By: Adam Levy
Yahoo publically alleged recently that social-networking giant Facebook infringed on 10 to 20 of its patents, demanding license fees or alternatively face a lawsuit. Facebook, still in the “quiet period” following the February filing of its S-1 (a required SEC filing for companies going public to register their corporate securities), is still evaluating Yahoo’s claims.
Yahoo’s aggression is somewhat out of character, even for a company called Yahoo! If Yahoo’s threat escalates into a full-blown lawsuit, it would be Yahoo’s first offensive patent litigation against a large public company. At any rate, Facebook’s options seem limited. Other large companies under attack for patent infringement normally threaten to use their own patents in retaliation. Here, however, Yahoo possesses far more patents than Facebook; Facebook holds a mere 160 while Yahoo holds 1,100 with another 2,661 in the pipeline. Yahoo has primarily held these patents defensively to deter patent infringement suits directed against them.
The quiet period further limits Facebook’s options. Undefined by federal securities law, the point of the quiet period is to prevent a company from conditioning the market, or “hyping” its stock, by influencing investors with information not filed with and reviewed by the SEC.
Groupon’s recent IPO trouble is telling as to how the quiet period works. At the end of 2011, the SEC investigated Groupon because its CEO stated in an inter-company email that Groupon was out performing competitors and seeing “unprecedented growth.” Aggravated by the SEC’s scrutiny and the complicated quiet period communication rules, Groupon put out their own humorous quiet period guide. According to The Groupon Guide to the Quiet Period, “The “Quiet Period” is the time right before a company “goes public,” during which it is legally prohibited from saying anything to the press that may make the company look “good,” “successful,” or “not currently on fire.’” Zynga, the leading social game developer for Facebook, also had trouble during its quiet period in that Zynga was limited in the ways it could publically defend themselves against critics’ allegations that the company was not very talented or original.
Accordingly, Facebook is restricted in how it reacts to Yahoo’s allegations, as it must be weary about making public comments in light of the recent “quiet period” debacles. The allegations, have the potential to hurt Facebook’s brand (though this is probably not very likely) while Facebook has fewer defense tools.
Of course, Yahoo may actually believe – and could be right – that Facebook is infringing on its patents, and not merely attempting a strategic ulterior move. Nevertheless, some commentators speculate that Yahoo’s threat could force Facebook into paying Yahoo with pre-IPO stock. Google gave Yahoo 2.7 million shares part of a patent settlement before Google’s 2004 IPO. Other commentators indicate that Yahoo’s actions track a pattern signaling the end in the tumultuous world of large tech companies. A month before Kodak’s bankruptcy filing, Kodak sued Apple and HTC for infringing on digital-imaging patents; Nokia and Ericsson took similar action before merging with other companies.
Concerned that they are similarly destined, perhaps Yahoo is threatening Facebook to get a kick in acquisition value before a merger. A writer at Forbes thinks an acquisition of Yahoo by Facebook would be prudent. Having Yahoo’s revenue on the books would improve the multiples used to value Facebook. (Facebook’s market cap is 100 billion but their revenue stream is only about 5 billion, a 20x price/revenue multiple.) But perhaps a company as unique as Facebook cannot be valued using basic valuation techniques. Investors are in it for the long term, and without a viable competitor, the untapped economic potential for Facebook to monetize its data and network of over 845 million users is virtually limitless. Sure, Yahoo is making noise now, but notwithstanding the quiet period, it’s not clear how much good that noise will do. The world’s fastest growing and most popular company, after all, can afford earplugs.