NOK - Analyzing Patent Intellectual Property In High Technology Companies

2023-04-17 17:12:59 ET

Summary

• Virtually all companies rely on their Intellectual Property to differentiate themselves as a measure of the innovation of a company.
• Patents are a key IP that rarely gets analyzed and is not even factored into book value calculations.
• We discuss some simple means of obtaining patent metrics for a company.

Virtually all companies rely on their Intellectual Property ((IP)) to differentiate themselves and as a basis for most of their products. Roughly speaking, IP can be considered as a measure of the innovation of a company. While many companies report on R&D expenses in their financials, this indicates their investment into innovations, which is not always their success in achieving innovation. While IP comes in several flavors, one of the more straightforward metrics that can provide insights into innovation is the number of patents that a company has to their name.

My hypothesis is that IP analysis is important in that it does not get reflected in a company's book value. Patents are one of the more mysterious assets in many companies own. They rarely show up on a company's quarterly results or get discussed in analyst reports, as an intangible asset, they do not even get factored into book value calculations. Book value only considers the cost to liquidate a company's fixed assets and securities. It does not consider intangible assets such as patents and other intellectual property. Given that value, it would appear book value becomes is a misleading metric at best for technology companies.

Yet for technology companies of all types, the number and quality of patents and the relative amount of patent activity are important assets and can be a measure of competitiveness and R&D effectiveness. Patents, being most typically a result of R&D activity, provide a metric of how well a company's engineers and scientists are progressing in new development and competitive technical advances. As discussed below, that does not always translate into company performance or stock valuation.

So can this be useful for stock analysis? I have previously proposed that, for smaller companies which are more difficult to analyze, a technology company's acquisition value may be in good part determined by its Intellectual Property. I used U.S. patent portfolio size (the number of active U.S. patents) as a blunt estimate of companies' quantitative IP. To normalize for company size, I used an IP metric of (# of patents/enterprise value (in )) as a relative measure of company IP investment. The higher the number, the more patent-related IP investment is assumed for a company of its business size. The metric has limitations, it does not include other IP such as trade secrets or amount of R&D investment, but assuming important ideas would be patented, it should statistically track the company's investment in IP (anyone who has a better IP metric, I would love to discuss it). As with most analysis, it is far more useful when compared to peers, rather than in isolation.

Understanding patents can also have a direct insight on company valuations. As a relevant example. Consider MIPS Technology (in full disclosure, a former employer of mine), acquired by competitors in 2012. The terms of the acquisition, agreements are insightful. While their operational business sold for approx. $80M, their 580-asset patent portfolio was separately acquired for $350M. While more visible than many, this type of valuation for IP has not been unusual.

Happily, finding information on patents is relatively straightforward. While specialized tools exist for this type of search, there are at least 2 methods that are free and simple to use. One is the USPTO, which maintains a database of all U.S. patents. The second and my preferred method is patents.google.com , aka Google Patents. This is a free tool that allows an in-depth analysis of the patents owned by a company. It can be somewhat unwieldy for reviewing specific patents, but it does a good job for gathering statistical information. Using the tool is simple and fairly intuitive to use from a command line. So, as an example; to search for all the U.S. patents granted to Intel over the last 10 years, enter

assignee:"Intel Corporation" country:US before:priority:20221201 after:priority:20120101 status:GRANT type:PATENT

This returns a search result of 21,400 issued U.S. patents. We can, of course, look at patents over longer periods of time, but looking too far back risks the error of relying on historical vs recent innovation. Note that not all of these patents are active, as companies do allow some patents to lapse, to be sold, or otherwise change ownership. More specific searches are available, and not much more difficult, but are outside the scope of this discussion.

So what is the value of patent analysis? Metrics we look at in analyzing companies are for the most part backward-looking, in comparing current values to the prior year, quarter, etc. Most forward-looking metrics we get from analysts are soft, In that they are based on opinion and estimates as much as metrics. Patents provide a view into a company's future in terms of their anticipated innovation but do not indicate if it is being implemented within a given product. Whether innovation directly translates into improved stock returns is more indirect, since company financials and stock pricing involve a myriad of factors.

I applied this to some recent analysis into some technology companies of personal interest, disclosing some interesting, if troubling observations in the following table. I am only using U.S. patents in this analysis, since essentially the same patent topic can be filed in many different countries, but almost always filed in U.S. This avoids the confusion of a given patent idea being counted several times due to its multiple country filings.

The focus of my analysis has been on semiconductor companies and communications-related companies, both of which are highly competitive areas with significant patent activity and that rely on innovation as differentiation to their products. I intend to continue related future analysis into areas such as pharma, medical and industrial devices that also share these innovative and competitive characteristics.

The results, just looking at relative patent portfolios vs company stock performance, were disappointing in that there were few clear trends to be determined. Against the logic of my assumptions, companies with smaller portfolios such as Nvidia Corporation (NVDA) and Advanced Micro Devices, Inc. (AMD) were market winners, and ones that made significant investment in patent portfolios (INTC, NOK, ERIC, IBM) did poorly over the last decade. The sample sizes used are too small to gather any real statistical significance, it is possible that a larger sample would indicate a more useful trend.

Looking at large processor companies, Intel Corporation (INTC) is by a good margin one of the more prolific patent holders, and AMD and Nvidia among the least. It is interesting to compare these to Qualcomm (QCOM), who is in a related but not overlapping space. It is worth noting that Qualcomm does have a significant part of their business in licensing their patent portfolio in technology areas such as wireless processing.

Looking at analog IC companies, Texas Instruments (TXN) and Analog Devices (ADI), despite being in similar businesses, have very different patent portfolios, with TI investing essentially twice as much in patent ownership as ADI and having a proportionally better return. Marvell, a competitor which is a fraction of their size. has one of the higher metrics, but still falls behind Texas Instruments in terms of stock return.

Looking at communications, we see the somewhat unexpected result of 2 foreign players having a much larger patent investment than Cisco, the largest domestic company in that space. Both Nokia (NOK) and Ericsson (ERIC) show a much higher patent per EV metric than most U.S. companies. It is worth noting that both Nokia and Ericsson are known to have patent licensing as part of a business model.

I include for reference International Business Machines (IBM) and Apple Inc. (AAPL) in this table, as IBM has historically had the largest number of patents grant of any domestic U.S. company, and Apple is of course an outstanding product innovation company over the last decade.

My assumption that a patent metric might be considered in looking at investments and in particular in making decisions between different investments in the same general technology/business area. My hypothesis is that companies that a more innovative for their size will own more patents than other companies of similar size in the same business and that innovation can be a determinant in a company's success in the future. At this point, the best I can say is it is just one of many factor that might be considered in making a technology investment. The historical record shows that my hypothesis appears sketchy, with some companies with larger patent portfolios having poor market performance (INTC, NOK, ERIC, IBM) and those with smaller patent portfolios doing well (AMD and NVDA, most obviously). There are of course always circumstances that explain these results, but in the interest of transparency, it is important to note that a great patent portfolio will not overcome poor management, finance or operational performance, and of course the converse. That said, I do believe that the theoretical basis for considering patents as a factor in investment decisions does provide a forward-looking metrics that should quantitatively determine value and, given that patent data is publicly available yet not typically used, investors may wish to factor it into their investing process.

It will be interesting to investigate the relevance of patent portfolios in other industries, such was pharma, medical or industrial technology, where forward innovation is also a key determiner of success. I may look into such investigations in the coming year.

As always, caveat emptor. I make no recommendations. I speak only for myself in sharing analysis done for my own personal use. All the above is based on my interpretations of information that I reviewed from public sources. I may have gotten it wrong, errors may have crept in. In talking about the future, you are almost always likely to get the best parts wrong. That's what makes it interesting.

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