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IP, Patent, RPX

RPX IPO: Patent Aggregation, Terrorists and Goldilocks

As patent aggregator RPX prepares to go public, despite suspicious financial disclosures, analyzing the RPX business model for sustainability becomes paramount for any investor. Unfortunately, RPX’s sustainability plans also spell disaster for its clients, create disincentives for RPX to actually help its clients, and result in a “Goldilocks” problem that may not be solvable under its current model.

RPX describes its aggregation service as follows:

We identify and purchase patent assets of high value, relevance and risk that could be used offensively against members of our client network. Depending on the situation, we may acquire assets from a third party or directly from an NPE. When necessary and possible, we will purchase patent rights directly out of an active litigation.

More importantly, in their S-1, RPX admits:

Our ability to attract new clients and renew the subscription agreements of existing clients depends on our ability to identify patent assets that are being asserted or that could be asserted against our existing or potential clients.

But how true is this in reality? First of all, as I’ve discussed before, encouraging potential clients to become paying clients motivates RPX to actually avoid buying patents outright.  John Amester noted “We might well buy a sub-licence to the technology for our members and leave the other five to their own devices.”

Beyond that, turning to pre-assertion versus post-assertion activities, RPX may also not want to buy too many unlitigated patents to avoid doing too good a job of clearing potential threats for its clients.  Just as conspiracy theories suggested CIA involvement in domestic terror attacks as a pretense to securing post Cold War funding for the US intelligence community, RPX may also be motivated to periodically remind clients of the “value” of defensive aggregation by allowing its high profile clients to languish in litigation.

Granted, buying too few patents would have the opposite effect, as clients would prefer to take their chances in litigation and allocate the RPX membership fee toward their litigation budget.  This creates somewhat of a “goldilocks” problem that may not be solvable.

For example, consider RPX’s ability to buy out potential threats demonstrates another gaping loophole in their plan.  For each of the past 10 years, the patent office has granted north of 150,000 patents, and more than 2000 patent infringement lawsuits were filed. That’s 150,000 and 2000 each year for 10 years:

(Source: PwC 2010 Patent Litigation Study)

According to its audited financials, RPX’s total revenues for 2010 (for the 9 month period ending September 30) was $65 M.  If RPX plans to spend half of its subscription revenue annually to acquire new patents, the math quickly falls apart.  Over $30 M of 2010 revenue is allocated to amortized patent costs, so spending $32 M on patents and leaving less than $3 M in profits seems unlikely.

Even assuming RPX is willing to spend at the $32 M high water mark, now consider the increasing number of patent lawsuits over the past several years.  Suppose a nice round number of 2000 new lawsuits a year over a three year period, where (perhaps due to serial litigation over the same patents) less than one third of those lawsuits represented unique patents.  To acquire 2000 patents, RPX would have to buy them for an average cost of $16,000 each.

If patent owners were willing to part with patents at an average price of $16,000, there wouldn’t be 2000 lawsuits filed each year.  It’s simply too expensive to justify such aggressive action. Looking at this another way, assume the average patent owner values his or her patents at an amount equal to the cost of litigation (a low assumption, to be sure).  For argument’s sake, we’ll say the cost of litigation is $2 M.  At an average price of $2 M each, RPX can only afford 16 out of the 2000  patents (or 0.8%) asserted each year!

Thus, it seems that companies should have very little incentive to continue to renew a multi-million dollar membership that avoids less than 1% of all potential patent threats in the marketplace.  Further, even if RPX could afford to do more, it has little incentive to acquire any more than absolutely necessary to maintain and grow its client base.  Thus, RPX’s success hinges on the ability to find the “goldilocks” number–the “just right” number of patent acquisitions to keep its clients satisfied and motivated to retain memberships.

That said, wherever the “goldilocks” number lies on the spectrum of threat acquisition, wouldn’t you think it would be somewhere significantly north of 1%?

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