Understanding M·CAM

Manifesting Intangibles: Accounting for Value

David E. Martin
Berkeley Springs
May 5, 2008

"From time immemorial, gold, the miser's metal, had been the measure of value of all things, from the bridal dowry to the price of cattle to the worth of land. Gold had reached its peak of authority, however, only in the nineteenth century, the high summer of Western expansion, when the imperial buccaneers of Europe financed the building of the United States and Latin America, subdued Africa, raided Asia and tied all world trade into a global mesh bound by golden strands of sacred commerce. The mythology of gold persisted almost unchallenged until the Great Depression of the 1930's, when the gold standard of world bankers brought economic life in the West to despair in the streets. Bankers insisted that all exports and imports, all trading bills, all national currencies must be redeemed in gold - and if a nation could not pay gold for what it needed, then that nation and its people must hunger and go without. The anguish that so cruel a system brought to the world and the efforts of nations to escape from its dictation were among the larger factors contributing to World War II."^[1]

From the Swamp Decree of 1807 - in which intangible value could first be taxed - to the 1944 Bretton Woods conference - in which sovereign currency would peg to the currency of final resort - the U.S. Dollar - to Nixon's 1971 decision to decouple the dollar from gold and have it rest squarely on debt backed by the assumption that U.S. innovation was "incomparably supreme"^[2], a quantum shift is upon us. Ironically, today's shift happened in April of 1971 when, for the first time since 1893, the U.S. posted its first trading deficit. Specifically, the shift happened on Friday, August 13, 1971, when, to avoid a complete loss of U.S. gold reserves based on collateral calls on the U.S. dollar, Federal Reserve Chairman Arthur Burns' observation that "the old rules no longer work" led the nation and the world to abandon gold.

The Old Rules No Longer Work.

It is only with slight irony that we can now observe Nixon's actions in their maturity. To reclaim the supremacy of the world's most powerful - all allegedly innovative - economy, the U.S. government launched a domestic spending program to not only foster ingenuity but invited the whole world to come and learn about the same in our colleges, universities, and national labs. We sought to buy an innovation economy but never took the time to assess its metrics or qualify the dimension into which it would be delimited. So, while the nation financed cognogenitive options, the financial system lay mired in accounting systems built at the last transition a century and a half earlier when the economy shifted from commodity receivables to manufacturing output. In 1971 we decided what would NOT any longer denominate value but, we never put in place a mechanism to determine what would.

It is against this backdrop that, in 1997, Mosaic Technologies formed Mosaic Collateral Asset Management. Formed on the simple premise that there must be a means to transition the financial markets to an understanding of, and facility with, the collateral of our time - innovation - M·CAM created a financial instrument known as a collateral enhancement. A collateral enhancement, unlike any financial instrument created before, insured a secondary market for innovation as collateral. Historically, credit enhancements - insurance for creditworthiness - had relied primarily on historical financials. M·CAM's collateral enhancements relied on the ability to correctly assess the degree to which Gross Innovative Output (GIO) could be separated into:

• Invention - the creation of a new mode or method for a new outcome;
• Innovation - the synthesis of one or more inventions for a particular value proposition; or,
• Incrementalism - the subtle modification for ease of manufacture, distribution or use.

Once this determination is made, we then can integrate historical, present, and prospective market information contained in research and development (R&D) records and plans, merger and acquisition data, and licensing or sales reports to assess the commercial consequence of controlling some piece of the market dynamic related to the GIO component. Where gold-standard thinking focused on value in the abstract, M·CAM's approach focuses on the statutory provision of a timed market control - an actuarial assessment across time, not a value assessment at a point in time.

In particular, our models address:

• Incumbency Impairment - an assessment of the degree to which the underlying innovation deployment methods evidence full disclosure of "knowable" facts and the degree to which the property temporally exists as invention, innovation, or incremental adaptation;
• Sovereign Performance Impairment - an empirical assessment of the performance quality of the public sector interest responsible for the promulgation and awarding of enforceable property rights and the geographical coverage under which the property rights enjoy exploitation value;
• Interdependency - many forms of intellectual property rely on, or relied on, 3rd party properties in one form or another. Quantifying and qualifying this reliance is essential to understand the duration of business continuity afforded by the properties and the assets they support;
• Risk Hedges - Drawn from interdependency assessment, availability of hedge and option structures (procurement of 3rd party properties, rights, or contracts or integration of portfolio interests already controlled) provide yield protection as well as terminal liquidation options; and
• Actuarial Horizon - while the timing and severity of loss on a case-by-case basis has kept traditional capital from the intangible asset market, creating diversity in pooled structures can balance individual component volatility while overcoming historical anti-trust pooling concerns as each component - albeit drawn from disparate segments - has identifiable and discreet contributory value to the pool as a yield-continuity constituent.

Built first as an underwriting platform called 3DS, M·CAM has created and deployed a unique underwriting process that provides a worldwide view of human ingenuity and commercial intentionality in an efficient and reliable risk rating heuristic. While one can use considerable abstraction to explain its nuances, in its simplest form, M·CAM's platform asks the three basic questions of collateral and, then provides a roadmap to market consequence based on the best path evidenced in the global data. The three questions are:

1. Do you have something? This seems ironic that one would need to know if there's really an asset there however, in the case of market control rights, very seldom to peoples' representation of ownership match what the actually have. "I have..." needs to checked against actual statutory granted rights including the limitations recorded in statutory proceedings that are not commonly accessed in market due diligence. "I have worldwide rights..." needs to be check against actual jurisdictions of filings in the over 130 countries where separate administrative filings must be made to preclude legal expropriation of ingenuity. "I have..." needs also to be measured against who else can make the same assertion given that the vast majority of proprietary allegations are based on defensive rights - patents, for example, procured based on market conditions into which many are entering to allege something proprietary even when NO invention was made.
2. Does anyone else care? This question exists in two dimensions. Following from the defensive comment above, most patents are procured in response to someone else's creativity. If the creativity of others has been annexed, the degree to which they'll care is proportional to their ability to detect and defend abridgement to their position. Beyond this, another dimension of this question goes to whether there's any evidence of related concepts, goods, or services, where what is being represented actually has evidenced a market response that creates commercial activity. If someone holds a patent on a new incremental improvement to a cell phone, its value is unlikely to have consequence because the all-cost value of the technology is already experiencing a commodity dynamic in which a new proprietary differentiator is unlikely to arrest valuation erosion.
3. How much does who care? This is the fundamental question of secondary market. M·CAM refers to this dynamic as the Orthogonal Confidence Factor or OCF. Orthogonal is a statistical term meaning existing in an uncorrelated (perpendicular) orientation. What we test for is the existence of another party(ies) in whose hands the ingenuity could be deployed to enable, enhance, or expand market controls that preclude commodity dynamics. Integrating ingenuity data into grants, corporate reporting, and market data allow for this assessment to be made in an objective fashion.

This disciplined review process enables M·CAM to accurate measure the "magnetic" potential (either as an attractor or a repeller) of each proprietary position. Then, with this understanding in place, each potential challenge becomes a risk-management option. For each threat to title, there's an option to integrate a compromised right into an established market value chain linking individually nonviable pieces into a viable networked whole. For each threat to enforceability, there's an option to use overlooked or abandoned rights to create innovation commons. And, when market making needs to be enhanced, cross pollinating ingenuity across deployment verticals in the market can ameliorate downside risk.

It is helpful to consider a set of actual cases in which this process has been deployed. For the purpose of these examples, we will blind identities however preserve all material facts.

Debt:
An East Coast bank had a small business client who manufactured specialty products for the pre-measured infant formula market. Despite a strong personal interest in providing a loan, this regulated lender needed collateral to support a credit line of approximately $1.5 million. M·CAM provided the underwriting for this program where we identified ancillary proprietary rights holders who could offer alternative products. We also found the company who owned the largest market share for generic infant formula sold as private label products to giant discount retailers. In the event that this proprietary packaging technology was called as collateral, it may have been interesting to other plastics manufacturers and, therein had some secondary market value. However, for the distributor of infant formula, moving packaged product was their life. M·CAM procured, on its own behalf (for the security of a collateral enhancement contract to the bank), a post-bankruptcy contingent purchase commitment from the distributor for a sum greater than the minimum 80% LTV required for the collateral interest and the loan was made.

Royalty Securitization:
A large electronics and communications company faced balance sheet pressures and the public market was dissatisfied with earnings. They needed an acceleration of cash-flow from IP licenses in the digital media market. A large conglomerate interest was interested in buying cash-flow streams with compelling discounts to stabilize investment income in a market uncorrelated investment segment. The conglomerate needed to assess the underlying assets and cover its income risk based on obsolescence. M·CAM identified the full owned asset space (considerably different from the explicitly identified assets) and measured the enforceability of each position. Wherever there were downside risks, M·CAM identified all 3rd party holdings worldwide which could be optioned into the portfolio to cover enforcement risk. Additionally, M·CAM quantified terminal earnings risk from new technologies which were emerging in the market and constructed a private equity option set for preserving future value thereby allowing for the ever-greening of the fixed income investment. A $50 million purchase was made and the investment has provided a >15% annualized return.

Insurance:
For close to a decade, M·CAM has worked with the largest insurance companies in the world on managing intangible asset risk. From litigation cost abatement to collateral enhancement to representation and warranty risk transfer, M·CAM has used its underwriting platform to create risk transfer products which have operated at loss-ratios under 40% where industry standard loss-ratios typically operate in excess of 107%. The nuance in insurance is that M·CAM's underwriting allows for two unprecedented innovations in insurance. First, by quantifying unknown or undisclosed interdependencies, the insurer can exclude risks or force pre-emptive resolution of known exposures thus limiting future claims. Additionally, as new claim threats emerge, 3rd party positions can be preemptively managed by invalidation, integration, or non-judicial resolution. Finally, premium income can be significantly augmented by having explicit value adjustments on both premium calculation and risk retention on the part of the insured.

Equities - Public:
While M·CAM was integral in the promulgation of FAS 141 and 142 and IAS 36 and 38 (the regulations for accounting intangibles in acquisition), no public market has reliable visibility in the component of value tied up in intangibles. Therefore, M·CAM has executed a series of transactions to document the arbitrage of ingenuity in the public markets. An example of this was the 2001 market demonstration "Pantently Obvious". M·CAM selected public companies who, for their own reasons, had placed their proprietary assertions into public visibility in the market, either announcing a proprietary market position or suing someone else for the same. M·CAM would analyze all parties' positions and then publish a report on what neither side had reported in public. This material included clarifying title, documenting interdependencies, or demonstrating perpendicular market considerations. M·CAM posted its reports as freely available downloads and then monitored market responses. These reports were issued when no other information entered the market from other sources. When our analysis was converted (by the leading soft dollar independent research distributor) to buy and sell recommendations, M·CAM's analysis lead to an industry-beating excess of 40% return on equity.

During these market sensitivity trials, M·CAM documented that in public company contests over proprietary allegations, the market penalizes BOTH parties. The ratio of penalty occurs at 3:1 (or worse) level where the loser suffers at least 3X the penalty of the "winner". On the other hand, significant value accretion occurs when the market sees disciplined market activity focusing on building intangible asset accountability within market. This trend holds true even during recent market volatility. M·CAM documented spot-price premium value accretion of over 30% in two trading days during 2007.

Equities - Private:
Considerable mythology exists in private equity that venture capital and private equity "understand" intangibles more than the public or debt markets. Ironically, what is evidenced in the industry is a capital selection efficiency of less than 10% which, in behavioral sciences, is within the realm of randomness. M·CAM innovated both the regulatory construct (under Federal procurement rules) and the practical assessment metrics which link procurement with innovation. Since World War II, governments are the largest buyers of technology. Therefore, M·CAM has added to its underwriting processes a new form of royalty income - sovereign procurement. By establishing a private company's ability to promote and defend a proprietary service offering in a sovereign procurement, the government-rated receivable is finance-able in a similar royalty model as that described above. M·CAM has provided this platform for sovereign activities in the Americas, Asia, and Northern Europe for close to three years.

Global economies must now come to terms with a variety of competing forces that are aligned. First, the era of unrelenting consumption characterized by an unsustainable view of natural resource exploitation and unchecked energy consumption - two paradigms that lead to balance sheet risks - now must confront a risk-rated world view that assumes limits and renewability - concepts foreign to the modern mind. Agriculture and industrial economies fundamentally rely on the notion that resource control, management, logistics, and markets are the basis for the denomination of and aggregation of value and wealth. In historical context, this construct is a relatively new aberration that has its roots in the transformation of Western thought in the 16th and 17th centuries. As has occurred repeatedly over the past four millenia, humanity is again confronted with the realization that the denominator of value and, by extension, of power is based on knowledge and the management thereof. In contrast to the more centralized approach of the priestly and monarchist purveyors of centuries past, technology has enabled a democratization of this market of knowledge networks on a scale that has created a virtual collective innovation mind. Our species' challenge is to pursue the amazing opportunities represented in this new paradigm with a conscience.

In our 13 years of study, M·CAM has conclusively shown, in every major global market model, that what we have termed the Fusion Economy is now being built on human ingenuity and the networks through which is shared. Each person, as a consumer or creator (a position that is non-digital and fundamentally fluid in time) will participate and be operating within a sphere of contribution to, or consumption from fusion networks or nuclei. Value, both at the level of commodity and excess, will be a function of the "plasma" effect. In other words, the fluidity and consequence of innovation and human creativity will be the basis for value in contrast to the ignorance arbitrage that yields few lottery winners and most losers within the present system.

Charles Augustus de Coulomb gave us the picture of the future when, from 1786-1789 he performed the fundamental work on electricity and magnetism that gave us Coulomb's Law (and Barrier) and the theoretical framework for fusion physics by defining the electrostatic barrier that must be overcome to achieve fusion. Whether by George Gamow's quantum tunneling mechanics or by nuclear transmutation, we understand that the self-sustaining reaction of the Fusion Economy will need to tunnel and transmute the current paradigms to achieve exothermic potential. Our goal is to foster an environment that overcomes the electrostatic addiction to non-sustainable models of asymmetric consumption and create an environment where contribution to value networks is encouraged and normative.

The transition to this model provides us with the deuterium that is required to begin the catalytic reduction. Inefficiency in the fixed income and bond markets gives us the vehicle to introduce Sovereign Technology Credit Obligations™ or STCO in which origination of novel solutions to fundamental infrastructure challenges can be financed. Rather than spending public funds for outmoded technology that has passed the narrow feasibility and scale reviews of incumbent titan prime contractors, STCOs provide all contributors the option to be viewed as equally viable and reward those who overcome electrostatic resistance the fastest. Debt markets, constrained by risk reserve and collateral insufficiency, can be acquired using actuarial planning that biases credit risk for integration into innovation networks rather than outdated models of assessing value primarily based on historical performance. Private and public equity can be built around the syndication of the aforementioned offerings and can be used as a vehicle for greater economic transparency than we've enjoyed for the past 80 years.

We find ourselves at the intersection of great inevitabilities. We know that the majority of the planet will need to define its existence in a world where the colonial hermeneutics have perpetuated asymmetries that have been dogmatically held to preserve incumbencies. We have not embraced the state-of-the-art. Rather we have regressed toward the "attainable" with adequate margin and distribution efficiencies. One needs look no farther than Toshiba's decision to relent of HD-DVD in light of Sony's Blu-Ray. The betamax loser learned its lesson - it's the message, not the mode. This indoctrination into the modal nuance rather than the quantum now is challenged to embrace an epistemology that is build on the necessary improbable and impossible emerging to solve the intractable. When the well-being of the planet hangs on the precipice of pandemic bird flu and antibiotic resistant infections, we cannot embrace a paradigm that celebrates yet another pleasure and performance enhancing drug and justify it in the name of pharmaceutical research. Shipping glass bottles of water from Norway to stores around the world cannot be celebrated when over 1 billion people do not have a clean drop to drink.

The Fusion Economy has arrived and we are witnessing its first blink of sunlight and its first breath of air. With the map to how we lost our way, we now can overcome the repelling forces of magnetism and pass through the quantum tunnel to emerge in the plasma that is self-sustaining and energy accretive.