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.