuler, of Robert W. Baird & Co. Inc., has a $22 target attached to his "outperform" rating. "We expect investor appreciation for [RPX's] unique model to increase over time," Mr. Mueler says.
Perhaps we will still have difficulty valuing patents when they remain buried on the balance sheet of a large company. But when these niche players turn them into cash every quarter? Yes, that we can appreciate.
David Milstead