While only one biotechnology-patent securitization deal has been completed so far, two Boston-based individuals have proposed a plan to make the process of securitizing these assets simpler.
Pat Trombly and Ronald Douglas, who each have tax backgrounds from big-five accounting firms, have devised a way to use "check-the-box" tax regulations to ease the process of trying to fit a securitization vehicle into a trust for tax purposes. The Treasury Department's "check-the-box" tax rules allow certain eligible entities to simply choose their classification for federal tax purposes, thereby liberalizing the process of formulating a structure for securitization deals.
Trombly and Douglas say that this more liberal method of tax classification may lend itself to the concept behind biotech securitizations, in that it provides a method of achieving off-balance-sheet financing for technology licensors. Among the proposals which the two men have developed is a method of getting "non-entity" federal tax treatment of the special purpose vehicle (SPV) as well as achievement of "debt treatment" for the instruments issued, Trombly said.
The structure, which is quite risky, places value on a pool of licenses that have a steady revenue stream, similar to the way a mortgage-backed security is structured.
"You wouldn't have the issue of trying to fit your special purpose entity into the qualifications of a trust for federal tax purposes," Trombly said.
In the age of intellectual property, putting a value on an intangible asset can be quite a daunting task (ASR 11/27/00), let alone securitizing the royalties associated with licensing. Copyright and entertainment royalty-backed deals have pushed their way from the obscure to the mainstream, but now biotechnology and pharmaceutical companies are seeking ways to find alternative financing.
"It wouldn't simply be an evaluation on the underlying technology," Trombly said. "You have to look at the [licensing] contracts themselves."
What Works Best
Although biotech-license securitizations are considered risky to investors, some observers see potential value in these transactions. However, the structure may not be conducive to every type of revenue-generating patent, sources say.
Genome companies, while having highly valuable patents for their extensive databases, do not generate a steady cash flow to warrant securitization. "I don't know if [the securitizations are] going to fit within FASB 125. The license itself has to be structured a certain way to make an income stream," Trombly said, who pitched his idea to the Harvard Biotechnology Club and J.P. Morgan prior to its merger with Chase Manhattan Corp. The bank has put Trombly's plan on hold due to the merger.
However, the structure has the potential to be successful for other types of patents.
Universities do not wish to mass produce a patented item, but instead choose to raise capital off of the IP by licensing it to other companies. "There are companies or universities which only want to generate income from licensing technology," said Bruce Berman, president of financial consulting firm Brody Berman Associates. "They don't want to manufacture...so they just take the piece they can take and leave the development to other people. They want a cash flow. "
Universities are also making use of securitization to help fund construction projects without touching their endowments.
In the first public patent royalty deal completed in November, (ASR 10/30/00), Yale University had licensed its patent on the HIV/AIDS drug Zerit to Bristol-Myers Squibb. To help construct a new building on the campus, it sold the patent and all revenue rights into a trust, BioPharma Royalty Trust. The trust issued the bonds, or securitized the revenue stream from the royalties to the benefit of the bondholders.
Insurance May Be The Key
However, there are some serious risks associated with patent license deals.
"The biggest issue with these transactions is being able to overcome the technological risk involved in the patent, because you are relying on future licensing fees generated by the patent," said Jay Eisbruck, an analyst at Moody's Investor's Service. "If another technology were to come along that would make the technology the patent uses obsolete, that could dramatically reduce your revenues."
Issuers who are contemplating bringing such deals to the market need to show that the patent is going to have the staying power to continue to generate the revenues over the life of the transaction and not be rendered obsolete by new innovations.
Insurance could help, though. "If you have insurance against invalidity, you're less afraid as an underwriter to take on the securitization risk, because invalidity is taken out of the picture," Berman said. "You've given up a little yield to insure it."
Once the first few deals are completed, people will be more apt to structure more patent deals in the future.
"I'm sure a lot of entities will be pursuing this once they really get wind of it to see if it fits into their own capital structure," said Ellen Welsher, a director at Standard & Poor's Ratings Services. "People know it's doable in certain situations. It's not necessarily doable with a product [in which] the patent is about to run out, or if there's a lot of competition. There's a lot of things that we have to look at [in order to] get comfortable with the product and asset structure."
