Importance of Intellectual Property in Mergers and Acquisitions

Last month, Google astonished quite a few analysts when it announced the acquisition of Motorola Mobility for $12.5 billion. The hefty amount meant that the software giant parted away with nearly a third of its $39 billion cash reserves. It also meant that Google deviated from its earlier M&A strategy of acquiring small companies with superior technologies which it could easily integrate into itself as it did with Android in 2005. It also signified a major upheaval in its operating strategy because now they have not only increased their headcount by 66% but they have also entered a space which they have relatively very little experience in and one whose dynamics are way different than the one they are used to. The question is despite such large differences, why did they take such a decision? While some may argue Google is trying to go the Apple way by making its own hardware and software (which if true, might take some time coming), the reality lies in Motorola’s intangible assets - patents and 24,500 of those (17,000 approved and 7,500 pending approval). Google believes that this portfolio can be used as a leverage to ward off the increasing number of patent litigations from Apple and Microsoft against the Android-based phone manufacturers like HTC and Samsung and thus build confidence in these manufacturers to continue using them.

Technology-Driven M&A Deals

Welcome to the world where the M&A transactions transcends the boundaries of products and customers and enters into intellectual property (IP) as a huge value addition prospect. In this knowledge economy where innovation is touted to be one of the supreme drivers of growth, IP protection takes centre stage because this model has been widely successful in encouraging innovation. So, when an M&A acquisition involves parties which are technology-driven, IP is bound to be a key asset whose importance will influence the deal in a big way.

When we talk of technology-driven M&A, we are talking of huge numbers. According to PwC, the total value of the technology deals i.e. in internet, IT services, hardware and software in US alone was $77 billion in 2008 (yes, this was the year when the world faced an economic downturn!), $53 billion in 2009 and $107 billion in 2010. If one takes the pharmaceutical sector alone where patents are considered to be the backbone of any company, there have been 1345 deals in the last 10 years with a cumulative deal size of $694 billion. When one comes to think of patents being at the heart of these companies, it’s difficult to ignore the value it can play in an M&A deal. According to Nader Mousavi, a leading IP transactional lawyer who has worked with big law firms like Sullivan & Cromwel and Wilmer Cutler Pickering Hale & Dorr in the US, “IP as a percentage of deal value in M&A has been growing over the last 30 years. IP rights have gone from, as a percentage of overall value of S&P 500 companies, in the teens to 85 % or more.”

Significance of IP in M&A Strategy

Reducing Pressure on Internal R&D – In this knowledge economy, more and more companies are turning to an open innovation process in which they buy or license innovations to supplement and even replace their internal R&D. With the increasing emphasis on innovation and decreasing technology life-cycles, it’s imperative that a company looks into the ROI of its internal R&D. This will not only help them manage their R&D expenses better but also increase the number of innovation available to them and increase the speed of their product introductions. For this, it’s essential that the companies study the patent landscape and implement strategic analyses. These analyses will help them in identify the target which is active in the desired technology domain.

Bridging the Technology Gap in the Core Business – Companies are always looking at ‘synergy’ in any M&A deal. Many a times this synergy can be derived from complementary technologies. The addition of this technology to their portfolio would mean end-to-end integration of all components required to launch the product in the market. Take the case of the acquisition of SwitchOn networks by PMC-Sierra for $ 450 million. SwitchOn was a pioneer in wirespeed packet classification and inspection technology. It provided standard semiconductor and software components to enable applications such as QoS, Load Balancing, URL Switching Firewalling, etc. at wire speeds exceeding OC-48. It also had a patent pending on this technology, which on being granted would provide it the right to exclude any other company from using this technology. PMC-Sierra, on the other hand had expertise in broadband communications and has worldwide technical and sales support network. The addition of SwitchOn's packet classification expertise was complementary to PMC-Sierra's broadband communications strategy. With SwitchOn’s acquisition, it also acquired its patent which helped it achieve the strategic leverage in its domain.

Mitigating IP Litigation Risks – In a recent survey of Wall Street professionals conducted by CRA International, 75% of respondents indicated that patent litigation exposure was “important” or “very important” in valuing investment opportunities. Well, who could be in a better position to vouch for this than our beloved Google! In order to protect itself from the barrage of patent litigations involving Android, the count of which had reached 37 by March this year, it was no less than desperate to look for a strong patent portfolio. After the Nortel loss, when it bid an amount of $‘Pi’ billion for 6000 patents, it would have realized the actual seriousness which surrounds such patents not only in terms of money but also the business sense that they make. Its acquisition of Motorola Mobility is testament to the fact that a sound patent portfolio is one of the best cushions to have in the technology space. 

Patent Trolls – Strong patent portfolios have been the targets of several non-practicing entities (NPE) also referred to as trolls. These NPEs acquire companies having strong patents but are in either in distress or are ready to be acquired (read: sell their patents) for the amounts offered by the NPEs. However, the NPEs do not develop any products around those patents. They initiate patent litigations against the practicing companies with the sole intention of receiving generous settlement amounts. While the jury is still out on the ethical part of this business model, as far as it legal, a few companies continue to do it and successfully so. Firms like Intellectual Ventures, MOSAID, Tessera etc. have portfolios running into thousands of patents. All they do is find a hot patent and assert it against large companies.

Non-Technology Driven Deals

All the technology-driven M&A deals would tend to focus on the patent portfolio which is at stake. However, there are other forms of IP like copyrights and trademark, which can figure in the strategic objectives of a company. Here are a few reasons which would cause IP to influence a company’s M&A strategy:

Improve Distribution Channels – The merger of AOL and Time-Warner was one which involved equals in their respective industries. Time-Warner had a huge collection of copyrighted entertainment media including content magazines, movies, books, music and programming. However, with the increasing penetration of internet it was looking at alternate distribution channels to reach out to its audience. Thus, the decision to merge with AOL, which had become a huge brand in the internet space made a lot of sense.

Build a Brand Presence – When Indian tea-maker Tata was faced with the decision of expanding its foothold in the lucrative US and European market, acquiring a famous brand in these regions was the obvious answer. Thus, the acquisition of Tetley saw the light of the day. The deal catapulted Tata Tea into the global arena, as Tetley is an international brand with a presence in over 44 countries. Tetley has a presence in India, Canada, the US, Australia and Europe, and is the world's second largest tea brand. The acquisition helped Tata to cash on the widely recognized Tetley trademark and use its expertise and infrastructure in sourcing teas worldwide for the Indian market too.

IP Related Issues in M&A

Valuation - There has already been a paradigm shift in the IP due diligence process which is currently being undertaken by firms that identify IP as central to their long term objectives. They look at it from a value addition perspective rather than the traditional transactional perspective and thus, conduct a comprehensive due diligence using the latest tools and analyses. However, valuation still remains the trickiest part. This is so because IP valuation has no fixed model and is largely contextual. Risks, timing, cash flows, option value, alternatives and intended use (e.g., defensive, offensive) of specific IP assets form the pillars on which the valuation may be based. At the same time, CFOs are confronted with an ever-changing landscape of tax, financial and regulatory reporting requirements that impose differing and sometimes ambiguous standards for valuing IP.

Anti-trust Regulations – Most anti-trust laws prohibit M&A which will significantly ‘lessen’ the competition or lead to a monopoly in the market. Such issues are more serious when it comes to patents, as they by nature provide the holder the right to exclude anyone from practicing the patent.

With the growing importance of a knowledge-economy in today’s context it is beyond doubt that IP will be a key consideration for the companies as they carve out their strategic objectives. IP will thus, play an increasing role in fuelling the future M&As especially in the technology-intensive industries. 

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Google's strategy for Android

The mobile industry has grown exponentially since the 1990's to have about 5 billion connections worldwide and a penetration of more than 100% in several parts of the world. This evaluates to there being more than three times the number of mobile users than PC users with about 500 million connections added every year.

Along with mobile phones, smartphones have captured majority of the cellphone market. High end smartphones have become affordable because of availability of cheaper hardware and technology and fast, affordable internet. The smartphone business has shifted from being device based to being operating system based with Android being the fastest growing operating system. Android has captured nearly 50% of the world market share in 2011 as compared to less than 4% in 2007. But how does Google benefit from all of this? How does it source its revenues from Android?

Google's derives more than 95% of its revenues from advertising using web based services like Google search, Google mail etc. Google perceives the rising consumer base of smartphone consumers both as an opportunity and as a threat. The high penetration and the huge consumer base across all demographics is a lucrative advertising opportunity for the company. However, the dependence on mobile phones for internet access can lead to less dependence on PCs for consumers where Google is the dominant web based service provider for search. But in smartphones, it is the manufacturer and the operating system that determine the default services. So, Google can end up losing its overall market dominance if the smartphone manufacturers decide to move to different default services.

Google provides Android with zero licensing cost along with an entire plethora of services like Google maps with street view and mail customized for Android running mobile phones. This has ensured presence of a complete and standardized platform across a range of manufacturers. Android gives them the flexibility to develop their own UI and enhance user experience as per the manufacturer's target segment. A tremendous surge in the smartphone market hence ensued because of lowered barriers to entry and has created a tsunami like impact on Nokia, which is now unable to make use of its scale. Google also provides cloud computing services which links all its mobile services to its online services. This gives it an edge over most of its competitors like RIM and Apple. Android gaining dominance is significant because technology markets tend to get standardized around one dominant platform. The standardization of Android and availability of many substitutes for hardware will lead to reduction in profits from manufacturing. This pushes the business in the mobile industry towards providing mobile based software services i.e. application development.

Apple with an App Store of over 350,000 applications leads in the applications race, followed by Android's Google Marketplace with over 275,000 applications. However, devices based on other operating systems have barely over 50,000 applications. The business model for both these application markets is different. For Apple, the application store acts as a major source of revenues through paid applications and hence paid applications consist of about 65% of the total number of applications. Google on the other hand encourages free applications over paid ones for the Android platform and has about 60% free applications. Google's policy is skewed towards free applications for two strategic reasons. The first one being that providing good quality free business and multimedia applications would help in increasing the consumer base and also affect consumer disposition to switch from paid applications, that Apple has created, to free applications. Another reason is that if application developers cannot derive revenues from the sale of applications then the only other way of deriving revenues is through advertisement. And Google owns AdMob - one of the largest mobile advertising companies in the world.

Apple depends on sales of applications in its App Store for its revenues. It mainly targets the segment of people who would otherwise not buy a smartphone and brings them into the world of smartphones.  These are potential consumers for Android who can switch for better services and specialized business applications (which Apple cannot move into without alienating its current consumer base) at a much lower price. Google, hence, perceives a low threat from Apple. Another area where this duopoly is heading into is the tablet PC market. This is another fast growing consumer electronic which Apple was successful in commercializing and popularizing. Now, Android based tablet PCs are entering with a similar strategy as that in the smartphones. Thus Google is trying to make Android a standardized platform for mobile phones as well as tablet PCs by creating a vibrant ecosystem of manufacturers, software providers, carriers, developers and advertisers for the consumers so as to supplement its advertising revenue and secure its dominant position in the market.

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“Teach your old doc new tricks”

Its 9:00 AM, you walk into your office and open Outlook to check email, start on that report on MS Word and build the model alongside on MS Excel. Within an hour you’re in the conference room giving a presentation you made on MS Powerpoint to the boss. Seems like just another day right? In all of this, what would you have done without the companion which has become a part of your life like none other - the ubiquitous MS Office.

One of Microsoft’s profit havens, MS Office as a concept was challenged by Google Docs, a product that helps users create and edit documents online. MS Office has been the suite for editing and saving documents, excel sheets and powerpoints for years. Its products are user friendly, feature rich and most importantly, widely used. Hence, replacing them by a web-based document system is not an easy task. Started in August 2005, Google Docs had fewer features than MS Office and did not achieve high adoption. Although it is extremely useful for collaborative work, old habits die hard, and making people switch completely to a browser based system has not worked yet.

In Feb 2011, Google announced a new ace up its sleeve – Cloud Connect, a toolbar that will “teach your old doc new tricks”. It can be added onto MS Office and then used to save documents online or edit them collaboratively. This appealing feature added to the comfort of a familiar software has the capability to emerge as a winner. From MS’s point of view, it is a downright cheeky move – a free application that sits right inside MS Office and connects all documents to the web.

Cloud Connect is a service that allows you to access the Google Cloud via an MS application. It is the first step to moving all computing onto the cloud and will go a long way in familiarising users with the concept of an online operating system.

‘The cloud’ is another one of those technical buzzwords doing the rounds today which refers to the concept of offering software as a service. The next battle is touted to be on the cloud – a place where Google has definite advantage over MS. Google has developed its cloud technology over the years since fundamentally, cloud computing is closer to Google’s current way of operating than MS’s way of on-premise software.

It is nothing new for Google to challenge a market leader. Apart from specialising in creating entirely new markets and needs for web-users, the company has become famous for challenging companies on their own turf and emerging with flying colours. Starting with search, Google has slowly entered MS’s profit havens by bringing out its own operating system – Android, internet browser – Chrome, documents sharing and editing system– Google Docs and mobile apps - YouTube, Maps.  To counter Google’s moves MS invested heavily in its search technology and released Bing, a ramped up version of MS Live Search in May 2009. It also bought over Yahoo’s search technology to challenge Google Search – which currently has 65.4% market share. 

With the boundaries between online applications and offline software getting blurred, MS and Google are now at loggerheads to gain supremacy in the computer users’ world. While MS went for Google’s bread and butter by re-entering the online search market, Google has encroached on MS’s Office, Internet Explorer and Windows turf. MS is famous for being a master at imitation, and with its pockets full of cash and an army of developers, it has the capability to crush Google products in the same manner that it crushed Apple’s Mac. However, Google has successfully challenged MS in every arena so far, emerging as MS’s strongest competitor.

While we’re teaching our MS docs to do Google tricks, the war between the two technology giants has just started.

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