MD+DI Online is part of the Informa Markets Division of Informa PLC

This site is operated by a business or businesses owned by Informa PLC and all copyright resides with them. Informa PLC's registered office is 5 Howick Place, London SW1P 1WG. Registered in England and Wales. Number 8860726.

Building Acquisition Value with Intellectual Property

For medical device companies, procuring patents and substantiating their commercial merit are critical challnges.

BUSINESS PLANNING & TECHNOLOGY DEVELOPMENT

Illustration by JUPITERIMAGES.

Small to midsized medical device companies with strong patent portfolios are frequently targeted for acquisitions favorable to their investors. While acquisition valuations of medical device companies vary widely based on the internal criteria of acquiring companies, successful companies understand the importance of a company's intellectual property (IP) portfolio—particularly patents—in deriving an accurate preacquisition valuation. This is important for the parties on both sides of the transaction.

There are a number of recent examples of deals driven by IP. In 2007, Bausch & Lomb (Rochester, NY) made a $37 million equity investment in Acufocus Inc. (Irvine, CA). In 2006, Angiotech Pharmaceuticals Inc. (Vancouver) acquired Quill Medical Inc. for $200 million. Among the shared strengths of the target companies in these two transactions were strong IP positions that protected shares of well-defined product markets. Through its Acufocus deal, Bausch & Lomb acquired access to corneal implant technology that offers a plausible alternative to glasses and contact lenses among an estimated 50 million people in the United States who can't read without them. The Quill portfolio acquired by Angiotech covers advanced wound-closure products that were launched in early 2007 into a market that the company values at about $1.7 billion.

As these and other medtech acquisitions demonstrate, companies value patents based not only on the inherent strength of their claims, but also on their ability to translate into products that will make money despite any existing competition. Therefore, accurate valuation depends on accurate identification of the relevant product market, likely competitors, and the products that will be protected by the patent portfolio. The following article describes key considerations for determining and conveying the value of a medtech patent portfolio.

Medtech Patent Valuation Caveats

A patent is an agreement between a patentee and the government—the United States, for the purposes of this discussion--that authorizes the patentee to exclude others from making, using, selling, or importing the patented subject matter for a specified period of time in exchange for full disclosure of the subject matter to the public. Although a patent might give its owner a period of exclusivity for commercialization of the claimed technology, it does not have independent economic value. In other words, a patent is only as valuable as the market share it protects. Thus, it is critical for patentees to determine the value of the target product market. They must also ensure that the scope of their patent claims is adequate to exclude competition as expected.

There are some unique factors to consider when estimating the value of medical device patents. For example, it is important to consider a patent's useful life—the duration of the patent term that is likely to remain after the patent is granted and FDA has approved the patented device. A U.S. patent term is typically 20 years from its filing date, and it takes, on average, three to five years from the filing date to obtain a medical device patent.

Delays in FDA approval for devices based on the patented technology can further diminish the duration of patent protection from the time of market entry. In addition, medtech executives must consider whether their company's product will become obsolete before the patent expires, further reducing the useful life of the patent.

Moreover, in medical device sectors with a history of risk, the likelihood of adverse events and recalls may be a factor to consider during the patent valuation process. Of course, not all such factors can be evaluated with precision. Nevertheless, patents covering technologies perceived as high risk might be less desirable to potential acquirers.

To wit, in late 2005, Guidant's defibrillator recalls and resulting lawsuits caused Johnson & Johnson Inc. (J&J; New Brunswick, NJ) to reconsider its $25 billion bid for the company. J&J revised its offer, lowering the price by $3.5 billion. The company clearly viewed Guidant's portfolio as having diminished in value, despite a favorable Federal Circuit holding of patent validity in late 2004. Fortunately for Guidant, the lowered bid opened the door for Boston Scientific Corp. (Natick, MA) to start a bidding war with J&J, and Guidant shareholders ultimately received a premium price. Since the acquisition, however, industry analysts have questioned whether Boston Scientific might have been too optimistic in its valuation of the company's technology.

Defining Products and Markets

The market for new medical technology is driven by the shortcomings of existing therapies and devices. The success of a device depends on whether it provides a clear advantage over existing products used to solve the same problem. Ideally, an assessment of a technology's competitive advantage should be made prior to filing patent applications. Being able to demonstrate the competitive edge of patented technology is important when a company seeks to substantiate the value of an existing suite of patents prior to acquisition.

To show value, a company must identify the customers—whether physicians, patients, or both—who will buy the patented product, and convince the acquiring company that the product is likely to succeed due to its competitive advantage. Identification of current products on the market is straightforward, but identification of potentially competing products that have not yet been approved may require a little more research—and perhaps some guesswork.

IsoTis OrthoBiologics (Irvine, CA) provides a recent example of an acquisition that was driven by the competitive strength of an IP portfolio and its placement in an untapped market. Currently, orthopedic surgeons are plagued by the need to remove bone tissue from one area of a patient's body to graft into another after replacement surgery. IsoTis's regenerative bone matrix products eliminate the need for the additional surgery and accompanying complications—a clear advantage over existing practices by any standard.

The technology was an easy sell to physicians and patients alike—an accomplishment that caught the eye of larger players in the orthopedics sector. In October 2007, IsoTis secured a $51 million buyout bid from Integra LifeSciences (Plainsboro, NJ). The promise of IsoTis's unique patent portfolio also helped it garner a respectable price. The buyout price was $7.25 per share, a significant premium over the company's $6.35-per-share stock price just two weeks prior to the deal.

Protecting the Right IP

The strength of patent protection is essentially the function of two variables: claim scope and validity. If a company defines its targeted product market prior to filing patent applications, the claims can be drafted to ensure product coverage. If applications are already filed or patents granted, the target product market must fall within the allowable claim scope if the portfolio is to be marketable for acquisition. Stated more laconically, a patent is only as valuable as the competitors a company can successfully sue with it. Thus, acquiring companies will demand assurance that the subject matter of its target's patents was differentiated from the most relevant prior art during patent prosecution—and thus, competitors cannot erode the target market without infringing one or more patents.

The $3.2 billion buyout of Sofamor Danek by Medtronic in 1999 provides a good example of the acquisition draw of a patent portfolio with strong claim scope and validity. Following its acquisition of Sofamor Danek's patents—generated by the work of Gary Michelson, MD, and others—Medtronic possessed a portfolio of spinal fusion implant technology that accounted for a $1.8 billion share of the spinal device market by 2005. Incidentally, around the same time, Medtronic paid an additional $1.35 billion to Michelson to secure full patent rights and settle litigation.1

Regardless of the price it paid for the portfolio, Medtronic's IP acquisition was a lucrative one. The reason for Medtronic's success was that the scope of the claimed subject matter of the Michelson patents effectively shut out the competition, enabling Medtronic to cash in on years of near market exclusivity before competing technologies began to emerge.

Substantiating the Economic Value of Patents

Prior to putting up $3.2 billion to acquire Sofamor Danek, Medtronic obviously recognized the value that was inherent in the company's patent portfolio. Demonstrated patent value is critical to any successful acquisition. It's often up to the target company to identify and showcase the attributes of its patents that are good predictors of their efficacy in protecting targeted product market shares.

Deciding how well a patent will protect a specific product market share is inherently speculative. Patent prosecution histories are a good source of information for determining whether the most relevant prior art—which will undoubtedly be discovered during due diligence in the acquisition context—was or can be overcome. If prior art can be overcome, it cannot be considered a real threat to validity.

However, determining the value of the protected market share, which will change over time, depends on several factors. Companies must consider not only how likely the patent claims are to capture a share of the existing market, but also how rapidly new competing technologies will emerge in the market. A company's ability to make predictions in these areas—and to justify those predictions to potential acquirers—is limited by the amount of information that is available about competitor research and development. In addition, the company must be able to use that information to identify development trends and extrapolate threats of market share erosion by new technologies.

The following are exercises that are useful in predicting and demonstrating the level at which a patent portfolio will protect market share.

Document Market Information. Market information for a specific patented technology can be elusive and largely inferential, but its accurate analysis is a prerequisite to meaningful patent valuation. Proper context is critical. For example, forecasting revenues based on product manufacture and sale involves different considerations than estimating licensing royalties. The former context must take into account the costs of manufacturing, marketing, and sales. The latter involves analysis of deal structures in related product markets.

Due diligence in most acquisitions will involve an evaluation of a patent portfolio in both scenarios. Even if an acquiring company plans to market and sell the target's products, it will also want to know how much revenue is to be expected from an infringer in the event that litigation ensues. Such a figure would be based on related licensing transactions.

Sales revenues for a patented technology can be estimated using information about competitors found in Securities Exchange Commission filings, press releases, and market data. Similarly, licensing information is usually available in the form of press releases for public companies, although many of the specifics might be lost. These data can be assembled and used to estimate potential royalties and damages collectible against infringers in view of Georgia-Pacific v. U.S. Plywood, a patent infringement case that provides a fairly exhaustive discussion of the factors considered by courts when awarding damages against patent infringers.2 Of course, if a given patent has been enforced successfully in court, any resulting damage awards are applicable to the valuation. In the event that the portfolio has already generated royalties without litigation, that income provides strong evidence of patent value as well.

Analyze the Relevant Patent Landscape. The more accurately the market to be protected by a given patent portfolio has been defined, the more productive an analysis of the relevant patent landscape will be. Spending time assessing the threat of competition from market players that have not patented in the area of interest is a waste of time, and competitors without relevant patent protection should have been eliminated during the market analysis. Once the market to be protected by the patent portfolio is identified, companies must evaluate whether patents exist that are closely related in scope to those of the portfolio of interest, whether such patents have been tested in court, and, if so, how they held up.

A search for relevant patents should include a company-based search for holdings of identified competitors. Once those holdings have been identified, useful information can be gleaned from them. For example, the most active inventors can be identified and researched to capture related technology without recorded patent assignments, or possibly technology owned by spin-offs of major competitors.

Pertinent patent classifications can be identified and used in a separate search strategy to gather documents with key terms that disclose relevant subject matter. Documents that have expired or will soon expire can be disregarded, and any remaining patents can be analyzed after determining whether they are active and enforceable. Relative threats can then be assessed by applying value factors based on custom criteria, such as the existence of favorable enforcement verdicts or lengthy remaining terms.

Identify Approval and Reimbursement Requirements. Medical devices have to meet specific requirements for market approval by FDA, and meeting these requirements costs money. Clinical trials must be conducted, and applications for approval must be filed with FDA. Thus, any favorable results should be considered as part of the value of the patents covering the device. Additionally, the likelihood of reimbursement by insurance companies and the government for devices and associated medical procedures should be weighed into the overall value of the patents covering the products of interest.

Conclusion

Unfortunately, there is no crystal ball that medtech companies can use to completely and accurately predict the demand curve for medical devices, the likelihood of market approval or adverse events, the presence of secret competition, or issues that may arise in the event that a patent is tested in litigation. Nevertheless, the processes described in this article can lead to the discovery of information that can be used to bolster the perceived value of a patent portfolio for sale. All of the variables discussed play into patent valuation. Companies that are aware of the competitive environment surrounding their patents and are able to articulate positive valuation attributes will be in a much stronger position at the negotiation table.


References

1. Andrew Pollack, "Medtronic to Pay $1.35 Billion to Inventor," The New York Times (April 23, 2005).

2. Georgia-Pacific v. U.S. Plywood, 381 F. Supp. 1116 (S.D.N.Y. 1970).

Scott Lloyd is an analyst at Nerac Inc. (Tolland, CT), a research and advisory firm.

Copyright ©2008 MX
Hide comments
account-default-image

Comments

  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.
Publish