Over the last year, market-wide uncertainty has swelled to levels not seen for over a decade. Market fluctuations now have investors increasingly searching for non-correlated returns across all asset classes in an effort to diversify away the risk brought on by this volatile market. Should investors turn to precious metals? Real estate? Emerging markets? There are many options when looking for non-correlated investments, but one asset in particular – intellectual property (IP) – has been slowly gaining prominence in mainstream institutional investing. With a market value well into the trillions, IP is one of the largest asset classes globally. Data from the World Intellectual Property Organization (WIPO), indicates global spending on R&D increased by about 3.9% in 2020, reaching an estimated $2.18 trillion. This figure includes both public and private sector spending on R&D, as well as spending by governments and international organizations. By exploiting IP-based investment strategies an alternative asset manager can deliver strong, differentiated investment returns and a diversified book while reducing correlation and leverage and increasing Sharpe ratio.
There are a number of IP-based investment strategies, all with varying volatility and risk/return profiles. These strategies range from long/short equity and debt strategies, IP direct lending, to LBOs. Largely, all IP-based strategies can be broken into three major groups: Liquid Special Situation Investments, Illiquid Special Situation Investments, and Private Equity.
Liquid Special Situation Investments
IP-driven, Liquid Special Situation investing offers the benefits of traditional distressed, activist, or arbitrage strategies with the added benefit of the edge provided by technical knowledge and experience in the IP space. Identification and screening of these opportunities is more thorough, and the analyses conducted are more appropriate for opportunities carrying significant value in intangible assets, leading to a greater chance of success and/or excess returns. Specific liquid special situation strategies include:
- Distressed IP Investing – Distressed estate valuation modification attributable to IP
- IP Activist Investing – Activist campaigns based on failure to optimize IP strategy
- Change of Control Transactions – Ensure proper takeout prices by including IP valuation and monetization strategy
- Patent Arbitrage – Superior IP purchasing knowledge and capital deployment permits IP buys /sell arbitrage
- IP Litigation Outcomes – Insight into the underlying IP issues and litigation tracking
Illiquid Special Situation Investments
Illiquid Special Situation investing in the IP space gives the participant a premium over traditional asset-based lending, however significant diligence on the collateral valuation must be conducted. Additionally, some Illiquid Special Situation investments create reasonable reputational risk (i.e., enforcement or monetization funding). There is an opportunity in the intangible asset-based lending space given the quality of the proposed collateral, as well as in royalty stream securitizations given the relative low risk nature of these investments.
Private Equity
These opportunities can include late-stage venture funding, growth equity, middle market investing, or LBOs. IP diligence and portfolio robustness is considered in the evaluation of these opportunities, which center around businesses across all industries with significant value held in their respective IP portfolios. Value can be found in defensive portfolios, IP providing barrier to entry in a market, and unique, protected technologies which allow these companies to drive excess value through bolt-on strategic acquisitions in their space. In fact, strategic acquirers are often the best solution for IP-heavy companies, paying over a 30% premium than other IP aggregators and acquirers.
Many companies have either failed to monetize their IP, have important IP whose value is not reflected in their price, or offer proprietary technologies, protected by IP, as a differentiating factor in their sector. This deep value can be exploited by and inure to the benefit of private equity holders. It can also be used to finance LBO debt and, through collateral package enhancement, either reduce the coupon on or increase the principal amount of the LBO debt available.
Challenges and Rewards of IP-Based Investing
IP-based investing is not without its own unique challenges. Because IP is such a niche asset class, the strategies involved require specialized business and technical knowledge, due diligence capabilities and legal and transactional capabilities. Traditionally, investors interested in this space have gained access to this specialized knowledge through third party consultants or advisors, however it is becoming more and more commonplace to see institutional investors with their own IP focused groups, or IP-specific funds. This alone speaks to the benefits of IP-based investing. Providing an IRR consistently above 15%, and sometimes well in excess, reliable downside protections, and a significant shift in IP policy in the last 5 years in favor of IP and its owners, IP has begun to establish itself in the institutional investing world as a premier non-correlated asset class.
Contact
Ryan Zurek is a Managing Director in the Investment Group of Ocean Tomo, a part of J.S. Held. Mr. Zurek leads the firm’s Advisory Services practice which is composed of IP Transaction Advisory, Investments, and non-securities Investment Banking. He holds the FINRA Series 7 and 63 license. He plays an integral role in all aspects of the firm’s investment banking and asset management initiatives, including facilitating IP-driven transactions, mergers and acquisitions, IP monetization strategies, financing, and IP-based special situations investments. Contact Ryan at +1 312 327 8006 or [email protected].
Trevor Krajewski is a Director in the Investment Group and Advisory Services of Ocean Tomo, a part of J.S. Held, which is comprised of Transaction Advisory, Investments, and non-securities Investment Banking. He holds FINRA Series 7 and Series 63 licenses. Contact Trevor at +1 312 327 8181 or [email protected].