Yahoo-Facebook: First fisticuffs, then flowers?

Across the tech world, the immediate reaction toYahoo suing Facebook for patent infringement was one of outrage and utter contempt--a clear example of a broken patent system and a low-blow attempt from a desperate Yahoo to squeeze a ton of cash out of the company it once tried to buy.

Paul Graham, the Y Combinator co-founder who sold his company, Viaweb, to Yahoo in 1998 for about $49 million, was blunt in his criticism. "This was a clumsy move that will blow up in Yahoo's face," he said in an e-mail. "The biggest priorities for any tech company right now is hiring, and this is going to make it impossible for them to hire good people."

From Fred Wilson, the VC/blogger who's a principal of Union Square Ventures: "Yahoo! has broken ranks and crossed the unspoken line which is that web companies don't sue each other over their bogus patent portfolios," he wrote on his blog. "I used to care about that company for some reason. No more. They are dead to me. Dead and gone. I hate them now."

And then came Mark Cuban, who of course made his gajillions by selling Broadcast.com to Yahoo for more than $5 billion in Yahoo stock in 1999. He took to his blog and, in a fiercely sarcastic post called "I Hope Yahoo Crushes Facebook in its Patent Suit," concluded this way: "I hope Yahoo is awarded 50 billion dollars. It's the only way that consumers will realize what is at stake with patent law as is."

An alternate scenario
But here's another view of how this nasty Silicon Valley fight might play out: a team of lawyers and dealmakers from Facebook and Yahoo hole up for days on end and hammer out a deal in which Faceook does more than license some of the patents from Yahoo. Instead, it buys them outright for billions--an outcome that could ultimately help both companies.

This scenario was put forth to me by Erin-Michael Gill, the chief intellectual property officer for MDB Capital, an investment bank that specializes in analyzing and valuing the IP of both public and private companies.

Gill, in fact, has been a step ahead of this whole drama. He became deeply familiar with Yahoo's patent portfolio after assessing it for hedge fund manager Daniel Loeb, who was building a stake in Yahoo, and last November predicted that Yahoo would end up suing Facebook over patent infringement.

Now, Yahoo is essentially arguing that Facebook misappropriated most of the technologies that helped Facebook become what it is, as my colleague Charlie Cooper spells out in this story.

This is a monstrous problem for Facebook, especially coming at it in the weeks running up to what is expected to be the biggest Internet IPO in history. No investor wants this uncertainty hanging over Facebook--and Yahoo obviously timed this suit to put Facebook up against the wall.

While Facebook said its execs were surprised by the suit, that seems far fetched. Facebook has been hit with scores of smaller patent suits, said Gill, and it has quietly been building its own patent portfolio, fully aware of the critical importance that patents play for any successful tech company. Today, according to Gill, Facebook has as least 54 granted U.S. patents, most of which it acquired in the past two years.

"Facebook isn't just two kids in a dorm," said Gill. "It's a multinational corporation with a valuation that will likely be $100 billion. And it's been acquiring assets to build its own patent portfolio...They're not as poorly positioned as one might expect."

Gill says next the step is that Facebook will doubtless file a counter suit and claim that Yahoo is in fact infringing on some of Facebook's patents. This is the only way Facebook can have any leverage in negotiating any kind of deal, and Gill says that Facebook has in fact picked up some valuable patents.

He points to a broad patent that Facebook acquired from Hewlett-Packard in 2010 that covers an "apparatus and method for communication between multiple browsers." The claims made under this patent seem as though they could easily apply to some of Yahoo's products. In fact, Yahoo has cited this exact patent in its own patent filings, something that patent applicants are required to do when there are similarities to existing patents.

In a counter suit, Gill points out, "It's not like Facebook would just be guessing at what's applicable to Yahoo."

Getting to the negotiating table
That would get the two sides into negotiation mode. This is where Gill is saying it could turn into a full-blown IP acquisition. Gill said Yahoo has 1,205 granted U.S. patents and, his firm estimates, another 2,000 pending. Facebook, Gill reasons, could end up going after 700 or 800 of them. Other than some licensing deals with Microsoft, Gill says that he suspects Yahoo's portfolio is clean--in other words, free for a new deal or to be sold.

"Facebook could look at this as an opportunity to solve the patent problem," he said. "They could decide they need to make a big play. That could end up being a whole new ball game."

In other words, Gill said, Yahoo could become Facebook's Motorola Mobility. He's referring, of course, to Google's $12.5 billion purchase of Motorola Mobility that was done almost entirely to get control Motorola's treasure trove of patents to help defend its Android business.

In some ways, Facebook's situation doesn't appear as complicated or dire as Google's was. Facebook has fewer direct competitors, and it's not licensing software to hardware makers who can also become entwined in patent battles. Yet it's certainly likely that other firms will target Facebook. The most likely, according to Gill's analysis, would be Amazon, but others, such as AOL, also have patent portfolios that might arm them well if they want to pick a fight with Facebook.

What would this cost Facebook? Yahoo doesn't put a value on the its patents in the suit filed yesterday, but it gives a hint in the suit as to what it expects:

Since 1997, Yahoo! has filed thousands of applications for patents on innovative computing technologies that it has developed. Every year, Yahoo! spends hundreds of millions of dollars in research and development so that it can offer its users the most innovative products. From 2008 through 2010 alone, Yahoo! invited more than $3.3 billion in research and development.

Okay, then. Based on that statement, it's clear Yahoo is going for several billion. If Facebook takes this route, the deal would likely include include some Facebook stock, Gill said--just as Google paid Yahoo in stock when it settled a long-running legal battle just before its IPO in 2004. Facebook could also grant Yahoo a license to use some of the patents.

Such a development would of course be a boon for Yahoo. This company, now fully hated by so many in tech, is equally disliked by Wall Street. Even as the Nasdaq crossed the 3,000 mark for the first time in more than a decade, Yahoo's stock barely budged.

Perhaps a fat, unexpected payday from Facebook to buy up some patents could give it a nudge.