Weekly Comment

The shimmer of patent valuation

Complex webs of assumptions are spinning a lie about the real value
of today's companies, lulling directors and shareholders alike into
a false sense of value creation.

The reality is that as companies push for more intellectual property, and spend ever-fatter sums on defending their patents, they are merely raising their level of risk-based investment.

For intellectual property may be a useful barrier against competition, and may generate some cash, but its value is wildly calculated: both by our centuries-old accounting methods and by the market.

Moreover, the distortion in valuation is only growing as the sums involved at the pinnacle of this lottery game become larger. In 1991, Polaroid extracted damages near to $1bn from Kodak in a US patent infringement case, and several others have come close to half a billion. Now, Blackberry is fighting for its very survival against a patents holding company.

Such high-profile, high-value battles only lend legitimacy to counting every ticket in this lottery as a winner.

Yet not all patents are valuable, and very many are worthless. Unless companies can now move to differentiate the mission-critical from the moribund, the currently excessive valuation of intellectual property could turn out to be the bubble of this decade.

Intangible assets now make up two thirds of corporate market value in the US for both old and 'new-economy' businesses, according to Baruch Lev, professor at New York's Stern business school. And in many cases, intellectual property lies at the core of these assets - biotech firms around the world are typically seeing intellectual property account for some 60 per cent of their market value.

Yet we have seen just how easily intangible assets can evaporate into thin air - Enron's intangibles were once estimated by investors to be worth $60bn.

Experts have long warned about the inadequacy of existing accounting norms in capturing the monetary worth of patents. Those that are generating licensing revenue and royalties can be valued on a discounted cash-flow basis. A further slice is deemed valuable because of the competitive threat it prevents.

In the food, pharmaceutical and biotech industries, for instance, where it is now commonplace to seek to block out an entire market space with a patent barricade, some 11 per cent of the patents filed are subsequently contested. A patent battle, alone, is the first mark of real value, according to some commentators.

Elsewhere, within some companies, the monetary value of patents are deduced by looking at what it would cost to license in the same notional technology. This provides a theoretical basis, but little real data to work with.

Yet the most striking fundamental of patent valuation, overall, is how few fundamentals there are. Companies themselves struggle to evaluate their own intellectual property.

And this problem at the level of book valuations is multiplied manyfold in market values. Specialists at the Inno-Tech institute in Munich's Ludwig Maximillian university have shown that the ratio of book value to market value for companies' intangible assets has declined dramatically from 1:1 in 1978 to 1:7 in 2000.

This means that any misplaced value on the books is now getting amplified by a factor of 7 in market valuation, and rising.

At the same time, more and more valuations are being built onto the same shaky foundations. A price tag on a biotech firm is derived from what other companies with this kind of intellectual property are trading at: and so the circus continues.

It is a dangerous situation, for companies and investors alike. Today's investor gambles not on whether a business will succeed but rather that its intellectual property will be considered as valuable as it is today in the long-term.

Companies also suffer. As mysterious as the financial benefits might be, the costs of intellectual property are real enough. Patents are not cheap to set up, or maintain, and with 958,000 issued last year, their creation is big business. Yet any real cost-benefit calculation is impossible.

Moreover, the lack of real information on the value of intangible assets leads to abnormally high volatility of stock prices, systematic biases in managerial decisions and the erosion of investors' confidence.

Patents have always been lottery tickets but in the current economy to buy a ticket is to be prematurely declared a winner. The truth is, however, that patents are themselves worth little. It is what is done with them that creates any value.

And so it is that as courts become more favourable to patent defence, and market trends encourage firms to license in patents to boost their balance sheets, up their R&D budgets, and set ambitious goals for patent activity, our economy is steadily being built on a flimsy structure of mythical assets.

Which is just fine: until investors decide that risk is risk however you count it. And watch the bubble burst then.

Dominique Patton is the editor of NutraIngredients.com, where she has been recognised by industry awards for the publication's strength and for her own news reporting.

If you would like to comment on the article, please contact Dominique Patton​.

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