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The debate over risk, technology, and the value of IP outside of a business context is heating up. After the Nortel patent auction and many subsequent, eye-opening, IP-related transactions chronicled in the lay press and elsewhere, technology (and its enabling of IP) has begun to take on a presumed life independent of its hosting business. A recent article at SeekingAlpha frames the debate from technology’s perspective:
Technology is real and business is just a man-made notion to which we give real-world life. Technology brings to the world something that has real value. The business is more of an arbitrary construct in order to extract the real value of the technology.
The article further states, “So why is it that we live in a world where when a business fails, it can result in the death of a technology? Technology is what had the real value, and a flawed business model or failed execution of a good business model shouldn’t get in the way. Over the last few years, people are starting to understand this.”
Though valuation analysts see what has happened to date and are rapidly moving to improve their skill sets in understanding and valuing IP, there has to be a collective cringe when fundamentals of valuation are recklessly cast aside, a cringe that should serve as a warning to investors. That is not to say that good IP isn’t thrown out with bad business models. More to the point, IP requires “a” business context to have value, though perhaps not “the” business context currently engaged.
Think IP Strategy offered a classification of features that make IP valuable, providing a complementary checklist for valuators. Assets that have value have features that:
- Are required for the company to be in business;
- Protect key differentiators that influence buying decisions;
- Are required to defend against competitors; and
- Can be licensed to create alternative revenue streams.
The article goes on to state that realizing the value of IP (and creating additional value) is dependent upon leadership in an organization, tying the value to upper management buy-in, probably as a result of the efforts of an IP champion or chief intellectual property officer. The conclusions drawn seem obvious, but they beg the question: Why don’t all organizations have CIPOs? With IP value taking center stage, valuators and investors should take note of whether an organization recognizes the potential value of its IP enough to have invested in a CIPO.
The Appraisal Practices Board (APB) of The Appraisal Foundation has released the working draft of “Valuation of Customer-Related Assets.” Comments are due by July 31, 2012. Any questions on the draft should be addressed to Paula Douglas Seidel at
paula@appraisalfoundation.org.
The working group on customer-related assets concluded that the valuation of customer-related assets is a complicated exercise that requires significant judgment. This paper presents concepts on how to approach and apply the valuation process appropriate for customer-related assets.
In an upcoming study on benchmarking remaining useful lives of intangibles identified in business combinations, BVR found customer relationships to be an oft-used category with widely disparate interpretations. Analysts performing purchase price allocations are advised to read the APB document carefully and are encouraged to comment on any section. Here are some of the discussion points wherein the working group directly solicits comments:
A. Asset identification: Are there circumstances where the customer contracts and related renewals should be recognized and measured as two separate assets?
B. Subsequent events: Should the assessment of economic lives of customer relationships include consideration of post-acquisition efforts and their effect on customer buying patterns or should very low projected attrition imply very long customer lives in all cases? In other words, should the valuation specialist consider factors other than observed or projected attrition when determining customer lives?
C. Economic life: Should migration churn be included in customer attrition calculations?
D. With-and-without method: What is the most appropriate discount rate for the without scenario:
- A higher discount rate than in the with scenario?
- The same discount rate as used in the with scenario?
- A lower discount rate than used in the with scenario?
- If a different discount rate is used in the with scenario and the without scenario, what discount rate should be used in the weighted average return on assets calculation in a business combination?
E. Cost approach:
- Should the cost approach be tax-affected or not?
- Under what circumstances should the cost approach be employed to value customer-related assets?
F. Deferred revenue: Many valuation specialists believe it may be appropriate to adjust income-based customer relationship valuation approaches for deferred revenue considerations. Two questions should be asked related to this topic:
- Should an income-based customer relationship model be adjusted if a company has a deferred revenue liability on the balance sheet?
- If you believe there should be an adjustment, how should this adjustment be made?
After more than two weeks of trial and deliberations, the jury rendered a verdict of noninfringement on all counts in the epic Oracle v. Google litigation. More importantly, on May 29, the district court denied Oracle’s request for a judgment as a matter of law, finding “ample” evidence to support the jury’s decision and dismissal of claims. The next day, the judge also ruled that the Java application programming interfaces (APIs) were not subject to copyright. Taken together, the rulings have led some patent experts to conclude that software—which consists largely of mathematical algorithms—has no value except to provide “a list of ways a lawyer can assert that the patent has been infringed.”
“Patents and software need to get a divorce before somebody gets hurt,” agrees another blogger, who posted daily updates from the courtroom. “The damage from software patents is astounding, and the IP is so puny. There is an imbalance in the legal universe, and it needs fixing. Software is algorithms, and that is mathematics, and it’s wrong, totally wrong, to let math be patented. These patents should never have been issued.”
Five Daubert opinions. Oracle has promised to appeal the rulings. In the meantime—and of particular interest to IP appraisers and damages experts—the case has also produced five Daubert opinions on damages: three against the plaintiff’s expert, one against the court-appointed expert, and one against the defendant’s rebuttal experts. Key takeaways include:
- When applying the entire market value of any asserted technology, the expert “must in every case” apportion damages between the patented and unpatented features of the technology;
- Current patent law requires only a patent-by-patent apportionment, rather than claim-by-claim (as the court found in one of its prior orders);
- Consumer and market share surveys are not “inherently unreliable,” but may become so when the experts (as in this case) “artificially force” the participants or the data to a desired outcome; and
- Until they track larger datasets, current patent value studies do not inspire a high level of confidence in their predictive power.
Here is a pre-IPO, independent valuation of Facebook that is worth the read:
Andrew Butler’s insightful and delightfully funny comparison of Google and Facebook, published on May 8, could be titled “Look at All the Lonely People; Where Do They All Come From?” Instead, it’s simply “Facebook Will Always Be #2.”
What is Facebook’s real business model? Who are its real customers? If Google has replaced the need for directories and Yellow Pages, what need is Facebook satisfying? Do the SEC filings tell the whole Facebook story? For a great read, based on foresight, not hindsight, here is the full article as found in The Market Oracle.
And from Professor Damodaran, a dismissal of conspiracy theorists:
Commenting on the Facebook IPO, Professor Aswath Damodaran, who holds the Kerschner Family Chair in Finance Education at Stern School of Business, NYU, chalked up the problems more to market inefficiencies and banker ineptitude than any conspiracy, delivering a line that could become iconic in the valuation community: “Facebook’s IPO is just proof that if you want something valued, you should not ask a bank to do it.”
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