Patents, Spin-offs and Shareholder Activism: 3 Sources of Value for the Taking
As has been the case the last few weeks, I found several interesting items worthy of discussion in yesterday’s New York Times Business Section.
1. William Holstein on Commercialization of University-developed Technologies
I found this piece to be informative, depressing and exciting, all at the same time. It is presented in the form of an interview between Mr. Holstein and William R. Brody, President of John Hopkins University. Here is President Brody’s take on the financial implications of a standard university licensing program:
Q. What’s wrong with the way universities are commercializing technology?
A. From the university’s perspective, it’s mostly a money-losing operation. The fees that universities get don’t cover the expenses involved in licensing and marketing the inventions. That’s because only a very small fraction of licenses actually generate much revenue. In the year 2000, universities had about 21,000 active licenses with industry. But only 125 generated more than $1 million in licensing and royalty income. Unless you have a big hit like Gatorade, which came out of the University of Florida, or a drug that the University of Wisconsin had many years ago to prevent blood from clotting, or the recombinant DNA patent that the University of California at San Francisco and Stanford share, the aggregate income doesn’t cover the expenses.
Ok, Mr. Brody, I get it. The system is broken. But just why and how is the system broken?
Q. For every idea that reaches the marketplace, how many more might there be?
A. I don’t know if it’s a 5-to-1 or 10-to-1 ratio. But it’s probably more than 2 to 1. Companies say universities are difficult to deal with. Universities say companies are difficult to deal with. Both are partly true. On one hand, universities would prefer, in keeping with the intent of the federal government, not to license something to one company exclusively. Our intention is to make technology as broadly available as possible. Companies, on the other hand, want exclusive licenses. That’s one bone of contention.
Q. Is there broad agreement on how much these ideas are worth?
A. If universities have a patent, they think it’s worth a lot. But companies feel a patent isn’t worth a lot because they’re going to have to invest a ton of money to bring it to market. So the question is, what is the actual value? That oftentimes generates a lot of angst in the negotiations.
Q. How significant could improved technology transfer be for the American economy?
A. Let me give you an example. Many years ago, there was a music professor at Stanford University and he was doing computer-generated music. Because he was in Silicon Valley, he got a company to put this information on a semiconductor so the chip could actually create music. He took it to Stanford’s technology licensing office. They tried for a long time to license it and were eventually put in touch with Yamaha, which at that time was bringing motorcycles into the United States. Yamaha licensed it and basically created the electronic keyboard. The entire keyboard industry was created out of that patent. My point is, that patent could never have seen the light of day. I’ve seen lots of ideas in universities that people said would never go anywhere and suddenly one of them takes off.
For my part I know for a fact that universities, even those less prestigious than Johns Hopkins, have intellectual property portfolios that are incredibly valuable. Yet somehow precious few universities are good at mining these intangible assets, to the detriment of its coffers, the companies who can commercialize and market the product of the IP and society as a whole. The problems appear to principally revolve around:
- Exclusivity
- Cost and risk sharing
- Conflicts of interest
Exclusivity
Welcome to the real world, Bill. You can’t have it all (or, in Wall Street parlance, “Hogs get fat. Pigs get slaughtered.”). You and your university cohorts are being piggy, with predictable results. In the real world you need to place your bets. Maybe a limited exclusive, if the price is right. Maybe a market-specific exclusive. There are any number of permutations where you can provide enough incentives for companies to do business with you and to make the necessary investments in commercialization and marketing. You can also create a competitive environment where you are willing to give an exclusive to a winning bidder, provided the bid is above a reserve price. If the IP is attractive enough, you’ll get multiple bids and get to choose with whom to work. While you may be limited in your ability to deal with many different companies around the same technology, wouldn’t you rather do a good, commercially reasonable deal with a single party than to keep all options open and do no deal with anyone? This is how things work in the real world. If you want to continue leaving money on the table and depriving the market of products stemming from your IP, keep it up. Otherwise, get moving, get smart and do some deals. You have nothing to fear but inertia.
Cost and Risk Sharing
If you are able to cut a deal, why not structure it such that the university’s costs are minimized until there are revenues available to absorb costs? Forget about big costs associated with marketing and licensing inventions. Why not create direct lines of communication with corporations who are logical buyers/licensors of your technologies, and set up a web portal where interested parties can see the latest IP available for licensure and who can contact you directly? You could even set up an auction format whereby certain “hot” technologies are put up for bid, where most parameters of the deal (i.e., a term sheet) are set, and there are only a few variables to fill in like royalty percentage and term? Also, why not push the legal costs of putting a licensing agreement in place onto the corporation, which will be paid back to the corporation after revenues are being generated? If this process was managed more like a real business and less like a university appendage my sense is that much more could be accomplished in much less time and with far less pain, yielding far better financial returns than in years past.
Conflicts of Interest
The interview went on to mention potential conflicts of interest between professors developing new technologies, licensing these technologies to corporations, the corporations funding research projects at the university and the professor getting a direct financial pay-off if the technology is commercially successful. Can the professor be unbiased during the research phase? I think this concern is easily mitigated through the creation of an IP Board which oversees the IP licensing and commercialization process. There is no reason why this Board should be materially different than one overseeing a start-up company, with the requisite skill sets of financial discipline, negotiating savvy and ethics and best-of-breed governance. Potential conflicts are a fact of business life – not to mention university life – and should not be viewed as a deterrent to doing business. It is only that the proper controls and oversight need to be in place to make it work. No big deal.
In short, universities have a golden opportunity to do good for their constituencies and for society at large. They just need to view the monetization of their IP portfolios as a business, and to run it as such. Current practices are beyond abysmal and are wasteful. This is an easy thing to change. Please do it.
2. Barry Rehfeld on the Value of Spin-offs
Barry had a fact-filled story on the historically attractive financial performance of spin-offs.
BIG-NAME corporate spinoffs have garnered considerable attention this year, starting in January when CBS split off from its parent, Viacom, and resumed trading on the Big Board. Early last month, 155-year-old Western Union became a separate company again when it split off from First Data. And late last month, Altria said it was moving closer to spinning off its giant food subsidiary, Kraft.
Investors drawn to the reemergence of marquee names like these may be onto something: investing in spinoffs can be very profitable. Nearly two-thirds of the companies spun off over the last three years have beaten the Standard & Poor’s 500-stock index this year, according to figures from Spin-Off Advisors, a Chicago research firm.
In 1999, a 10-year McKinsey study found that shares of spinoffs trounced the S.& P. 500 over comparable two-year periods by 10 percentage points. Spinoffs also beat so-called carve-outs or partial spinoffs, in which the parent keeps a majority stake in the company, by three percentage points, the study showed.
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In February, a Lehman Brothers report looking at spinoffs from 2000 to 2005 told a similar story. It found that the average two-year gain of spinoffs was 45 percent higher than the S.& P. during the period.
This phenomenon is of particularly interest to me due to my personal investment in an algorithmic asset management firm called Clear Asset Management, which is now sub-advising on a spin-off ETF product with Claymore Securities (as noted in the WSJ) out its subsidiary Clear Indexes LLC. This is a perfect application for an ETF product, where a phenomenon that is largely structural creates a window of opportunity for those who can consistently invest in this specific asset class. I suspect that the Claymore/Clear ETF will perform very well, and represents a niche that is not “fruit of the day” but one with proven, enduring value.
3. Andrew Ross Sorkin on the Expectations for Activism
Andrew has an interesting take how the highest-profile activist investors are perceived and how their impact is felt by company managements. He related a hysterical exchange between Jim Cramer and Dick Parsons on Jim’s show that warrants a quick read.
JAMES J. CRAMER, the manic investor turned television star, was talking on his program last week with Richard D. Parsons, the Time Warner chief executive, about the company’s recent stock run when he blurted out: “Carl Icahn hasn’t been good to the other shareholders. That’s just my own perception.”
Then, as if looking for an endorsement of his view, he asked Mr. Parsons about Mr. Icahn, who just six months ago had waged a losing battle against the Time Warner chief to break up the company. “Did he help us here?” Mr. Cramer asked with a look of incredulity, seeming to tee up Mr. Parsons to deliver a knockout blow against his onetime adversary. “Did he help shareholders at Time Warner?”
For a television program that always seems to be a whirlwind circus, Mr. Parsons’ answer briefly sucked out all the fun.
“I think that Carl gets some of the credit,” he said.
Come again? Did the chief executive of Time Warner just praise Corporate America’s Enemy No. 1?
Mr. Parsons, who could have stopped with just that comment, then added: “Carl also caused me to go and listen more deeply to our other shareholders.”
Oh, it’s fun to see Cramer get smoked now and again. But truly, Dick Parsons raised a great point. Carl Icahn did give Time Warner and Dick Parsons a wake-up call, and while, at times, the plans, strategies and PR of the glamour activists causes them to be taken less than seriously, there is generally a solid foundation under the veneer of madness. Sorkin goes on to reflect this very point.
So why does it seem that so many activist initiatives fall short of even their own expectations?
Perhaps because we — investors, analysts and the media — take their plans to turn around a company too literally. Activist investors typically like to bully their targets by coming up with their own extravagant turnaround plans that make current strategies look pedestrian.
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STILL, within the activists’ shoot-the-moon plans there is often a kernel of hard, important truth. Mr. Kerkorian saw that there was underlying value in General Motors. Mr. Snyder seems to be improving Six Flags by making it more family friendly.
For his part, Mr. Icahn understood the need for a big share-buyback plan — and that shareholders would reward the company for pursuing one — a point Mr. Parsons conceded to Mr. Cramer.
Shareholders “didn’t believe in the whole Icahn formulation of break it up to try to create value by separating it, but they all encouraged me to be more aggressive in terms of the stock buyback, and I think that’s one of the things that’s paying off.”
So let’s take the activism for what it is – a catalyst for management to re-assess current strategies and plans, and to take a hard look at what they are doing for their shareholders. Cut through the bluster and get to the point, and what you’ll find often makes a ton of sense.
