Sep 16, 2009

Valuing LTE Patents of Nortel - An approach

Now that Nortel's Wireless and Enterprise businesses have been auctioned, Nortel still has LTE Patents with it. LTE is a considered to be a successful technology for the 4G wireless business and is expected to take the world to seamless broadband wireless paradigm. Nortel is said to have 600 patents in this area. Now let’s try to assess how this asset can be valued.

Following is with the assumption that the potential buyer is going to know everything about the patents.

1. A Patent is an asset that will be used directly or indirectly through applications based on the patent.

2. First step would be to find the directly assessable market based on history. That market is of those products this patent and its extensions can directly substitute.
That is the possible market potential.

The subjective part here is how much one can be sure on this market potential.

3. Next is finding the potential of those products that are not conceivable as of now. This is the tricky one.

(i) One way to approach this is on the basis of historical statistics of patents from the same industry. For example, in this case of 4G, we can take a random sample of 600 patents (or possibly more) from the period when 3G (or any other technology) was a new area of research.

(ii) Now analyze how many of these samples proved to be huge successes, moderate successes and damp squibs. With this as the basis, we can use the same probability on this set of LTE patents (this is a huge assumption). Obviously this is not something that will always work yet if we are going to use history as any indicator then this is one way to follow.

(iii) The next 2 things we can draw from the above sample would be the standard deviation and volatility.

4. Now if we look at this set of patents as an asset, then the value of buying an asset with unknown potential is nothing but buying an option on the asset.

5. So now the value can be assessed as the value of a real option with a possible market value that was calculated in points 2 AND 3.
a. We have - Possible Value of the asset and the volatility.
b. We also have the risk free interest rate.

c. Now the tricky ones, the strike price of this option and the expiry time.
(i) The PV of the investment in productizing these products is the strike price. Why? Compare this to a stock call option - What you earn in a call is the difference between the stock price and the strike. Similarly, here the gain of the patent owner is the difference between the revenues and capital cost.

(ii) Now the expiry time is how long these patents are useful. We cannot sit on 4G patents when the market is already preparing for 5G technology. Beyond a certain time, any technology simply loses relevance.

6. At this point we can insert the values in any Black Scholes Calculator.

An alternative to this step is to break the 600 patents in several sets of like patents and then assess each set individually. The next step can be to sum them all and use these steps for overall value or consider each set as a separate option and value them one set at a time.

Major assumptions of the above approach -
1. This set of LTE patents will have a market performance similar to historical set of randomly chosen 3G patents from a similar period in 3G's lifecycle.
2. Cost of productizing and other capital costs.

I have applied theory of real options in this case and will try to find out of there are other better methods already used elsewhere. That would form some other post

- Siddharth Garud


1 comment:

Paddy Killimangalam said...

Interesting post, Sid. Do share your workings if you can. Also, I think you must add the disclaimer that Black Scholes isnt entirely appropriate because the model assumes efficient markets and liquid underlying i.e, easily tradable (if I am not mistaken).

I know we talked used this in the Arundel case. In fact, I used this for one of the EMFF cases, and Prem was glad to jump at me and point that there are some limitations:)


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