Patents: The New Tech Bubble

Last Updated Aug 17, 2011 4:05 PM EDT

The return of tech IPOs this year, and the accompanying hefty share prices, generated of talk about a new tech bubble. But the last few months have shown the existence of a second bubble. A tech patent bubble.

Patent wars between tech giants have turned legal protection on intellectual property into a driver of corporate valuations and deals. However, it's an odd type of bubble in which bankers have little impact. Instead of greed, what's fueling its growth is pure fear.

The only thing to fear is a big, fat lawsuit
According to the U.S. Constitution, patents are a form of temporary protection extended to inventors so they'll make their inventions public. However, in the business world, patents exist to keep competitors at arm's length. They are both offensive and defensive weapons.

A well-designed patent portfolio lets a company not only keep competitors away from areas in which it directly works, but can also bar them from easy alternative paths. And, almost like getting paid to carry a big intimidation club, patents can generate real revenue from those who need permission to use a technology.

Whether Internet stocks in 2000 or the famous 17th century tulip mania, greed is usually what fuels a bubble. People burn with the fire of speculation and a nearly religious belief in the greater fool theory -- that no matter how much you pay for something, someone else will pay more.

That's the big difference between the current patent fever and most bubbles. Companies aren't speculating. Instead, they're looking to protect their market positions.

Big bucks in patents
Market dynamics are why significant patent portfolios that can offer both sword and shield have gained so much in price. It's a reaction by companies that know the long-term cost of not having protection, in legal and licensing fees, is far larger than the $12.5 billion a Google (GOOG) might pay for Motorola Mobility (MMI).

A real market, whose participants have much to lose, sets the price, not bankers or speculators. It's almost like the 80s, where leveraged buy-out sharks would snap up a company, break it into its parts, and then sell them to make more than the cost had been. Only today it's the patents that can drive the value.

Motorola currently has a market cap of about $11.3 billion. Just a few weeks ago, before Google indicated how much the company's patents were worth to it, that figure was about $7.5 billion. That's a 50 percent premium based on patents presumably allowing Google to keep Android on the market.

Eastman Kodak's (EK) patents are likely worth five times the value of the company itself. Not because holding them give anyone else access to some new coveted technology, but because the patents could be a critical bargaining chip to essentially negotiate a right to do business -- or, as Microsoft and Apple (AAPL) have been doing with Android, preventing a competitor from doing so.

The down side
Any bubble can pop. When it comes from speculation, investors can lose money. Lots of it. In this patent bubble, a company may suddenly find that it has paid for protection that may no longer exist, either by a patent office reexamination or by a court's action. In the recent CyberSource Corp v. Retail Decisions case, for example, the Court of Appeals for the Federal Circuit said that many broadly-constructed software patents are invalid.

There's also the issue of the cost of patents. The Motorola patents are going for about $400,000 each, while the Nortel patents sold a few months back fetched about $750,000 a head. When companies spend that amount of money, it's no longer inconsiderable. That's cash unavailable for innovation, acquisitions, or investment.


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    Erik Sherman is a widely published writer and editor who also does select ghosting and corporate work. The views expressed in this column belong to Sherman and do not represent the views of CBS Interactive. Follow him on Twitter at @ErikSherman or on Facebook.