Is There Hidden Value in Your Balance Sheet?

Guy Proulx remembers a number of conversations he had with Taiwan mobile devices maker HTC a few years ago about building a patent portfolio. “They essentially said: ‘We’re not interested, we’re fine, we don’t need any patents,’” recounts Proulx, chairman and CEO of Transpacific IP, which specialises in intellectual property issues in Asia.
 
It was a mistake. When Apple sued HTC in 2010 for allegedly infringing on patents related to the iPhone, HTC owned fewer than 100 patents. “Having 100 patents is way too few for a company like HTC,” says Proulx. “If you’re looking to sell smartphones worldwide, you definitely need thousands to defend yourself.” That’s probably why HTC signed a settlement agreement with Apple in 2012 for an undisclosed sum.
 
It’s an expensive lesson. (In a similar dispute, a US jury last year ordered Korea’s Samsung to pay Apple US$1.05 billion for infringing the patents of the iPhone and iPad.) “From a CFO’s perspective, one of the biggest issues in Asia is just setting aside money to build a patent portfolio,” says Proulx. While things are changing, many companies still see patents as a waste of money or are not convinced there is value in them.  
 
Proulx concedes that it’s not always a simple open-and-shut case. “It’s very difficult to recognise the true value of the intellectual property on your balance sheet,” he says. “What you carry on your books is what you paid for it, which in the case of a patent is the cost of drafting and filing the application.”
 
You get an indication of a patent’s hidden value only if you have licensed it out and the license fees come in or you sell the patent to someone else. “But most companies don’t see any dollars coming in from their patents,” says Proulx. “So a lot of them are taking a look at their portfolio and asking: ‘Are we getting real value?’”
 
For CFOs, the challenge is to decide whether it makes sense to patent (or trademark, in the case of brands) the company’s IP assets to protect against lawsuits and/or to make money off them. The alternative is let them become part of the public domain, meaning that anyone can then make use of them.
 
Know what you have
How to come to a determination? The first thing to do is to know exactly what IP assets you have. IP assets are not necessarily always inventions. “If you come up with a new economic formula or algorithm, something along those lines, that’s something you can register,” says Proulx. If not patented, ideas, innovations and products can be copyrighted or trademarked instead, such as mobile apps, for example.
 
Every company, in other words, has IP assets. The key is to know what and where they are. That’s not as easy as it sounds. “It’s true around the world, the patents on the balance sheet tends to be forgotten,” says Proulx.
 
The engineers, the R&D people and others in operations know they are there, but finance does not always realise their value and does not know how to monetize these assets. What stands out for finance is the money paid out for other people’s IP. “If it’s a royalty rate, it hits the gross margin; if it’s a license fee, it hits the expense line items,” says Proulx.
 
Technology companies the likes of HTC and Samsung obviously have IP assets. So do companies that make and sell routers, mobile base stations, TV and LCD panels, and medical devices. Universities have them, too, although finance and other administrators may not always appreciate them. In 2005, Proulx worked with one university in Hong Kong, whose researchers were publishing 2,000 papers a year – but was filing only 20 patent applications.
 
There are also cases where the company may not be aware of the existence of IP assets that came from an acquisition, for example. In an M&A deal, observes Proulx, “people tend to know that [IP assets] are there, but they don’t pay a lot of attention to them. In fact, they can be the most valuable part of the acquisition.”
 
Valuing IP assets
Because IP assets are valued at the cost of filing or the amount the company paid for it, if it was developed by another party, and then are amortised over a certain period, “it’s very difficult to recognise the true value of the intellectual property on your balance sheet,” says Proulx.
 
But they can be valuable. “I can tell you there’s any number of CFOs worldwide where, when it looks like they may have a tough quarter, they’ll reach out [and monetize] some patents, because that’s basically a drop right to the bottom line if they can close the deal before the end of the quarter,” says Proulx.
 
How to value what you have? “One indication is if you have licensed out an IP asset and you see the license fees that come into your p&l,” says Proulx. There are hundreds of thousands of patents that go into smartphones, tablets or PCs, and the manufacturers don’t necessarily own them – they pay a certain amount to license them instead or they simply appropriate them, running the risk of the patent owners suing them.
 
Much depends on what the market will bear. “Values vary from company to company; it’s very subjective,” says Proulx. That said, “we’ve done a lot of license deals and I wouldn’t qualify them as expensive at all,” he adds. Among the factors to consider in valuing IP assets are therefore the potential number of licensees and how important your IP asset is to them.
 
Something that is a ‘need to have,’ such as a patent in a medical device that requires 50 patents, is more valuable than a ‘nice to have’ patent in a smartphone that has thousands of patents. Proulx gives the example of a mobile phone antenna. “You need to have one, but there are dozens of different ways you can incorporate it in the device.” You as a patent holder does not have pricing power when there are other companies that can license out a similar part.
 
To patent or not?
These and other considerations should guide finance, R&D and others in the business in making the decision of whether to patent an asset in the first place. Drafting and filing costs can be significant, reaching US$2 million in cases where the company takes out a patent in more than one country.
 
“If you don’t ever intend to go outside Asia or sell anything in the US, you don’t have to focus on owning a US patent,” says Proulx.  Be aware, however, that if you don’t file a patent in a particular market and the invention or process becomes public knowledge there, nobody will have the ability to patent it there. Everybody will be able to make it or incorporate it in their own products.
 
“If you’re looking to sell only in Hong Kong or Singapore or China, you would need patents, but it’s probably a small number than what you need if you sell worldwide,” Proulx adds. “People tend to litigate less in China, for example, than in the US or Europe.” You’re not going to see a lot of people go to war in Hong Kong and Singapore because they are small markets and there are not as many patents filed in these economies than in other places.
 
Instead of taking out a patent on a worldwide basis, companies can consider filing a PCT – that stands for Patent Cooperation Treaty – patent application. A PCT reserves the company’s place for 30 to 31 months (the period depends on the market and other factors) to file a patent application on its innovation in the 172 countries that are signatories to the treaty.
 
“It gives you the ability to evaluate whether your idea is really valuable or not, before you have to spend a lot of money to protect it in various countries,” says Proulx. As placeholder, the PCT application also gives the business time to evaluate its expansion plans and decide which markets it will need to take out full-blown patents to protect its products.
 
Patent infringement
Whatever you do, though, always respect other people’s intellectual property, counsels Proulx. “Anytime a company is looking to come out with a new product using other people’s technology which it doesn’t have the rights to, you’re taking a risk that maybe you’ll end up in a lawsuit,” he says.
 
The truth is, however, that patent infringement “is done on a daily basis” in Asia, though the situation is changing. “Is a company making a smartphone device going to have a license for everything that’s included in that device?” he asks. “It’s unlikely, and there’s a risk to that. That’s basically what you weigh as a major manufacturer of consumer electronic products or any product for that matter that has a patent component to it.”
 
After all, you cannot monetize your IP assets if others do not respect your ownership and right to license them out – and you yourself do not respect the IP assets of other companies.
 
About the Author

Cesar Bacani is Editor-in-Chief of CFO Innovation.   

 

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