AOL Sells Patents to Microsoft and Facebook buys Instagram -a Look at Value

By Peter Bernstein April 10, 2012

One of the wonderful things about working here at TechZone360 is that our CEO Rich Tehrani encourages us to not just express our opinions but to do so even if they are at odds with his. Thus, when it was revealed yesterday that AOL was selling more than 800 of its patents to Microsoft for $1Billon, it was not surprising that our amazingly prodigious leader sent me an email with a quote he said could be used in writing about the deal. It went as follows: “A $1B+ patent sale to MSFT by AOL shows potentially massive hidden value in tech firms.” I humbly agree and disagree. 

Determining value is not easy

Intellectual property to me is like most if not all markets. Price is always based on perceived value, i.e., what a motivated buyer at any given moment in time is willing to pay and what a seller is willing to accept. Whether something is of “hidden value” then becomes a matter of buyer and seller perceptions. These perceptions in turn are based on a number of variables that can range from the rational (ability to pay and competitive necessity) to the irrational (emotionally driven acquisitions based on them conveying some kind of special status desired by the buyer, for example). 

 Determining value is thus subjective. It revolves around perspective. A famous saying that has been attributed to a host of people including Nelson Mandela applies, “Where one stands depends upon where one sat.” Thus, a buyer could believe they uncovered a diamond in the rough while the seller might at the same time be celebrating unloading a costly and non-productive asset.   Another way of saying this is that “hidden” truly is in the eye of the beholder.

Perceived value and the latest transactions

The fact that AOL sold 800 patents to Microsoft for $1 billion on the same day Facebook bought Instagram for $1B provides grounding for this being something more than a question of semantics. 

In regards to the first, AOL has been under pressure from disaffected shareholders to monetize its patent portfolio. Details of what Microsoft has purchased remain clouded in secrecy, but it is hard to believe that the crew in Redmond did not do their due diligence. Whether the purchase was done because Microsoft thinks it can get licensing fees AOL could not extract, for protection against IP law suits, as part of a fishing (not phishing) expedition for capabilities that can be quickly turned into apps for the new Microsoft store or for some combination of the above, patents are available for public scrutiny and therefore are not hidden assets. They are assets whose value remains problematic until they change hands. Time determines whether a fair price was struck. Again, this depends on the respective motivations of buyer and seller. What may seem like a great way to increase shareholder value and trust in the short-term by AOL management could turn out to have been a major misstep depending on what Microsoft does with them. From the Microsoft perspective, even if only a few of the patents turn out to be important, if they help satisfy goals that can quickly have billion dollar consequences, with 20/20 hindsight this could be a real bargain.

Much the same argument can be made about the Facebook purchase of a company that is roughly two years old, has 12 full-time employees, a questionable path to monetization and has rocketed from a valuation not that long ago of $100 million to $500 million. In fact, it is now estimated to be worth 12 times the value of the now bankrupt Kodak which some have argued is sitting on a closet full of some very “valuable” patents of its own in a variety of areas.

Mark Zuckerberg’s willingness to pay twice the price, especially given the instant uproar by Instagram loyalists about Facebook’s questionable privacy terms and what this might mean in the future, also is all about perceived value. For Instagram’s founders and investors, what a great exit! For Facebook, worried about the disaggregation of its business which is heavily weighted toward photo-sharing and where the company had a gaping hole in the mobile photo-sharing space, $1B may be a small price to pay to ward off competition. Plus, what’s a few billion amongst friends when Facebook is about to go IPO and reap billions upon billions. Again, time will say this was fool’s errand impulsively done by an impetuous CEO or whether it was a stroke of genius that protected the brand. 

Valuing assets is almost as hard as valuing public pronouncements

Zuckerberg has been quoted as saying that such an acquisition is very strategic and is not likely to be a common occurrence. He also was careful to try and not offend Instagram’s followers by saying it was Facebook’s intent to run the companies independently and that Instagram would continue to work with rival social networks. Valuing this statement is another one of those dicey exercises. Zuckerberg after all, while noting that privacy is certainly a material problem for Facebook going forward from a host of interested parties including governments around the world, was noticeably coy about how all of this relates to Instagram’s view on the matter which is much stricter and one of its attractions.

This is really only the second time, if you count Google+, that Facebook has had the wind in its face (pardon the pun) rather than at its back. Given the accelerating rate at which the “next big thing” pops up on the Internet (Pinterest and Instagram being prime examples), it is hard to imagine that changed circumstances won’t lead to similar moves.  Zuckerberg and his team are learning that with dominance comes envy, scrutiny and a lot more entities looking to knock you off your perch. They are used to an environment former New York Mayor Ed Koch used to describe as, “I don’t get ulcers, I give them!”

With everyone in the tech space seemingly in court with everyone else over intellectual property issues, hidden or not, there can be no question that IP is valuable. Just how much, to whom, for what reasons and at what time as the saying goes, “Is why they play the games.” 

This leads to a final thought about value. As those who follow my musings on things related to the IP wars know, the 800 pound gorilla in all of this tends to be haggling over what constitutes FRAND (Fair, Reasonable and Nondiscriminatory) use of the IP of someone else. This is what regulation and litigation are mostly about setting aside emotion. It leads to a final question, how does one put a value on the moving target that is litigation? 

Thanks, Rich, for getting the ball rolling.

Edited by Juliana Kenny
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