Tuesday, 25 August 2015

When intangibles will no longer be invisible: big data helps sharpen the focus

“Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content.  Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world’s largest accommodation provider, owns no real estate.  Something interesting is happening" -- Tom Goodwin, SVP, Strategy and Innovation, Havas Media

The world: changing
Tom Goodwin has a point; something interesting is happening.  The world is changing, and those changes have profound implications for investment research.  The former bedrock of corporate value, the tangible solidity of physical property, is being replaced by relative ephemera.  Intangibles now dominate enterprise value, and for businesses and investors operating in knowledge economies, ideas are assets. This is not mere conjecture; the facts speak for themselves: an estimated 70%-plus of enterprise value is attributable to intellectual property (including patents) and intangible assets.  This represents a challenge for investors.  In the Brave New World of ideas and intellectual property, do the trusted investor and financial market indicators tell the whole story?

In truth, equity research and investment analysis have changed little over the years.  While layers of sophistication have been added, along with new models to help make sense of the data and deliver that all important investment edge, investment decisions are still largely based on the same financial indicators they always have been: revenue, profit, dividend and debt.  There are many sensible reasons for this.  First, the data is readily available; secondly, financial data can be a proxy for the current and future health of the company.  Conversely, the position for intellectual property rights (IPRs) is very different.  Companies are not required to include these assets on their balance sheet and most companies do not even disclose what they have. 

However, in a parallel universe, vast quantities of data relating to key IPRs have been accumulated. Until now, however this has not been accessible to the financial markets, for numerous reasons: the available data is complex, incomplete, distributed and only comprehensible to IP specialists such as patent attorneys, licencing executives or litigation lawyers. So, while everyone agrees that intangible assets are valuable, there is no uniform or easy way to value them.  The investment community in turn has resolved this conundrum largely by ignoring intangibles -– which is understandable, given there has been no reliable access to data, and no simple and cost-effective means by which to understand the relative merits and downsides of IPR portfolios.  In short, ideas might be assets but, if their value cannot be understood in the wider context of the market, how can they begin to inform investment decisions?

In this changing world, where a significant part of corporate value is captured and represented by these assets, there is pressure for improvement and change. Smart investors are increasingly recognising that access to meaningful insight around IPR value and risk could provide a vital competitive edge. Perhaps more importantly, it is increasingly true that equity and investor research that does not offer meaningful, credible insight as to corporate intellectual property strategy, risk and value is simply incomplete. For instance:

  1. IP has a material impact on share price:  Investors need to understand the mechanisms that create this impact and develop an ability to forecast them.  That means assessing organisations’ IPR strategies, the value and risk associated with their patent portfolios and how these issues impact on value drivers like innovation and product development, as well as risks like competitive pressures.

  2. IP intelligence offers a new understanding of R&D:  Research and development is the engine room for ideas and IP rights, but it remains difficult to measure.  Combining known financials relating to R&D with IPR analytics promises a fuller understanding of return on R&D expenditure, helping investors to forecast how effectively investment in innovation will translate into revenue and market share in the future.

  3. Understanding IP strategy can shine a light on corporate strategy:  Looking at trends in patenting activity, for instance identifying a recent refocus, can deepen understanding of corporate strategy - and can explain how businesses monetise IP assets that otherwise seem out of step with current strategic focus.

  4. Competitor analysis is incomplete without a view of IP:  A market sector review must now take into account the main players’ sector specific patenting activity.  No view of their relative strengths and weaknesses, and therefore the dynamics of the sector, can be complete without it.

  5. Patent litigation risk is corporate risk: Given how important IP is to corporate value and competitiveness, and the sheer scale of patent litigation today, this is another issue that simply cannot be ignored.  Expensive, uncertain and misunderstood, it can precipitate the award of huge damages and even see crucial patents ruled invalid.
Big data to the rescue

Intellectual property has for a long time been recognised as an indicator and driver of corporate health.  There have been numerous studies that show that investments in companies with a strong IP portfolio are a better bet.  However, until now, there has been a chasm between this rhetoric and the reality because the financial markets have had virtually no information about IPRs as an asset class. 

Big data: big need
for machine learning 
But again, something interesting is happening.  Big data solutions are driving change. As a result, investors have an opportunity to achieve a new level of insight and understanding of the role of innovation as a driver of corporate growth and value -- insight that has that until now been impossible in any practical sense. In this context, “big data” is a shorthand that describes a three stage process: (i) the aggregation of all data relating to intellectual property and related events e.g. litigation and licensing, (ii) the application of data science and machine learning to analyse the data and (iii) the use of analytics to analyse the drivers of risk and value. This big data approach enables tools like Cipher to aggregate, analyse and visualise the world’s data relating to innovation and the drivers of risk and value - data relating to over 30 million patents, 1m+ owners, 100,000 licences and 50,000 litigations.  They provide real time access to insight around who owns which technology, the output of R&D, and corporate technology trends, and the key drivers of IP risk and value - and thereby offer a new lens through which to assess the hidden 70% of corporate value.

This approach is best understood by reference to a simple two-by-two grid:

In this visualisation, the position of two companies T (the focal point of the analysis) and C (a competitor or peer) are compared relative to each other. T has lower IPR value and greater risk than C.  The relative positions are generated from data associated with the size, quality and nature of the IP portfolio (a value driver), whether the companies aggressively assert their IP, or conversely are frequently targeted by others (a risk driver), and known licensing activity of both, as both licensor or licensee (a value driver).

Data aggregation and analytics are not
the only way of shedding light in the darkness,
but they are a lot more efficient.
Behind this simple grid visualisation is a wealth of data –- now aggregated, organised and accessible – and capable of being presented in diagrammatic form.  This data is also useful because it relates to patenting activity, litigation, licensing and targets a business’s position relative to close competitors or the main players in a specific market sector.  It provides investors with a genuine insight into something that was previously in darkness -- the relative IP profiles of T and C. While this may only be an evolution in the way IPRs are analysed and assessed, it is likely to lead to something of a revolution in the financial markets:

  • Lending: The recent UKIPO Banking on IP? study identifies the obstacles to using IP as security for debt.  Access to trusted data is identified as a key obstacle to be overcome.

  • Insurance: IP litigation is a major risk for companies across a broad range of sectors including technology, media, telecoms, pharma, biotech, capital goods and financial services.  The insurance markets will only engage at scale when provided with reliable data relating to events and outcomes.

  • Investment: Over the past five years there have been over 10,000 patent transactions, with only a few making the headlines e.g. Nortel, Motorola Mobility, Kodak.  With increased transparency, there is potential for increased liquidity around IP.
For now, however, investment research remains in relative darkness when it comes to understanding IPRs and intangibles more generally – and that will remain the case until the investment community engages with the big data solutions that can deliver real insight.  Until then, we will continue to observe the effects that flow from a massive asymmetry of information, which sometimes leads to chaos and at other times ruthless arbitrage.

An example of chaos is the 12% fall in GoPro shares after an Apple camera patent was granted.  Aistemos has published data proving that this is one of several thousand similar patents.  Absence of real time analytics is an obstacle to rational pricing. Kyle Bass (Hayman Capital Management) is the most recent example of the novelties of the patent system being used for financial gain. He has organised the filing of multiple court actions against companies including Shire, Biogen, Acorda Therapeutics and Calgene. As the stock markets struggle to assess the implications, Bass is able to short the stock [for the latest news of Kyle Bass's challenges, click here].

The moral of this blogpost is that big data is bringing big change.  Thanks to the increased availability of data, the low cost of cloud computing and smart implementations of data science, intangibles will no longer be invisible and the role of ideas as assets will be sufficiently understood to help shape investment decisions on a massive scale.

This blogpost is based on an article written by Aistemos CEO Nigel Swycher for the CFA Society of the United Kingdom's Summer 2015 Big Data Special Issue of Professional Investor.

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