Show me the money!

Nothing is ever exactly as it seems in the business of technology and that certainly applies to AOL’s recent patent auction, won by Microsoft with a bid of $1.056 billion. This event wasn’t really an auction and had little to do with patents, yet it probably marks the peak of the current patent bubble.

On the face of it, AOL selling its 800 patents to Microsoft was about raising cash for the troubled online company, allowing it to pass some of that money on to disgruntled shareholders in the form of a one-time dividend or share buy-back. And the patents were substantial, since they included not just AOL’s own productivity but also that of Netscape, Mirabilis (ICQ), and any other AOL acquisitions over the years.  Bidders were Facebook, Goldman Sachs, and Microsoft. But that’s where the obvious part comes to an end.

The reason there was an auction at all was probably because of AOL’s concern about adversarial shareholders. Had AOL simply sold the patents to Microsoft in a private transaction the company might have been at risk for shareholder lawsuits claiming the price was too low. A public auction was the best defense against such lawsuits.

Only the auction wasn’t real.  No company but Microsoft was ever going to buy those patents.

Facebook is friends with Microsoft, one of its larger investors. Goldman Sachs isn’t normally in the business of buying patents, but as Microsoft’s longtime investment banker and the company that took Microsoft public, they stepped-in as a favor to Redmond, making sure there were at least three bidders so the event at least appeared to be a legitimate auction.

The auction started on March 22nd and ended on April 8th, which was probably the shortest such auction in history. Normally the sale of hundreds of patents would have required months of due-diligence from bidders, not two weeks.

As patent theater it played well, too.  Facebook bought 800 IBM patents (notice the identical number) instead for an undisclosed but presumably huge sum, Goldman was simply out-bid, and Microsoft walked with the patent portfolio, presumably to bolster it for the coming battle with Google — a battle I’m not even sure is coming, by the way.

But Facebook’s IBM patent purchase was tiny in comparison with a price tag of no more than $70 million and probably a lot less.  When Big Blue sells excess patents by the pound, which it does regularly, the going price tends to be $20,000 for little patents and $100,000 for big ones. You do the math.

Facebook’s patent guy used to work for AOL and knew what he was passing-up.  Maybe Microsoft will cross-license with Facebook, making the loss immaterial. And speaking of immaterial, if you think the IBM patents went for more than $70 million, how was Facebook able to avoid reporting the transaction details as the SEC requires if they are material to the company’s results?

So why the drama when Microsoft could have just bought the damned patents? Part of that is covered by AOL’s needs as described, above. The rest is Microsoft’s need to make the transaction one that would be viewed as an asset purchase, adding to the company’s balance sheet, rather than a penalty, detracting from Microsoft earnings.

It’s all about accounting.

Remember AOL was one of the companies that successfully sued Microsoft for anti-trust, both in its own name and that of its Netscape acquisition. Microsoft paid AOL $750 million back in 2003. Think of this $1 billion payment as the final installment of Microsoft’s settlement with AOL.

The 2003 settlement with AOL didn’t cover patent infringement.  Even back then Time Warner lawyers felt that there was another $500 million to be recovered from Microsoft for patent infringement. Yet for some reason they never went back for the money.

So Microsoft has had that potential litigation hanging over its corporate head for almost a decade. Not only was there infringement, but that infringement could be easily documented as willful with a decade of litigation leaving a clear paper trail of causation. Microsoft couldn’t claim they were unaware of the AOL patents. And since they were aware they could be subject to treble damages. That’s a potential $1.5 billion hit to earnings.

Much better to cut the present deal, paying just over $1 billion as an asset purchase.

The price was high, but not as high as it might have been for Microsoft, and from an accounting perspective it was ideal.

But as a pure patent sale, the price was probably too high, which is why I say it marks the peak of the patent bubble. Big companies have been bulking-up their patent portfolios of late and my sense is that process is pretty much complete. Apple, Google and Microsoft might enter into a huge legal battle now but I don’t see it happening.

Just like in the Cold War, mutually assured destruction will probably keep them safe.

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Nortel Networks, the bankrupt Canadian telecom company, came that much closer to disappearing completely yesterday with the cash sale of its portfolio of 6000 patents for $4.5 billion to a consortium of companies including Apple, EMC, Ericsson, Microsoft, Research In Motion (RIM), and Sony. The bidding, which began with a $900 million offer from Google, went far higher than most observers expected and only ended, I’m guessing, when Google realized that Apple and its partners had deeper pockets and would have paid anything to win. This transaction is a huge blow to Google’s Android platform, which was precisely the consortium’s goal.

Google is the youngest of these companies and has probably the smallest patent portfolio, most of which isn’t mobile or telecom related. This puts Google and Android at a legal disadvantage and explains the 45 patent infringement suits that one analyst says Google in presently facing in the mobile area alone.

Google would have preferred to win the auction, but with the consortium sitting on more than $100 billion in cash, the outcome came down to determination, not resources. Google stayed in it only long enough to make sure of the consortium’s intentions and to make the purchase more painful for them, if that mattered.

It certainly mattered to Google, because that $4.5 billion number will be at the heart of the inevitable anti-trust lawsuit Google will file almost immediately. Every good anti-trust lawyer in America just cancelled his or her July 4th holiday to prepare their pitch for Google, which will probably claim Restraint of Trade as well.

Given that the courts will shortly be involved, Google can probably operate unfettered for another 2-3 years, during which they’ll try to build their own mobile patent portfolio. Google may well be able to use the courts to slow the actual Nortel transaction, too, according to my lawyer friends.

So the “Android is dead” story here is way premature.

In the long run, remember, Google will probably be able to use its legal strategy to force the consortium to at least license some or all of the patents. They’ll get a royalty from Google, I suppose, and thus benefit from Android’s success, but then Google is unlikely to be completely deterred, either.

The story everyone seems to be missing here is who gets what in this consortium deal? Most journalists and bloggers seem to assume the winners will all share equally in the IP spoils. But I have people who know people and the word I am hearing it that’s not the way the consortium works at all.

Some consortium members get patents, some get royalties, and some just get freedom from having to pay royalties.

Notice Nokia isn’t in the consortium? The Finnish company is apparently covered by Microsoft, tying Nokia even more firmly to Windows Phone.

Here’s the consortium participation as I understand it. RIM and Ericsson together put up $1.1 billion with Ericsson getting a fully paid-up license to the portfolio while RIM, as a Canadian company like Nortel, gets a paid-up license plus possibly some carry forward operating losses from Nortel, which has plenty of such losses to spare. For RIM the deal might actually have a net zero cost after tax savings, which the Canadian business press hasn’t yet figured out.

Microsoft and Sony put up another $1 billion.

There is a reportedly a side deal for about $400 million with EMC that has the storage company walking with sole ownership of an unspecified subset of the Nortel patents.

Finally Apple put up $2 billion for outright ownership of Nortel’s Long Term Evolution (4G) patents as well as another package of patents supposedly intended to hobble Android.

At the end of the day this deal isn’t about royalties. It is about trying to kill Android.

Note — Here’s a pretty good account from Reuters of the Nortel patent auction. You’ll notice they don’t include the participation breakdown of the winning bid (who gets what) that so far appears no place but here.