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In Praise of Patent Plays

In his classic cyber-punk novel Neuromancer , William Gibson depicts a place called Night City as "a deranged experiment in social Darwinism, designed by a bored researcher who kept one thumb permanently on the fast forward button."

When you think about it, that's a pretty apt description of the tech side of today's economy. Things are changing so fast that whatever you're selling, it's got to be continuously better/faster/cheaper if you want to survive. Resting on your laurels is not an option.

Unless, that is, you own a patent controlling some crucial part of your industry. Then you can let the other guys fight it out while you kick back and watch your licensing fees accrue.

I'm oversimplifying here, but only a little. The reality is that companies with key intellectual property (or IP, as the digerati refer to it) tend to be worth a lot. Qualcomm (QCOM), for instance, has sales of $4 billion, but a market cap 10 times that high because it owns patents central to some of tomorrow's wireless standards. Conversely, Eli Lilly's (LLY) market cap dropped by more than $30 billion on the day it announced that its patent on Prozac would run out a couple of years ahead of schedule.

But building a portfolio of future Qualcomms is harder than it looks. A lot of companies, it seems, have patents or patents-pending or some other kind of awesome sounding IP that they claim makes them unique. So without a serious background in physics and engineering, singling out blockbuster patents is a lot harder than comparing price-to-earnings ratios or growth rates.

Still, it's fun to try. So check out the following:

  • Research Frontiers (REFR) owns more than 300 patents on suspended particle devices (SPD), which fold light-absorbing microscopic particles into films that, when sandwiched between panes of glass, react to electrical current by changing shades. A picture window (or car windshield or interior partition) can thus be made lighter or darker by turning a dimmer switch. Imagine a house or office building with transparent interior and exterior walls that become opaque in varying combinations at the twist of a few knobs, and you get an idea of SPD's potential.

    There are a lot of competing display technologies, of course, and Research Frontiers is still tiny, with annual sales of less than $1 million. But some heavyweights have licensed its patents, including Polaroid (PRD), General Electric (GE) and Hitachi (HIT).

  • Interdigital Communications (IDCC - Get Report), like Qualcomm, has patents covering some basic aspects of wireless communications. To understand what's at stake here, remember that today's cell phones operate on several incompatible standards, none of which handle data very well. But the next generation of standards (collectively known as 3G) will be broadband, turning cell phones into Web-browsing, music-playing information appliances. The result will be a global trillion-dollar business.

    Interdigital's patents deal with things like bandwidth management and power usage, which are important today, but will be huge in a 3G world. It has an ongoing relationship with Nokia (NOK) to develop one standard, and has various patents firmly embedded in the other early versions of 3G. Nothing is guaranteed, but Interdigital looks like a pretty good bet to be in the mix when the final standards are set.

  • ACTV (IATV) has a portfolio of patents covering some of the "enhanced media" technologies involved in merging traditional media with the Web. We're talking basic, crucial things like linking music videos to Web pages containing song lyrics and CD order forms. And chat forums that operate on the same TV screen as the show that's being discussed.

    AT&T's Liberty Media Group (LMG.A) recently bought a chunk of ACTV and chose it to supply the platform for a new interactive TV venture. Then, when ACTV's stock followed the rest of the emerging tech sector down in May and June, Liberty bought more, bringing its stake to more than 25%.

    Beyond the Liberty relationship, ACTV's plan is to cut licensing deals with the other media firms racing to build interactive TV capabilities. Will it succeed? Hard to say, with all the controversy surrounding Internet companies patenting seemingly commonplace ideas (a subject for a future column). But if ACTV does succeed, it's sitting on a gold mine.

  • Guilford Pharmaceuticals (GLFD) is a relatively safe bet in biotech, a market where patents are the dominant form of asset. Go through any drug company's recent press releases and half the stories will be about this or that breakthrough compound, which, of course, has a decade or more of patent protection. This torrent of wonder drugs is great news for all of us, but a problem if you're trying, for instance, to decide which of 20 new Alzheimer drugs will actually sell. And then there's the specter of drug-price controls under a Gore administration that might make such patents a lot less valuable.

    Guilford is interesting because it's in the process of buying Gliatech (GLIA), the developer of a line of compounds that inhibit scarring in various kinds of operations. They're not as glamorous as cancer cures, but they clearly work, and post-op scarring is a problem across all forms of surgery. The first of the series to be introduced -- ADCON-L, for back surgery -- has met with a great response, according to the company. Other versions, each targeted at a specific kind of surgery, are in the pipeline. Meanwhile, Guilford has a potentially important cancer drug in late-stage tests.

    Anyhow, I could see making the search for hot patents a regular, maybe monthly, topic for this column. So send in your picks and I'll check them out.

    John Rubino, a former equity and bond analyst, is a frequent contributor to Individual Investor, Your Money and Consumers Digest. His first book, Main Street, Not Wall Street, was published by William Morrow in 1998. At time of publication, he had no position in any stocks mentioned. While Rubino cannot provide investment advice or recommendations, he invites your feedback at jrubino@thestreet.com.

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