October 15, 2014Share this:
If you do a search on "are patents an asset class?" you'll find results as old as 2007 and as new as last week debating the issue. We won't keep you in suspense: we believe the answer is yes, patents are an asset class. And they're an asset class worth investing in. Here's why. In a recent article, Neil Wilkof agrees that patents are assets, but contends they don't constitute an "asset class." Wilkof says that asset classes are
"categories [that] are used in connection with formulating a formal (or informal) investment risk strategy. Notions such as "lighten up on stocks", "reduce the duration of your bond holdings" and "the commodity super-cycle is over", are representative examples of the role that an asset class can play in making investment decisions. To speak of a "market for patents" in this context is simply inapt."
His main argument seems based on the notion that investors don't say they should "lighten up on patents" or use similar expressions. He argues that some patent owners want patents to be seen as an asset class because "To speak of one's assets as members of an asset class is to admit oneself into the world of professional investment." So is it just a matter of status and semantics? Or is there more to it than that? Investopedia defines an asset class as
A group of securities that exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same laws and regulations. The three main asset classes are equities (stocks), fixed-income (bonds) and cash equivalents (money market instruments).
Their description continues:
It should be noted that in addition to the three main asset classes, some investment professionals would add real estate and commodities, and possibly other types of investments, to the asset class mix. Whatever the asset class lineup, each one is expected to reflect different risk and return investment characteristics, and will perform differently in any given market environment.
Going by these criteria, it's quite reasonable to consider patents as an asset class. As an investment vehicle, patents are markedly different than other types of assets, such as securities or real estate. In an article on the subject back in 2007, IAM Magazine cited a panel with five speakers, one of whom said a "tipping point" had been reached and that patents were indeed an asset class. The other four weren't so sure. The speakers who disagreed mostly based their disagreement on the "risk" factor. One speaker, David Ruder,
did not see utility in the notion of an asset class. He described the extensive due diligence his group conducts on the validity, value, and scope of each intellectual property asset. Because patents are rights to unique inventions, noted Ruder, concluding that one particular patent is valid and valuable tells an investor nothing about the next.
We don't see the point in Ruder's argument. Patents aren't an asset class because each patent is unique? True, knowing about one patent tells an investor nothing about the next. However, real estate is widely considered by investment professionals to be an asset class, and you can say the EXACT same thing about real estate. Knowing the value of one building tells you nothing about the value of another building. Just as the number of buildings in a real estate portfolio is a meaningless measure of value - since some buildings are much more valuable than others - the number of patents in a portfolio is a meaningless measure. One really strong and important patent can be worth more than thousands of weak or unimportant patents. One Empire State Building is worth a lot of strip malls.
Characteristics of Patents as an Asset Class
Many factors make patents unique as an asset class. The following list is not intended to be exhaustive, but rather illustrative:
- Patents are inherently high risk/high reward. Patents can be very valuable, worth tens or even hundreds of millions of dollars. The most valuable patent in history likely was the patent for Lipitor, which allowed Pfizer to generate $105 billion in revenue. But patents are also high risk: a patent that has generated tens of millions of dollars in licensing revenue can be invalidated at the Patent Office or in court, and overnight become worthless.
- Patents are a depreciating asset. Typical patent life is 20 years. The Lipitor patent cited above is now worthless, as it has expired. Several forms of generic Lipitor are now on the market, and Pfizer's revenues for Lipitor plunged by 90% in the first year after the patent expired.
- Patents are difficult to value. Ask five "experts" to quote a value on any given patent and you're likely to get five very different opinions.
- "Statistics" don't make portfolios easier to value than individual patents. When AOL put its patents on the market in 2012, Starboard Value said the portfolio was worth $1 billion. M-Cam, a patent advisory firm, said the portfolio was worth $290 million, "tops." The portfolio sold to Microsoft for $1.1 billion. As with real estate, the "real" value of a patent is whatever a buyer will pay for it. Clearly it helps to pick the right expert.
- The regulatory environment can impact the value of any asset class. Since patents are an artificial, intangible construct created by law, they're perhaps more subject to influence from changes in regulation than many other asset classes. The America Invents Act, which fully came into effect last year, had a profound impact on the value of patents.
- In many cases patents are a "hidden asset." Corporations typically carry patents for products they've developed on their books at the cost of securing the actual patent. This makes about as much sense as valuing a building based on the cost of obtaining the building permit - whether the building's in a blighted Detroit neighborhood or a prime Fifth Avenue location.Even the R&D behind a patent is typically expensed. As a result, it's very difficult for investors to understand anything about the value of a typical operating company's patents. Even when a company has purchased patents, the value assigned to the portfolio on the buyer's books may bear slight resemblance to the portfolio's actual value.
- Since patents are a depreciating investment, "buy and hold" is generally not a good strategy. Patents require active management (licensing or enforcement) to generate revenue.
- Monetizing patents requires specialized skills and resources. Patent monetization also requires substantial financial resources, since patent enforcement often requires litigation, and the average cost of a patent lawsuit is well over $1 million.
In theory, investors could invest in patents directly. There are many patents on the market; there are "patent brokers" who specialize in helping people buy and sell patents. However, the above characteristics of patents make them unsuitable as a direct investment vehicle for the typical investor. An alternative for investors who want to diversify their portfolios into the patent asset class is to invest in Public IP Companies (PIPCOs), such as Marathon Patent Group (MARA). PIPCOs are companies whose business is based on monetizing intellectual property, primarily patents. They have expertise and technical and financial resources for monetizing patents that are far beyond the capabilities of an individual investor. The mega-sized patent or patent-driven deals of the last few years - AOL, Kodak, Google's acquisition of Motorola Mobility, etc. - have alerted Wall Street to the value of patents. Patents are gaining respect as an asset class worth investing in.