Indian IT has invested over $1 bn in the last few quarters to gain access to IBM’s library of IP revenues with hopes of mid-teens IRR.
Indian IT has invested over $1 bn in the last few quarters to gain access to IBM’s library of IP revenues with hopes of mid-teens IRR. Investors do not seem to share this optimism on IRR. IBM’s rationale is to outsource development of IPs to partners that can innovate while freeing up resources for best opportunities. We believe the single point determinant of the IRR in these deals is revenues, which with limited information is difficult to forecast. We detail our thoughts and believe such deals lack strategic benefits. Indian IT companies have lapped various IP licensing deals from IBM over the last six quarters in the areas detailed in Exhibit 1. The rationale outlined by IT companies for these deals falls in the following areas – (1) entry into and understanding the dynamics of the IP business, (2) high synergy value derived through sell-with and sell-to strategies, (3) access to a high quality client base, (4) creation of derivative IPs which can be potential money-spinners.
This combined with mid-teens IRR, at the least per Indian IT, makes these deals attractive. We do not share this service provider optimism and believe these deals have limited strategic benefits. IBM has entered into well over 20 IP partnerships over the past two years of which six are with HCLT, one with Tech Mahindra and one with Wipro. IBM recognizes the upfront money paid by partners as IP income. Here is an extract of IBM’s IP strategy from its Q1CY17 earnings call – IBM’s clients see the value in the company’s IP, but it requires continuous innovation to stay in high value spaces.
IBM is forming IP partnerships to enable ongoing innovation in IP while allocating development resources to where it sees the best opportunities. In these partnerships, IBM licenses, but does not sell, source code to a technology or services partner who assumes the development rights and invests to innovate and build new functionality, enhancing the value of the IP. This, in turn, reinforces and supports IBM’s revenue stream. IBM retains the ownership of the IP and the revenue streams and pays a royalty to the partner for the enhancement of the IP.