IP Bond Plan Draws Interest of High-Tech

By CAROL HABER

NEW YORK — With R&D costs exploding, the timing can't be better: A new way for high-tech companies to make money-big money-fast.

New York-based Fahnestock & Co. is talking to "several" high-tech companies, including a major semiconductor firm and some smaller software and hardware companies, about the possibility of a bond issue based on future royalties and licensing fees from those companies' intellectual properties.

Fahnestock is dangling the possibility of "a bundle of cash up-front" from the fixed income financing, which could fund R&D needs in a timely manner and in a potentially painless way.

Also noteworthy: "A pop in earnings."

Company executives are intrigued-but cautious, said Fahnestock investment banker David Pullman to Electronic News. Mr. Pullman is credited with the idea.

A similarly-based bond financing by Fahnestock raised $55 million for rock star David Bowie, with "Bowie bonds" backed by future royalties for the singer's recordings. FROM PAGE Royalties and licensing fees from future sales and use of that music will be used to pay bondholders back over a period of years with 7.9 percent interest, it has been reported.

After the successful multimillion-dollar effort for the recording artist, the bankers are singing the praises of an IP-backed high-tech plan.

"They all want to talk about it, 11 said Mr. Pullman to EN about the companies he has approached. He declined to be more specific, but said they include hardware and software firms, public and private.

GETTING A JUMP

The goal for high-tech firms would be to get a jump on raising massive amounts of funding for R&D. The bonds would also put a value on, and "securitize," a company's intellectual property (IP), leading to more realistic evaluations of a company's worth and price/earnings ratio.

With R&D and fab costs spiraling, high-tech companies have no choice but to consider new avenues of financing, he suggested. Who could argue?

"A lot of high-tech companies are 'one-product wonders, " he said. "They can't keep ahead of the curve. By the time they make money on one product, they're behind on another. This way, they can tap into future earnings to provide R&D monies; it's an inexpensive source of cash."

Such a bond offer also would help "define" the balance sheet, clarifying the company’s worth. Companies could exhibit a value for their IP; they could show a firmer value for their assets. Besides, "The really valuable assets today are IP," he noted. Investor valuation of high-tech companies has been "a real problem," said Mr. Pullman. "This uncloaks hidden value. By securitizing the IP and receiving cash up-front, you know what it's worth, at worst.

In addition to being nondilutive and "inexpensive," such bonds would be "non-recourse," meaning no liability for the firm and its principals. Another plus: The company would keep the "upside" if the royalties/licensing fees on the IP are more than the interest paid on the bonds.

Such fixed-income financing provides an alternative to equity markets, when they are inhospitable.

But is such a financing feasible for the rapidly changing landscape of high-tech? Yes, said Mr. Pullman. "Some technology is very basic, like BIOS (basic input-output system). There are some technologies that don't change very much. They are just fundamental to the computing environment." Moreover, Mr. Pullman alluded to proprietary structures that would sidestep the risk of quick changes. one possibility is shorter terms, but "there are lots of things you can do," he said.

Companies that would benefit the most are those "that don't have that much cash on hand," he said, adding that "It's a way for non-investment grade companies to obtain investment grade financing."

Not everyone is a contender, though. The cash flow stream, which the fund-seeking firm wants to create into a bond, has to be seven figures or higher; so, companies with revenues lower than the seven-figure range-and cash flow per year lower than seven figures-need not apply.

Also, private companies particularly might benefit. "It's a great way for them to raise cash without having to go public," he said.

Venture capitalists who already have stakes may see it as "a great tool" to prevent those stakes from getting diluted.

Mr. Pullman declined to disclose the number of firms approached or detail their responses, but when probed on initial reactions, he acknowledged "a psychological reaction to something new; it is, after all, a brand new thing," he said.

It is expected that the bonds would attract large institutional investors like insurance companies.

"If there is a cash flow, we can securitize it," said Mr. Pullman. "It could be in any country, any industry." He added: "It could be a patent on Listerine, a patent on a door hinge, as simple as that, or as complex as a semiconductor.

INDUSTRY REACTION

What does the industry think?

National Semiconductor's CFO Don Macleod thought the idea "interesting," but more feasible to the fabless situation.

"My first reaction is that in our industry we don't actually sell IP as such; we sell products that embed IP in it.

It's for your own use. You don't license it to anyone. You protect it. We are not in the business to license the IP. We are in a business to further our own market and revenue growth goals."

Intrigued, however, Mr. Macleod followed his thoughts: "We would have to have an income stream from the IP that would service those bonds. The volatility of that income stream would be in some way implied in the valuation of the bonds. It isn't like you're going to get 10 percent here. It could be a very opportunistic leveraged situation, but it doesn't immediately appeal for the prime reason that there are many easier ways to raise funding. They aren't great today, but there is always the opportunity to raise financing, in the future, convertible to some sort of equity. Then there are the traditional debt markets. If you have to secure debt, there is always such a huge asset base in a semi company."

Also, technology is growing and stock is hot. "In the semiconductor business, you try to raise money through the equity markets by selling stock. The next step is to sell some instrument, a debt instrument like a bond that is usually convertible in the future to stock. Technology will grow over time, so many companies in the second tier sell debt that is convertible to equity. It's the carrot that you can hold out.

In the third-tier semi companies, it's pretty capital-intensive, even if one has to borrow with some security, there is a pretty heavy capital base of facilities and wafer fabs that you can secure any borrowing on, if it comes to that."

The fabless situation, however, offers a design-intensive IP base which those companies want to license others to use, he said. "High risk financing for design based software start-ups," he called it, where the companies intend to have other companies use their product in a systems solution.

Also, the MIPS and ARM microprocessor architectures are examples, he said. "These are processor cores that are licensed out, and there are royalty streams for the use of these cores."

Nevertheless, Mr. Macleod added: National has "a pretty rich" IP base, "over 2,000 patents in its IP library, and we are adding to that portfolio every year. We also, over the years, have obtained income by licensing those rights to other companies, particularly those growing in the industry outside the U.S. It's been pretty fruitful for us."

Lucent Microelectronics group president Curtis Crawford was dubious at first also, but warmed up a little to the idea. "It's certainly a novel approach, although I'm not sure if it's viable or not. But one thing I do know. The industry is at a stage where it ought to pursue and evaluate novel ideas. Actually, it's kind of interesting .... there's a lot of cash up-front."

Electronic News — May 5, 1997 Page 93