Monday, August 15, 2011

$2.5 billion Google-Motorola break-up fee reflects sellers' concern and buyer's desperation

After a first set of quick thoughts, I want to do a follow-up because shortly after that post I saw a Bloomberg report on the reverse break-up fee Google and Motorola Mobility (MMI) agreed upon: it's a whopping, mindboggling $2.5 billion that Google has to pay to MMI if the deal falls through. I'm still researching this but it seems that this is, in relative terms, the highest-ever break-up fee agreed upon in this industry.

"On an equity value basis, Google’s fee amounts to 20 percent, compared with the 4.2 percent median since last year", reports Bloomberg. The same source that told Bloomberg the $2.5 billion figure claims that MMI "would pay a $375 million breakup fee if it decides not to sell to Google".

Bloomberg's article then goes on to talk about the "increasing regulatory scrutiny" under which Google is in the U.S. -- where the way Google leverages Android to further strengthen its search business is now one of the key areas of the investigation -- and the EU. There are also antitrust issues (specific to Android) in South Korea.

Even though Bloomberg's article doesn't connect those dots explicitly, the exorbitant break-up fee and Google's antitrust troubles are closely related. I've previously contributed input to a merger control process (Oracle/Sun) and advised investment funds in connection with other M&A transactions. It takes an unusual combination of two factors that companies agree on such an extraordinary break-up fee:

  • There must be a buyer who, besides having deep pockets, must be completely desperate. (I'll get to possible reasons in a moment.) Otherwise the seller can't possibly command such terms.

  • But sellers don't ask for terms only because they can. If sellers (i.e., selling shareholders) don't have profound concern over the probability of the deal going through, they don't insist on an enormous break-up fee simply because it then makes more sense for them to optimize other deal terms than this particular one.

I listened to the executives on today's conference call on the deal and they exuded confidence. But if they were really so sure that regulatory approval is a slam dunk, there wouldn't be a break-up fee that is completely out of the ordinary. Money speaks louder than words in a case like this.

I was previously skeptical that this deal is really about "protecting" Android from threats, and I monitor Apple's and Microsoft's disputes with MMI quite closely. Now that I see the break-up fee and have thought some more about the overall situation, I've reached the point at which I simply don't buy the "protection" theory anymore.

Protection theory fails the plausibility test

My first reaction was to point out that neither Apple nor Microsoft were apparently deterred from patent assertions against Motorola by that portfolio. Let me elaborate on this now.

Technically, Motorola ran the race to the courthouse against Apple and filed its first lawsuit a little before. But from the beginning, it was clearly a defensive, pre-emptive move in anticipation of Apple's lawsuit: Motorola filed two lawsuits within a few days of each other in early October 2010, and one of them was a declaratory judgment action against 12 patents Apple previously asserted against HTC.

[Update] I've done this follow-up post that provides conclusive evidence for the fact that Apple decided to attack Motorola regardless of Motorola's own patents. [/Update]

Two months later, Apple was asserting 24 patents against Motorola, and Motorola responding with 18 patents. If you're interested in the first two months of that dispute, you can find a battlemap (with a slideshow and reference lists) on Scribd.

I also produced a visualization of Microsoft's dispute with Motorola. Last time I updated it, Microsoft was asserting 23 patents, and Motorola 21.

Both disputes are at a fairly advanced stage. For example, the ITC hearing on Microsoft's initial complaint against Motorola will begin in a week from today. At this stage, Motorola has certainly fired its best shots, and those aren't really impressive.

One particular issue with the weakness of Motorola's counterclaims against Apple and Microsoft is that Motorola asserts FRAND-encumbered patents. I explained that concept recently in connection with Apple v. Samsung. The short version is that patents essential to industry standards are typically encumbered by FRAND licensing commitments and, therefore, a fundamentally weaker tool in such disputes than unencumbered patents. A standards-essential patent is like a parking meter: you can use it to collect royalties. But it's not a gun with which you can simply shut a competitor down.

Some companies try from time to time to obtain injunctions on FRAND-encumbered patents. But this sets off the alarm bells at regulatory agencies. Any use of FRAND patents makes litigation cumbersome and less likely to succeed. Nokia used a combination of FRAND and (mostly) innovation patents against Apple, and the case involving FRAND patents would have required (if they hadn't settled before) three (!) separate jury trials...

Google's previous attempt to buy Nortel's patents, many of which are essential to industry standards, didn't succeed but would also have raised serious issues if they had tried to use those patents in order to force other players into cross-licensing deals under which those would have had to grant licenses to unencumbered patents. Regulatory agencies may very well raise this kind of concern in connection with Google's proposed acquisition of MMI.

Did Google try to prevent Motorola Mobility from settling with Apple and/or Microsoft?

MMI was under huge pressure in its disputes with Apple and Microsoft. The Microsoft dispute is the slightly more advanced one. MMI largely lost the claim construction battle, which is an important interim step. It unsuccessfully tried to push back the target date for the ITC investigation of Microsoft's complaint by three months (!) -- a request that the ITC flatly denied. That case will apparently be decided on schedule.

MMI was hoping to perhaps succeed with some of its patent assertions against Microsoft in the Southern District of Florida. That's almost a rocket docket, but just today this scheduling order showed up in the docket. The trial date was postponed from October to March. As a result, MMI won't be able to counter a possible ITC import ban with a Southern Florida ruling in its favor (which would probably not even be purely in Motorola's favor since Microsoft also brought various counterclaims there).

Maybe MMI was under such pressure in light of all of this that Google need to step in just to ensure that MMI wouldn't surrender before Microsoft and Apple in the meantime. Under the merger agreement MMI may not have the right to settle those disputes before the deal closes.

If regulatory scrutiny delays the closing of the acquisition, Google could end up buying a company that is formally enjoined from importing Android-based devices into the United States. That would be a really awkward situation. In that kind of scenario, Google might come under pressure from its own shareholders to consider paying the huge $2.5 billion break-up fee. Such an outcome could also raise serious questions about the strength of MMI's portfolio.

Some of the potential antitrust concerns are also relevant to Android OEMs

I'm going to do some more research on this in the days, weeks and months ahead. Right now the most logical type of antitrust concern I see is that the proposed acquisition would exacerbate existing concerns over Google's treatment of device makers. Google is known to act very heavy-handedly (I previously mentioned this partly EU-funded Open Governance report) and to restrict the choices those device makers have with respect to product differentiation and innovation. But post-acquisition we'd be talking about a fundamentally worse problem: Google could use revenues from its dominant search business to subsidize MMI and, as a result, undercut other handset makers. That kind of outcome would be a nightmare from a competition law point of view because it would distort competition in two markets at the same time.

I said before -- and I repeat myself -- that there's simply no way that other Android device makers would be able to compete on a level playing field with a wholly-owned Google subsidiary named Motorola Mobility. Google has already treated device makers differently, with some getting "private branches" of the code in advance. The idea of an artificial Chinese Wall put up inside Google is unrealistic.

As opposed to being protected, for which MMI's patents appear to be too weak, those other Android device makers are going to become second-class citizens. Google has set its priority. I said before: don't overestimate the patent part of the deal. This is about Google maximizing its control over Android for the reasons and with the effects I roughly described herein, and on which I'll comment in greater detail going forward.

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