Patents Mean Profits… for Firms and Investors

There’s a new war breaking out in Asia.

It doesn’t involve guns, bombs, trade, or any geopolitical posturing, though.

Rather, leading Asian tech companies are “turning to patents as ammunition,” writes The Wall Street Journal’s Juro Osawa.

And every investor should take notice.

For years, Asian heavyweights like Xiaomi and Huawei have been content to grow their businesses without patent protection.

Frankly, the only time patents entered the conversation was when these companies were on the receiving end of lawsuits.

But as these companies look to expand internationally, they’re quickly realizing the need for strong patent protection.

“We must systematically negotiate licenses to international patents and build a strong IP portfolio for defensive purposes, by both filing and acquiring patents,” states Xiaomi Vice President Hugo Barra.

This strategic change is as crucial for companies as it is instructive for investors.

It proves that patents matter more than ever in our global economy – both for businesses and investors.

The Three P’s of Patent Warfare

Before a company can book a single penny in profit, it needs a product to sell. Duh!

Yet in today’s fiercely competitive global economy, before a company can produce something to sell, it needs to patent the idea. Otherwise, it’s too easy for competitors to knock off the product and steal market share.

Or, as Jeff Wild of IAM observed in 2012, “What a commitment to patenting shows is that a company’s management has thought about the future, so that if they have something that people want to buy, they’re in a position to carve out a valuable niche in the market that others will find it hard to encroach upon without paying a sizeable rent.”

Put simply, being first to market is no longer a sustainable competitive advantage.

Companies need to be first to market and have patents that protect their products – thus ensuring sales and profit longevity.

But what if a company is looking to enter a market late, like many of these Asian tech companies?

Well, without ample patent protection, it’s a non-starter – a reality they’re confronting in three ways:

Weapon #1: Produce

Ahead of expanding into new global markets, Asian tech companies are aggressively ramping up research and development (R&D) spending in order to increase innovation.

In turn, their patent applications are rising, too.

Take smartphone maker, Huawei, for example.

In the last five years, the company has spent almost $30 billion on R&D.

Last year alone, it spent $9.2 billion, actually eclipsing Apple Inc.’s (AAPL) annual R&D expenditure of $8.1 billion.

As a result, that’s led to a surge in patent applications.

As you can see below, Huawei ranked as the largest filer of patent applications in 2014 and 2015, according to the World Intellectual Property Organization (WIPO).

It’s also worth noting that Asian companies now dominate the Top 10 list of global patent applicants, occupying six of the top spots.

Global Patent Wars: Patent Applications by Major Tech Companies

Weapon #2: Purchase

Inventing takes time. Yet, in today’s rapidly changing world, companies don’t have time to wait before entering new markets.

So they’ve found a shortcut – buy valuable and critical patents from others.

Consider:

  • In June, Xiaomi purchased 1,500 wireless, cloud, and multimedia patents from Microsoft Corp. (MSFT) in anticipation of expanding into new markets.
  • In 2014, Lenovo Group Ltd. (LNVGY) paid $2.91 billion for Motorola Mobility’s treasure trove of patents.

This trend promises to continue, too, as companies are “looking to get their hands on good, solid IP,” says Guy Proulx, CEO of advisory firm Transpacific IP Group.

Weapon #3: Prosecute

Producing and owning patents isn’t enough. Companies need to enforce them, in order to protect their market share and maximize profits.

And that’s precisely what’s happening.

In May, for example, Huawei sued Samsung Electronics Co. Ltd. (SSNLF) in San Francisco’s federal court over the infringement of 11 patents related to 4G mobile devices.

Ningling Wang, a partner in Shanghai with the law firm Finnegan, Henderson, Farabow, Garrett & Dunner, recently told Bloomberg that other companies will likely follow Huawei’s lead.

Their goal? “Extract value from high-quality patents,” wherever they may be, says Wang.

In fact, the value of IP is so high, governments are even stepping up to defend it.

In Japan and South Korea, government-backed funds are working to license patents for each country’s big tech companies, similar to how Acacia Research Corp. (ACTG) functions in the United States.

Rest assured, as tech markets become even more competitive, enforcement activities will naturally intensify in the months and years ahead.

So Why Does Any of This Matter to Investors?

Patents serve as a proxy for innovation.

As I’ve shared countless times before (see here, here, here, here, here, here, and here), patents serve as a leading indicator of profits, too.

And the data backs up such claims:

  • A landmark study from Georgetown found that companies that spend aggressively on R&D enjoy fatter margins and higher stock prices, based on 50 years’ worth of data.
  • Companies with strong patent portfolios routinely outperform the S&P 500, as evidenced by the Ocean Tomo 300 Index. Since its inception in 2006 through November 2015, the index of companies with high-quality IP outperformed the S&P 500 by over 1,600 basis points.

Bottom line: Asian tech companies are increasingly focusing on patents and we should, too. Doing so promises to help us make more informed and more profitable investment decisions.

Ahead of the tape,

Louis Basenese

You May Also Be Interested In:

All I Want for Christmas is… An Equity Stake in a Startup Crowdfunder

There’s a new war breaking out in Asia. It doesn’t involve guns, bombs, trade, or any geopolitical posturing, though. Rather, leading Asian tech companies are “turning to patents as ammunition,” writes The Wall Street Journal’s Juro Osawa. And every investor should take notice. For years, Asian heavyweights like Xiaomi and Huawei have been content to...