Public Valuations of Patent Licensing Companies and Strategic Implications
Public Valuations of Patent Licensing Companies and Strategic Implications
We provide a framework assessing public licensing company valuations and strategic implications for managers and deal makers.
Companies that depend in whole or in part on patent licensing to generate revenue have had mixed success in the public markets. We differentiate publicly traded licensing company valuations by examining their monetization models and portfolio characteristics (i.e., a company’s “assets”). The monetization model and the assets are interdependent. This framework for differentiating licensing companies explains why some have succeeded in the public market while others have struggled to benefit from it. Furthermore, it guides bankers and investors in pricing and valuing public and private licensing companies. Our framework is primarily empirical, although we do rely on years of industry experience.
The proposed framework differentiates companies involved in patent licensing based on how they approach revenue generation (what we refer to as the monetization model). The characteristics of the monetization models impact both the predictability/risk of revenue and the potential for revenue growth. Differences in revenue risk and growth potential correlate to the asset mix and the monetization models. Figure 1 illustrates how we use these criteria to group and classify companies involved in patent licensing. The resulting classification, in turn, aids our understanding of these companies’ public market valuations.
Figure 1. Public Licensing Companies
Data as of 10/8/2020.
ONE-OFF PATENT PORTFOLIO LICENSING
In this monetization model, revenues are most exposed to the binary aspects and unpredictable timing of litigation. By binary we mean that the outcomes of litigation, and the related revenues, are either zero revenue (litigation loss) or some unknown and generally hard-to-predict number. When companies operate on this model, they do so from one-off, life-of-patent licenses (i.e., the licensee pays once for a license to the patents and no further payments are expected from that licensee for that portfolio). Consequently, the value of the portfolio is fully extracted at the time of licensing. Because these licenses tend to be fully paid up, additional revenue must be generated from the acquisition of new assets or from the more challenging parts of the tail (i.e., other infringers, some of which may be smaller and/or less willing to pay without protracted litigation).
This monetization model has limited potential for growth in revenues as past portfolio licenses do not clearly indicate the value and timing of future licenses for new portfolios. The unpredictability of future revenue growth of these companies is reflected in the market caps and enterprise value (EV) ratios. As shown in Figure 2, the market cap for the group of one-off licensing companies closely tracks total assets. Total assets are, for the most part, current and operating assets as these companies do not need to invest in fixed assets.
$ in millions USD. Data as of 10/8/2020.
We find that these companies generally own either multiple smaller portfolios that are differentiated in technologies and target licensees or a single portfolio covering one core technology but broadly applicable to a specific industry (i.e., relying on licensing efficiencies that may result from licensing in one industry in which the company has a successful track record).
In both instances, the portfolios are not expected to grow organically over time as these companies are not engaged in research and development. As a result, the licenses provide only a narrow freedom to operate and no opportunity for longer-term relationships based on renewals that capture newly added patents and expanded freedom to operate. Consequently, this means each portfolio or target may require new litigation to drive licensing and therefore revenue. Companies in this category are also handicapped by SEC disclosure requirements, which give target licensees insights into the company’s ability to sustain costly litigation and afford licensees the opportunity to exploit any balance sheet weaknesses during settlement/licensing discussions. At the same time as information about the balance sheet is provided to the defendant or potential licensee, little to anything is actually disclosed about the licensing negotiations in the background that help investors set expectations about the timing and likelihood of revenue. This information asymmetry is akin to playing poker and showing some of one’s cards to the other players while not seeing theirs.
The renewal licensing monetization model takes full advantage of portfolio size and industry breadth to minimize litigation risk and offer long term potential for revenue growth. The licensor’s continued investment in developing and expanding the portfolio through organic patent portfolio development, large patent acquisitions, and transferrable technology development maximizes the chances of long-term relationships with licensees as well as opportunities for license renewals that lower the need for litigation.
Revenues tend to take the form of fully paid term licenses (often five-year terms as opposed to the life of patent licenses in the one-off licensing model) and may include structured payouts so that revenues are recognized over the course of the license rather than entirely up front. In addition, the scale of the portfolio helps the company close licensing agreements more often, which further smooths out periodic revenues. This makes revenues easer to predict and less prone to binary outcomes and volatility. For instance, it is likely that a past licensee will renew their license upon expiration although there are exceptions (e.g. Comcast’s refusal to renew its license with Tivo, now Xperi).
Equally important is that the renewal monetization model offers the potential for long-term revenue growth. Investment in the strategic development of the portfolio (e.g., older wireless technologies that have been incorporated into emerging 5G standards) and the acquisition of other patents ensure that the portfolio covers valuable features or adjacent technologies when the license is up for renewal. This strategic development is needed to sustain or improve renewal rates at the same or higher royalty rate. In addition, strategic portfolio growth opens new licensing markets. For example, InterDigital’s strategy of combining telecom and consumer electronics (CE) licensing programs has yielded synergies that, in the aggregate, have expanded InterDigital’s licensable market and broadened the potential licensing base, thereby creating an opportunity for revenue growth.
The potential for revenue growth built into the renewal monetization model improves the performance of these companies in the public market relative to one-off monetization companies. Renewal licensing companies produce a modest but discernable multiple of market cap to total asset. The current Market Cap/ Total Assets ratio for this set of companies is 1.26. By comparison, one-off licensor capitalizations are close to total assets minus liabilities (Figure 3).
* Netlist is excluded as an outlier. Netlist’s current market capitalization reflects investor expectations of the future licensing value of the Netlist patent portfolio based on a recent (June 2020) successful patent validity appeal for patents previously enforced against Google. The current capitalization appears to be speculative of the licensing value of the portfolio. Prior to expectations of a successful litigation or settlement with Google, Netlist’s market cap was approximately the value of total assets.
PRODUCT SALES AND TECH LICENSING
The mix of product sales and tech licensing, including patent licenses to practice a given technology, minimizes the exposure of revenues to litigation risk. The revenues depend more on product sales and/or technology licensing than on litigation. Diversified intellectual property (IP) licensing – patents, know-how, copyrights, and branding/trademarks – accompanies product sales and provides added value. This may take the form of brand recognition that drives increased sales (e.g., the Dolby mark on licensed consumer audio products). It may also take the form of decreased risks to custom-ers because the company owns core patents, giving it broad freedom to operate and the necessary technology to support product implementation (e.g., Universal Display Corp. and Qualcomm.). Companies using this monetization model regularly reinvest in creating more technology and related IP, adding acquisitions to remain at the cutting edge of their core technology.
The patent portfolio effectively bars entry to would-be competitors and discourages customers from seeking alternatives, which translates into a higher market share and/or premium pricing. As indicated by their market capitalization relative to total asset value and revenue multiples (Figure 3), these companies are priced very differently from those using the other two monetization models. Public valuations do not correlate closely with the book value of assets. Instead, the valuations are influenced by expected revenue and profit growth.
Practical and Strategic Implications
The framework that we have outlined here has implications for bankers, deal makers, and licensing company executives in terms of investment strategies and valuations. Below, we highlight three key takeaways for investors interested in exposure to IP monetization returns or bankers and executives working on deals that involve IP monetization.
- Differentiating monetization models is critical when selecting public company comparables for deals related to licensing companies. Not all licensing companies are the same, and public markets value these companies differently on the basis of their distinct monetization models and the related revenue volatility. The framework provides guidelines for IP monetization company executives and their bankers on how to think about comparables and pricing, and how to incorporate and adjust public company information. For instance, it would be inaccurate, in our view, to use a company such as Xperi or InterDigital to price a company with a one-off licensing monetization business model (and vice versa).
Bankers and analysts should duly consider that public markets tend to discount the value of patent licensing companies because of their unpredictable revenues (in both timing and volume) as reflected in the market capitalization of one-off licensing companies at or below total asset value. Investors account for liabilities and operational costs but attribute minimal value to future litigation-dependent revenues. This is not the case in a private market context as investors are able to exchange much more information related to future revenue, such as confidential litigation information and access to litigation counsel. In other words, in the private markets, investors have more information on the risks to future revenues when such revenues derive from litigation or licensing. This should be considered when valuing licensing companies in private deals.
- For licensing company executives, the present framework informs strategic options for value growth. It is possible to create equity appreciation in patent licensing investments by transforming a venture from a one-off licensing model to renewal-based monetization. Whether this can be accomplished in the public markets is unknown as no precedent exists of a company undergoing such a transformation. It may be more likely in the private context, however, where licensing companies are not subject to quarterly revenue reporting and balance sheet pressure, which target licensees can exploit.