Joff Wild over at the IAM Blog recently reported an upgrade in RPX’s rating from Barclays Capital from 2-EW to 1-OW, citing “secular sustainable growth” of the IP sector. Barclays’ briefing paper cites the growth of patent litigation as one of the “key data” supporting its analysis. While Joff accurately notes that I previously “questioned the long-term viability of the RPX business model,” I also observed in November that “the spike in 2010 patent litigation, and the possibility that 2011 will at least keep pace represents good news for investors of [RPX].”
In fact, RPX demonstrated their profitability under what most folks probably consider relatively standard accounting practices. Their recognition of subscription revenue over the subscription term (typically 2-3 years) and amortization of patent purchases over the “useful life” of the patents (as much as 20 years) paints a flattering picture of the company’s financial health. Despite this, skepticism crept in late last year as RPX lost more than 40% of its value in just a few short months. The downturn was likely fueled by the drop in new patent lawsuit filings after key litigation provisions of the America Invents Act took effect in September, suggesting investors in the IP aggregator are keeping an eye on the courts (increasing the value of services like Darryl Towell’s Docket Navigator).
Barclays acknowledges the potential reduction in actual litigation, but also suggests that court filings present an incomplete picture:
While we recognize that the new reforms could potentially pressure the number of litigations filed by NPEs over time, …[w]e note that through the first three quarters of 2011, there have been 54 ITC patent infringement investigations (vs. 56 in all of 2010) and RPXC estimates the total number of ITC patent infringement investigations for 2011 to be 72 (with ~22% of actions brought by NPEs).
As a result, Barclays concludes with confidence in RPX’s overall growth potential, noting:
With NPE litigation activity continuing to rise, patent asset acquisition prices remaining relatively constant, along with RPXC’s proprietary data and analytics offering, we believe our estimates of fundamental drivers are conservative and not priced into shares at current levels.
So, in the face of all this analysis, am I ready to surrender my skepticism and embrace the conclusion reached by others–that RPX has a sound, sustainable business model? In a word: no.
Consider one of Barclays primary reasons for upgrading RPX: “constant” asset acquisition prices. They even provided a handy chart, created by folks at RPX, to demonstrate pricing discipline on the patent purchase side of the transaction, despite fears of a “bubble” in the IP market.
While this graph does appear to support the underlying reasoning, a closer examination is warranted. After all, maintaining pricing discipline on patent spend is critical to RPX’s long-term survival. As RPX’s client roster expands, prospective sellers that are actively monetizing their portfolios (i.e. the kind of patent owner most relevant to RPX’s client base) will be asked to give up a larger proportion of their overall licensing prospects. As selling sublicense rights to the aggregator cuts off a larger portion of the market, RPX’s offers will undoubtedly to increase to compensate. As I explained in August:
RPX asks patent owners to make one sale that will effectively exhaust their ability to monetize the patent with almost 100 companies. For the opportunity, RPX effectively seeks a “bulk discount” for the privilege of monetizing a huge chunk of the market in one fell swoop. In addition, RPX then uses your patent to “pitch” other companies with whom patent owners would otherwise have separately dealt. As RPX’s client roster expands, this offer becomes less and less attractive unless RPX brings more and more cash to the table, effectively choking off the company’s growth.
See Patent Owners ‘Fleeing’ RPX Acquisition Model
By any measure, maintaining pricing discipline is a key metric for understanding the growth of the business model. Thus, it is worth a closer inspection. The RPX-supplied chart, above, displays a “rolling 12 month average” spend per patent along-side an “average ask,” presumably to demonstrate discipline in the face of irrational patent owner behavior. Naturally, a rolling average will generally tend to look more “flat” on a chart than other kinds of data points. The $200 data point for 1Q10 (most likely displayed in thousands) indicates that the period from 1Q09 to 1Q10 saw an average spend per patent of $200,000. Likewise, the 1Q11 data point, which appears to be approximately $475, indicates the period for 1Q10 to 1Q11 saw an average spend per patent of $475,000.
Even more interesting, however, is that the “average ask” is not demonstrated as a rolling average like the patent spend, and presumably represents the average ask per patent in a given quarter. In general, a quarterly average just naturally looks more volatile than a rolling average, and RPX’s data is no exception. In addition, however, the disparity in patent spend vs ask looks very different when viewed in proportion to the starting point. Below is a chart I created based on RPX’s provided data points that compares the difference in “rolling average” spend and “quarterly average” ask data points from the 1Q10 starting point.
Notice that the “rolling average” spend per patent more than doubled between the first and fourth quarter of 2010. Even more interesting, while the “rolling average” spend was increasing, the average ask peaked and then decreased to 20% below the 1Q10 average. Now recall that the red “spend” line is a rolling average, which means that average spend per patent was steadily increasing in the months following a 2Q10 spike in average ask. Contrary to Barclay’s conclusion, the data actually illustrates RPX’s vulnerability to increases in seller’s asking price. Further still, the amount of RPX’s per patent spend increase appears to be much greater than the per patent ask increase. The rolling average spend line is ultimately slower to illustrate the severity of RPX’s per patent spend increase, but the 4Q10 rolling average includes purchases made in the second quarter, when average ask jumped by 40%. Thus, the fact that this rolling average increased by nearly 1.5x in less than a year suggests that RPX’s average spend is not as “consistent” as the original chart would have you believe.
All that being said, the other factors mentioned by Barclays, including a steady interest in patent investment, all generally bode well for RPX. As long as new patent owners continue to explore patent monetization, RPX has the potential to remain a relevant player in the marketplace. Further, the company’s wholesale approach to patent licensing/risk management appeals to at least a portion of the IP market. However, I have yet to be convinced that the business model can grow and scale consistently with the expectations RPX previously laid out.