Friday, August 17, 2012

Rumors of Apple-Google alliance to buy Kodak patents show smartphone giants' auction fatigue

According to today's Wall Street Journal, Apple and Google as well as Android device makers including Samsung and HTC (both of whom are embroiled in litigation with Apple, as is Google's Motorola Mobility) may form part of a large group of industry players contemplating a joint bid for Eastman Kodak's patent portfolio.

The WSJ is right that these companies would be odd bedfellows, and I can also see why antitrust watchdogs might be concerned if this alliance materialized, but it makes a whole lot of sense. There's some auction fatigue in the industry. Even though Apple and the Android camp are probably going to keep fighting each other for a long time to come, what may end up uniting them for the purposes of this auction and possible future auctions is that they hate the notion of vastly overpaying for patent portfolios of, at best, average value only due to the auction dynamics that the Apple-Android patent war brings about.

More than a year ago, Nortel's patent portfolio sold to an Apple-led consortium for $4.5 billion, roughly five times Google's winning preliminary bid (the "stalking-horse bid"). That price was really high above analyst expectations, but at least this was a deal that presented some unique risks (to the losing side) and opportunities (to the winning side) because of the strength of the portfolio and the fact that bankruptcy could potentially render all existing contractual commitments (in a worst-case scenario even including FRAND pledges) renegotiable. I'm not going to take a position on what the legal situation of those patents is at this stage, and on what obligations Rockstar BidCo, the company formed by the prevailing consortium, may or may not have. That's outside my focus, and I lack most of the information I would need to form an opinion. I pointed to those risks and opportunities only because they were reflected by various companies' filings with a Delaware-based federal bankruptcy court as well as by the strong interest the Department of Justice took in the transaction. So there were certain winner-takes-all considerations that resulted in auction dynamics, and when winner-takes-all auction dynamics kick in, forget about valuation or any other rational criteria: it becomes a failure-is-not-an-option situation.

Google lost, and it panicked, as is evidenced by the $12.5 billion it shortly thereafter offered, and a few months ago finally paid, for Motorola Mobility. That deal was announced one year and two days ago, and from today's perspective it just wasn't worth it. But Google somehow felt it needed to do something to shore up its patent holdings and play a role in the patent arms race that is going on in the wireless platform industry.

Kodak's patent portfolio does not play in the same league as Nortel's. What calls its value into question is the outcome of an ITC investigation in which Kodak was going after Apple and RIM (though Kodak immediately announced an appeal). As I told the Rochester Democrat and Chronicle, the leading newspaper in Kodak's home region, after the ITC decision, buyers weren't necessarily going to lose their interest only because of one ruling on one patent (albeit a key one), and a buyer might think he could manage litigation better than Kodak did in recent years (see page 2 of the article I just linked to). And in such a large portfolio (roughly 1,100 digital imaging patents), there might still be some patents that could be leveraged effectively. But there is now a lot of doubt about the value of that portfolio, and initial bids were apparently so low that Kodak indicated it might just keep those patents and exploit them itself as a failed-business-turned-patent-troll.

A reasonable value of that portfolio would probably be only in the hundreds of millions of dollars. But if Apple and the Google-led Android camp were to be played off against each other, the price could reach irrational proportions only because of one camp's desire to keep the patents out of the other camp's hands -- not because of a lot of belief in the realistic commercial value of this portfolio. Those auction dynamics could be a joint Apple-Google-Samsung problem not only in connection with Kodak's patents but also, at some point, with such portfolios as RIM's. More and more companies with comparable patent portfolios may in the coming years reach the stage at which they are prepared to sell all or part of their portfolios only to benefit from the Apple-Android conflict.

Recently, both Apple and Google spent far more money on patent acquisitions than on research and development during the same relevant periods. Granted, a patent portfolio is an asset that you amortize over the years, while R&D is a reoccurring cost. Still, if there continue to be Nortel-like auctions and Motorola-like overvaluations every year, then these companies will continue to spend more, year after year, on patent acquisitions than on new innovation. That's not in the interest of those companies, their shareholders, and especially not good for customers. It would be a world in which the losers of the past would impose a massive tax on today's winners by playing them off against each other. Seen in that light, an Apple-Google alliance, however problematic it is from an antitrust point of view, makes a lot of business sense for those companies and whoever else may join the group in order to avoid this problem.

In my opinion, antitrust regulators should support alliances that serve the purpose of taking failed companies' portfolios from the market in order to neutralize them, but if fierce rivals such as Apple and Google join forces, a deal must be blocked unless meaningful measures are taken to ensure that such bidding groups are reasonably inclusive and that they won't use those patents unfairly against those who are not members of the club. That may not be easy to achieve, but I can't see how anything less than a meaningful FRAND commitment (by which I mean a sufficiently clear one that rules out, above all, the pursuit of injunctive relief, or royalty demands and damages claims that violate the entire market value rule) would be acceptable if Apple, Google and Samsung (considering that Apple and Samsung jointly represent about 90% of the mobile device industry's total profits) join forces.

Google (because of Motorola Mobility) and Samsung are being investigated for abuse of FRAND-pledged standard-essential patents, and HTC is being sued by Apple in Virginia because of a questionable transaction involving SEPs. When companies with such a track record are on board a cartel, antitrust regulators must impose tough restrictions -- I mean, very serious remedies, not just those of the cosmetic face-saving kind.

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