Not too long ago, if you talked to a U.S. senator or congressperson about innovation policy, the eyes of all but a few would glaze over at the first mention of the word “patents” — widely considered to be among the most boring subjects in the world. The topic generated even less interest from constituents than local library bonds.

Today, however, many of the 535 members of the U.S. Congress have become ardent advocates of patent reform — as have an increasing number of the 50 state legislatures and attorneys general (AGs) in America. In fact, the AGs of Nebraska, Vermont, and Missouri met at a roundtable event in New York City in early February to discuss the patent troll problem.

What accounts for the sudden change?

In large measure, it’s due to the behavior of patent trolls such as MPHJ Technologies Investments LLC. The attorneys general of several states have alleged that MPHJ has engaged in deceptive practices by sending demand letters to thousands of Mom and Pop businesses, claiming they were violating MPHJ’s patent rights by using common scan-to-email technology. MPHJ then demanded these businesses pay up to $1,000 per employee or else face a patent infringement suit in federal court.

Naturally, many of these business owners started protesting loudly to their elected officials and demanding action — as did representative trade groups such as the National Federation of Independent Businesses and National Restaurant Association. In our view, the actions of patent trolls against small businesses have been a major factor in damaging the reputations of the majority patent owners and giving the patent system itself a bad name.

All of which helps to explain the flurry of activity recently both in Congress and at the state level to rein in these patent trolls.

At the federal level, the Innovation Act (H.R. 3309), passed late last year in the House, does try to address patent troll behavior. But it also contains provisions that harm legitimate innovators, especially startup businesses. We’ll discuss these concerns in future blog posts as the Senate begins marking up its version of the bill.

At the state level, AGs have found consumer protection laws to be very effective tools in fighting patent trolls. As Massachusetts Attorney General Martha Coakley recently said:

“State consumer protection laws prohibit false, misleading, deceptive, and unfair statements in commerce.  When a patent troll sends a letter to a small company, non-profit, start-up, or even a well-established company that asserts claims to property that the troll knows to be false, or threatens legal action that the troll has no intent of bringing, in order to extort money, that is against the law.”

To date, the AGs and state legislatures in nine states (and counting) have filed suits and drafted laws taking aim at patent trolls.

Vermont Attorney General Bill Sorrell was the first to use his state’s consumer protection law to combat the abusive practices of patent trolls, who often hide behind an alphabet soup of shell companies. His May 2013 lawsuit against MPHJ — and the state legislature’s later passage of the “Bad Faith Assertions of Patent Infringement Act” — quickly became a model for action in Nebraska, Massachusetts, Minnesota, South Carolina, Missouri, Oregon, and Kentucky.

But the biggest success so far may have been New York, where state Attorney General Eric Schneiderman signed a consent decree with MPHJ in January of 2013 requiring it to repay all the money it received from businesses in the state. In its demand letters to businesses, MPHJ had falsely claimed that it had analyzed each target company’s scanning systems and determined it to be in violation of its patents. In fact, MPHJ had merely sent form letters to hundreds of firms of a certain size and industry classification without uncovering evidence of infringement. (We note that many of the points made in the consent decree align with Conversant’s Patent Licensing Principles.)

What’s more, said Attorney General Schneiderman’s office:

“MPHJ falsely told businesses that most other businesses it had previously contacted had acquired licenses when in fact only a handful of businesses had done so. MPHJ also provided misleading information about the fees that the (few) prior licensees had paid. And MPHJ falsely threatened to sue hundreds of businesses if they did not respond to its letters within two weeks; in fact, it has never filed a patent lawsuit against a New York business.”

The National Association of Attorneys General has established a working group that will continue to work on methods of protecting businesses and consumers from patent trolls. The larger goal, says Massachusetts AG Martha Coakley, is to “thwart the abuse of the intellectual property system by bad actors while preserving the incentive to innovate.”

Mark Harris, writing in IEEE Spectrum, has an extremely well researched and insightful essay on The Lowballing of Kodak’s Patent Portfolio.  Harris compares the difference between the selling price of 1,730 of Kodak’s patents and the much higher earlier valuation – the amount their consultants had told them to expect.

As a Certified Patent Valuation Analyst, I know there are many different ways to value a patent portfolio, but they all boil down to a discounted cash flow analysis of how much licensing revenue you believe can be generated from it.  How much should one pay for a portfolio which should generate $100 million per year in royalties over the next five year?  Superficially, it’s a simple question.

Scratch the surface, though, and you discover a lot of hidden variables.  For example, pre-existing cross licensing agreements may place certain prospective licensees out of bounds for a given licensor – but not for others. Thus, the plausible expectation of the $100 million that you could generate is far too high for your prospective buyer, and he will value the portfolio at a lower amount than you have.  Furthermore, assumptions about the annual cost of obtaining that $100 million (mainly litigation), or a reasonable time period for negotiations to take place, often lead to significant differences in a valuation.

This is why valuations of those 1,730 Kodak patents ranged from $1.8 to $4.5 billion. But the various consultants who came up with these different numbers overlooked one of the fundamental truths of economics: The worth of a thing is what it will bring.

Nicholas Cage was painfully reminded of this fact when he sold his Rolex Daytona for $500 in Leaving Las Vegas.  When a buyer knows you’re desperate for cash, expect him to make a very low offer.  That’s precisely what happened to Kodak.  The bidders knew Kodak needed the sale to allow them to refinance their debt while in Chapter 11, and thus secured not only the original 1,730 patents, but a license to approximately 20,000 additional patents Kodak was hoping to retain.  In the end, the patents sold for only $94 million, or 2% to 5% of the amount Kodak was hoping for.

I have one quibble with Harris’ analysis: A filing to the bankruptcy court claims that $433 million of the $527 million payment from the IV/RPX consortium was in fact for a license to the approximately 20,000 patents Kodak wasn’t selling, meaning the 1,730 patents sold for $94 million.  While legally indisputable, I believe this simply reflects another valuation exercise, and the $94 million is artificially low.  But one certainly cannot claim that the whole $527 million was for the purchase of the patents, which is what numerous commentators said or implied at the time, so kudos to Mr. Harris for doing the digging to bring this fact to light.

The same thing can happen in reverse, of course.  Rockstar and Google may have been irrationally exuberant when they were bidding on the Nortel patent portfolio, driving the selling price past the $1 billion valuation to a staggering $4.5 billion.  It’s not hard to find people who think Rockstar overpaid, but maybe they’re just a better judge of value than the critics think.

The moral of the story:  No matter how accurate your valuation model, when the time comes to actually sell your portfolio, many additional factors can come into play which can significantly affect the final selling price.   Caveat venditor – let the seller beware!

You don’t have to look very far to find people who have characterized Google’s 2012 acquisition of Motorola Mobility and subsequent sale to Lenovo as a “mistake”:

• Associated Press: “An expensive mistake by Google could turn into a golden opportunity for China’s Lenovo Group”
• US News & World Report: “Google’s Big Bust: Motorola Mobility Sold to Lenovo for Huge Loss”
• Slate: “Google’s Prepared to Sell Motorola at a Huge Loss”
• Wired: “Google Selling Motorola at Multibillion-Dollar Loss”
• Current Analysis: “Lenovo Buys Motorola Mobility, Unraveling Google’s Mistake”

These articles represent a cross section of mainstream media, technology reporting, and even a market research firm focused on the mobile phone industry.  Did they really all get the story wrong?

Each article eventually mentions that Google is retaining most of Motorola Mobility’s patents, although you often have to get through several paragraphs before that fact emerges.  But the patents were what this deal was always primarily about, as evidenced by Google’s announcement after the acquisition and by this leaked email from Larry Page following the sale.

Let’s do some simple math.  Google acquired Motorola Mobility, including its approximately 17,000 patents for $12.4 billion in May 2012 (all figures in US dollars).  They sold the set-top box business (and 1,000 patents) to Arris in December 2012 for $2.35 billion in cash and stock.  And now they’ve sold the handset business (and 2,000 patents) to Lenovo for $2.91 billion.  Now, the purchase of Motorola came with $2.9 billion in cash, so what we’re left with is $4.24 billion for around 14,000 patents.  (You can shrink that number further by taking into account things like $2.4 billion in deferred tax assets Google obtained in the original acquisition, but we’ll set that aside for the sake of this argument.)

According to regulatory filings, Google had valued the original 17,000 patents at $5.5 billion (by far the biggest piece in their valuation of the acquisition).  Now, anyone in the patent licensing business will tell you calculating a per-patent valuation for a portfolio is an over-simplification. But with all necessary disclaimers, this works out to around $294,000 each, and that they paid $303,000 each for the 14,000 they still have.  That’s pretty close to their original valuation.

And does that valuation hold water?  Probably the easiest checkpoint is Rockstar’s purchase of around 6,000 Nortel patents for $4.5 billion.  That’s $750,000 per patent.  (Before you start thinking this means Google may have undervalued the Motorola portfolio, please realize that such a portfolio comparison would be a futile, apples to oranges exercise. And don’t go multiplying your portfolio by $750,000 or $303,000 to try and value it.  Free portfolio valuations are worth what you pay for them.)

The bottom line:  Google never thought the $12.4 billion was just for the patents, but they certainly believed they were the biggest part of acquisition, and any analysis of the sale to Lenovo which doesn’t put the patents front and centre is missing the point.