IP Value After the Bubble

Enterprise value is the difference between a company's book value and a company's market capitalization. It is a consequence of the difference between value as defined by generally accepted accounting principles and value as defined by investors. Over the past few years, enterprise value has been used as a proxy for intellectual property value. During the market bubble years when market capitalizations were well in excess of book values, IP emerged as the new “must have” high-value asset. Skeptics now suggest that the collapse of the bubble took the air out of patent value. This author and his firm suggest that a requiem commemorating the demise of patent value would be premature. We also suggest that there is good empirical evidence why market-based valuation systems for IP are reasonable.

Post Bubble Market Decline

In the fourth quarter of 2000, the Standard and Poor's 500 (“S&P500″) index, a weighted average of 500 publicly traded companies designed to represent the market as a whole, averaged 1354, and the Brookings Institute noted that the market capitalization of an average company was five to six times greater than its book value. To champions of accounting reform, this was compelling evidence that the accounting system was broken. The fourth quarter of 2000 also marked the 1-year anniversary of the publication of “Rembrandts in the Attic,” and to champions of the knowledge economy, the magnitude of enterprise value was proof that capital markets were recognizing IP's true value.

Three years later and well into the post-bubble recovery in 4Q2003, the index was still down 21% at 1073. To determine if this market collapse impacted all IP, we selected a topical technology ' high temperature methods for high throughput production of nanoparticulates ' for a longitudinal value analysis.

Nanoparticulate Technologies

Nanoparticles, comprising bits of matter from as small as a few atom clusters to heftier lumps still no larger than one micrometer, are among the platform technologies that will change much of the materials-based world around us. Nanoparticles are so small that their electrons behave differently; eg, nanoparticulate iron does not rust. Nanoparticles are virus-sized, which opens up huge vistas in biomedical therapeutics as well as flavor and fragrance applications. But today, they are expensive to manufacture and hard to work with in large volumes.

There are a number of publicly traded companies working in this area and generating patents. Among them are Air Products and Chemicals, Dana, Dupont, Dow, Engelhard, Eastman Kodak, Eaton, Ford, General Electric, Corning, General Motors, Honeywell, Hewlett-Packard Compaq, Kennametal, Lockheed Martin, 3M, Nordson, Procter & Gamble, Praxair, Rohm & Haas, Smith International, Symyx Technologies, United Technologies, Valence Technology, and Xerox. These companies represent a diverse mix of large and small cap businesses that are both focused and diversified.

To study the longitudinal value of nanoparticulate technology IP, we created a research group ' an IP-centric financial portfolio ' comprising these companies. This portfolio, similar to fund indices and market macro indices such as the S&P500, served as the proxy for the “average nanoparticulate technology” company.

Nanoparticulate Technology Asset Characterization

We analyzed the financial and IP metrics of our nanoparticulate IP-centric financial portfolio using capital asset valuation tools. We calculated metrics for both 4Q2000 and 4Q2003. We also paid attention to the differences in the strength of the statistical models to estimate the influence of IP value on the market capitalization of the companies within the portfolio during the two time periods (see Kossovsky et al., RTM, 2004. 47 (3) 33-42).

The results of the study showed that despite an overall fall in the collective market capitalization (read, net value) of the portfolio, the value of nanoparticulate technology assets rose. The results also showed that, in contrast to 4Q2000, in 4Q2003 IP was a much greater and statistically more significant determinant of corporate value.

Nanoparticulate Technology Asset Metrics in Detail

Similar to the S&P500 trend, the collective market capitalization of these companies in 4Q2003 was still 9% below its level in 4Q2000. Moreover, owing to rising tangible asset value, the collective enterprise value of the companies of this portfolio was 18% below its level in 4Q2000. But index data comprising averages can be misleading when the individual values are log-normally distributed. Thus the median market cap actually rose 21% and the median enterprise value rose by 39%. The median enterprise value fraction of market capitalization changed little from 64.8% to 65.9% ' a multiple of 2 relative to book value ' and the more accurate antilog average of the log of enterprise value as a fraction of market capitalization was unchanged at 68%. Finally, between 4Q2000 and 4Q2003, the value of a nanotechnology patent, fully deployed and commercialized to the industry average level, rose 20% from a median of $6.63 million to a median of $8.38 million.

Equally interesting, the mean/variance analysis showed that in 4Q2000, the patent portfolios of the member companies of this nanoparticulate technology index were not statistically significant determinants of the market capitalizations of the member companies. Moreover, the patent portfolio's impact on market cap was on average $115,000 per a derivative of the size of a company's portfolio. In contrast, in 4Q2003, patents were clearly statistically significant determinants of the market capitalization of the member companies of the index, and their impact was on average $313,000 per derivative of the size, twice that of the previous period.

Last, for IP value completeness, the analysis showed the brand equity of the better-known companies was also a statistically significant contributor to the companies' market capitalization during both time periods. The magnitude of the contribution was unchanged over the 3 years of the study although the value of the brand equity of the various companies did change.

Capital Market Testing of IP Valuation

The capital asset valuation method we use is based on the notion that the market capitalization of a company accurately reflects the collective value of a company's assets, adjusted for risk. It is a market-based method. As we employ it, this method acknowledges that IP markets are imperfect and that market capitalization may also reflect irrational exuberance or undue pessimism. In this sense, the method we use borrows from arbitrage pricing theory.

From time to time, as possible, we like to validate our valuations against real market opportunities. Nanophase Technologies provided such an opportunity for testing our valuation of the nanoparticle technologies.

Nanophase Technologies (Nasdaq: NANX) is a publicly traded company. It manufactures and engineers nanoparticles. The entire focus of Nanophase is nanotechnology, with two distinct and patented processes for the preparation and commercial manufacturing of nanopowder metal oxides, ie, Aluminum Oxide, Zinc Oxide, Cerium Oxide, Titanium Dioxide, and several others. The company's products include, among others, coated materials for use as ingredients in sunscreens, Nanophase's largest application, and uncoated materials for use as ingredients in personal care applications (eg, antifungal aids), automotive catalytic converters and abrasion-resistant flooring.

Based on our capital asset valuation method and our mean calculated value for nanoparticulate production technology of $8.38 million, we expected that the company's market capitalization should average approximately $68 million for the year 2003. The company actually traded for an average of $69 million for the year 2003. The actual value and the mean expected value (and the two standard deviation confidence intervals) are shown in Figure 1, below.

[IMGCAP(1)]

Patent Value After the Bubble

This longitudinal study of patent value after the bubble shows that today, at least with respect to this one technology area, patent value is still rising. This should provide some measure of reassurance to those who may have been troubled by the apparent decline of enterprise value.

This study of patent value also shows that in contrast to the bubble years, IP today is both more closely linked with a company's market capitalization and has a greater impact on that value. This finding is relevant in light of the growing emphasis on market-based valuation mechanisms with respect to public accounting.

Market-based valuations have their limitations. We recognize that in the context of patent litigation, various cash flow models may be more appropriate for calculating an indication of the value of assessed damages. But with respect to public equity markets, the market capitalization of a company is only indirectly linked to the cash flows of IP. Market-based methods acknowledge this difference and seek to capture the public market impact in such a way that value reporting to those markets ' the mission of public accounting ' is accurate. The data suggest that due to the close link between patent value and market capitalization after the bubble, the push toward market-based methods for public accounting valuation is reasonable.

Enterprise value is the difference between a company's book value and a company's market capitalization. It is a consequence of the difference between value as defined by generally accepted accounting principles and value as defined by investors. Over the past few years, enterprise value has been used as a proxy for intellectual property value. During the market bubble years when market capitalizations were well in excess of book values, IP emerged as the new “must have” high-value asset. Skeptics now suggest that the collapse of the bubble took the air out of patent value. This author and his firm suggest that a requiem commemorating the demise of patent value would be premature. We also suggest that there is good empirical evidence why market-based valuation systems for IP are reasonable.

Post Bubble Market Decline

In the fourth quarter of 2000, the Standard and Poor's 500 (“S&P500″) index, a weighted average of 500 publicly traded companies designed to represent the market as a whole, averaged 1354, and the Brookings Institute noted that the market capitalization of an average company was five to six times greater than its book value. To champions of accounting reform, this was compelling evidence that the accounting system was broken. The fourth quarter of 2000 also marked the 1-year anniversary of the publication of “Rembrandts in the Attic,” and to champions of the knowledge economy, the magnitude of enterprise value was proof that capital markets were recognizing IP's true value.

Three years later and well into the post-bubble recovery in 4Q2003, the index was still down 21% at 1073. To determine if this market collapse impacted all IP, we selected a topical technology ' high temperature methods for high throughput production of nanoparticulates ' for a longitudinal value analysis.

Nanoparticulate Technologies

Nanoparticles, comprising bits of matter from as small as a few atom clusters to heftier lumps still no larger than one micrometer, are among the platform technologies that will change much of the materials-based world around us. Nanoparticles are so small that their electrons behave differently; eg, nanoparticulate iron does not rust. Nanoparticles are virus-sized, which opens up huge vistas in biomedical therapeutics as well as flavor and fragrance applications. But today, they are expensive to manufacture and hard to work with in large volumes.

There are a number of publicly traded companies working in this area and generating patents. Among them are Air Products and Chemicals, Dana, Dupont, Dow, Engelhard, Eastman Kodak, Eaton, Ford, General Electric, Corning, General Motors, Honeywell, Hewlett-Packard Compaq, Kennametal, Lockheed Martin, 3M, Nordson, Procter & Gamble, Praxair, Rohm & Haas, Smith International, Symyx Technologies, United Technologies, Valence Technology, and Xerox. These companies represent a diverse mix of large and small cap businesses that are both focused and diversified.

To study the longitudinal value of nanoparticulate technology IP, we created a research group ' an IP-centric financial portfolio ' comprising these companies. This portfolio, similar to fund indices and market macro indices such as the S&P500, served as the proxy for the “average nanoparticulate technology” company.

Nanoparticulate Technology Asset Characterization

We analyzed the financial and IP metrics of our nanoparticulate IP-centric financial portfolio using capital asset valuation tools. We calculated metrics for both 4Q2000 and 4Q2003. We also paid attention to the differences in the strength of the statistical models to estimate the influence of IP value on the market capitalization of the companies within the portfolio during the two time periods (see Kossovsky et al., RTM, 2004. 47 (3) 33-42).

The results of the study showed that despite an overall fall in the collective market capitalization (read, net value) of the portfolio, the value of nanoparticulate technology assets rose. The results also showed that, in contrast to 4Q2000, in 4Q2003 IP was a much greater and statistically more significant determinant of corporate value.

Nanoparticulate Technology Asset Metrics in Detail

Similar to the S&P500 trend, the collective market capitalization of these companies in 4Q2003 was still 9% below its level in 4Q2000. Moreover, owing to rising tangible asset value, the collective enterprise value of the companies of this portfolio was 18% below its level in 4Q2000. But index data comprising averages can be misleading when the individual values are log-normally distributed. Thus the median market cap actually rose 21% and the median enterprise value rose by 39%. The median enterprise value fraction of market capitalization changed little from 64.8% to 65.9% ' a multiple of 2 relative to book value ' and the more accurate antilog average of the log of enterprise value as a fraction of market capitalization was unchanged at 68%. Finally, between 4Q2000 and 4Q2003, the value of a nanotechnology patent, fully deployed and commercialized to the industry average level, rose 20% from a median of $6.63 million to a median of $8.38 million.

Equally interesting, the mean/variance analysis showed that in 4Q2000, the patent portfolios of the member companies of this nanoparticulate technology index were not statistically significant determinants of the market capitalizations of the member companies. Moreover, the patent portfolio's impact on market cap was on average $115,000 per a derivative of the size of a company's portfolio. In contrast, in 4Q2003, patents were clearly statistically significant determinants of the market capitalization of the member companies of the index, and their impact was on average $313,000 per derivative of the size, twice that of the previous period.

Last, for IP value completeness, the analysis showed the brand equity of the better-known companies was also a statistically significant contributor to the companies' market capitalization during both time periods. The magnitude of the contribution was unchanged over the 3 years of the study although the value of the brand equity of the various companies did change.

Capital Market Testing of IP Valuation

The capital asset valuation method we use is based on the notion that the market capitalization of a company accurately reflects the collective value of a company's assets, adjusted for risk. It is a market-based method. As we employ it, this method acknowledges that IP markets are imperfect and that market capitalization may also reflect irrational exuberance or undue pessimism. In this sense, the method we use borrows from arbitrage pricing theory.

From time to time, as possible, we like to validate our valuations against real market opportunities. Nanophase Technologies provided such an opportunity for testing our valuation of the nanoparticle technologies.

Nanophase Technologies (Nasdaq: NANX) is a publicly traded company. It manufactures and engineers nanoparticles. The entire focus of Nanophase is nanotechnology, with two distinct and patented processes for the preparation and commercial manufacturing of nanopowder metal oxides, ie, Aluminum Oxide, Zinc Oxide, Cerium Oxide, Titanium Dioxide, and several others. The company's products include, among others, coated materials for use as ingredients in sunscreens, Nanophase's largest application, and uncoated materials for use as ingredients in personal care applications (eg, antifungal aids), automotive catalytic converters and abrasion-resistant flooring.

Based on our capital asset valuation method and our mean calculated value for nanoparticulate production technology of $8.38 million, we expected that the company's market capitalization should average approximately $68 million for the year 2003. The company actually traded for an average of $69 million for the year 2003. The actual value and the mean expected value (and the two standard deviation confidence intervals) are shown in Figure 1, below.

[IMGCAP(1)]

Patent Value After the Bubble

This longitudinal study of patent value after the bubble shows that today, at least with respect to this one technology area, patent value is still rising. This should provide some measure of reassurance to those who may have been troubled by the apparent decline of enterprise value.

This study of patent value also shows that in contrast to the bubble years, IP today is both more closely linked with a company's market capitalization and has a greater impact on that value. This finding is relevant in light of the growing emphasis on market-based valuation mechanisms with respect to public accounting.

Market-based valuations have their limitations. We recognize that in the context of patent litigation, various cash flow models may be more appropriate for calculating an indication of the value of assessed damages. But with respect to public equity markets, the market capitalization of a company is only indirectly linked to the cash flows of IP. Market-based methods acknowledge this difference and seek to capture the public market impact in such a way that value reporting to those markets ' the mission of public accounting ' is accurate. The data suggest that due to the close link between patent value and market capitalization after the bubble, the push toward market-based methods for public accounting valuation is reasonable.