Twitter’s Lack of Patents Seen as a Risk to Investors

Profits aren’t the only thing lacking at Twitter Inc. ahead of its planned initial public offering. It’s got a dearth of patents, too.

The microblogging service said in its prospectus this week that it has nine issued U.S. patents. That compares with 774 cited by Facebook Inc. before its initial public offering in May 2012 and International Business Machine Corp.’s 6,478 patents accrued last year alone. Twitter’s smaller patent trove reflects its philosophy of letting engineers and designers own their inventions.

While Twitter’s policy is an effort to limit patent litigation, some investors and analysts are concerned it could backfire. Evidence shows that intellectual property can help companies raise more funds in their offerings, as patents enable investors to quantify the value of technological breakthroughs. Those safeguards are important for potential Twitter investors, amid the company’s widening losses and a lack of other financial metrics to go by.

“The lack of a large number of issued patents is a little concerning,” Maulin Shah, managing director at Envision IP LLC, an advisory and research firm in New York, said by phone. “If Twitter does deal with patent-infringement lawsuits, they don’t have too many patents to lean on to countersue. That does put Twitter at a disadvantage.”

Innovator Agreement

Twitter says in its prospectus that many competitors have “substantially larger patent” portfolios, which could make it a target for litigation.

At the same time, Twitter has said that too many patents may hinder innovation. In May, the San Francisco-based company implemented the Innovator’s Patent Agreement, or IPA, to keep ownership of inventions in the hands of the people who created them. As part of the policy, Twitter can’t pursue offensive litigation without the inventor’s permission. The IPA ensures that the patents “will be used only as a shield rather than as a weapon,” according to Twitter’s website.

The IPA will help the company lure and retain more talented engineers, said Robert Clarkson, a partner in the capital markets practice at corporate law firm Jones Day. More than 5,000 patent actions were filed last year, the highest number ever recorded, according to a 2013 study by PricewaterhouseCoopers LLP.

“Twitter has taken a somewhat different approach in that agreement,” Clarkson said in a phone interview from San Francisco. “This helps them attract leading individuals. They get more by attracting the best and brightest.”

Investor Risk

The policy’s biggest risk is that employees will take their inventions with them, posing a competitive threat if they leave, according to Jeff Sica, president and chief investment officer of Sica Wealth Management LLC.

“This is a radical way of dealing with patents, which is far different than anything investors have seen before,” said Sica, who oversees about $1 billion under management. “People may appreciate the openness and invitation of competition.”

Sica, who’s considering buying shares of Twitter, said that the company has developed a strong enough brand to withstand the competition.

Jim Prosser, a spokesman for Twitter, declined to comment.

Twitter is seeking to raise more than $1 billion in its IPO, people familiar with the situation said last week, and will probably start a roadshow to market the offering in the last week of October. The company pegged the fair value of its common stock at $20.62 a share in August.

Active Users

Twitter’s potential, as it lures advertising with more than 230 million monthly active users, means it could fetch $50 a share by the end of 2014, according to Robert Peck, an analyst at SunTrust Robinson Humphrey Inc. That user base is also critical to defending Twitter from competitors, he said.

“Investors are asking if Twitter’s not protecting their business,” Peck said by phone. “I think there’s a business risk there, but at this point, the network effect protects Twitter.”

Adding patents ahead of an IPO can help a company raise a higher amount in its market debut, according to a study of 234 software firms in the U.S. An additional patent obtained prior to the debut increased proceeds by about 0.9 percent, according to a working paper presented last year by Diego Useche, a researcher at the University of Bordeaux.

“The more that IP is protected, the less infringement opportunity there is, and therefore, would increase the valuation,” said Peter Adriaens, a professor of entrepreneurship and strategy in the Stephen M. Ross School of Business at the University of Michigan.

Patent Boost

Facebook placed a large focus on strengthening its patent portfolio before going public to protect itself from potential infringement cases, according to Envision IP. The social network acquired about 750 patents from IBM and another 650 from Microsoft Corp. prior to its IPO, Envision IP said in a Sept. 13 note.

While LinkedIn Corp., the professional-networking website, and Zynga Inc., maker of the online social game “FarmVille,” both went public with two or fewer patents, they were each profitable before their IPOs. Twitter’s net loss widened to $133.9 million in the first nine months of this year.

Twitter has been named in more than a dozen patent-infringement lawsuits, according to data compiled by Bloomberg. So far, it has successfully fended off the cases.

In August, Twitter won a U.S. appeals court ruling that it didn’t infringe a patent owned by Eaton Corp.’s Cooper Notification for a mass messaging system. In April 2012, it won a jury verdict that it didn’t infringe patents owned by closely held VS Technologies for a way to build virtual communities.

TechRadium Inc., a closely held company that provides a system for emergency response services, sued in 2009 after municipalities said they were opting for Twitter’s system. The two sides settled in December 2010, according to court records.

Patents Pending

Twitter may have access to eight more patents through its recent acquisitions of TweetDeck, Bluefin Labs and Dasient, though these patents have yet to be legally assigned to the company, according to Envision IP’s research note. Twitter also said in the regulatory filing that it has about 95 patent applications pending in the U.S. and abroad.

The company’s lack of offensive litigation could cut down on expenses. Each patent lawsuit can cost as much as $5.5 million, depending on the size of IP at risk, according to a 2013 study by the American Intellectual Property Law Association.

“It does help the company to reduce the litigation costs to reduce patents,” said the University of Michigan’s Adriaens. “You need to have enough to project confidence to investors in terms of what you have in the way of intellectual property.”