Presented at: National Meeting of the American Chemical

Society San Diego, CA April 3, 2001

Presented by:

Anthony Breitzman, VP/CTOPatrick Thomas, Research Analyst

CHI Research, Inc.10 White Horse Pike

Haddon Heights, NJ 08035www.chiresearch.com

abreitz@chiresearch.com

Identifying Undervalued Companies Via Patent Analysis As a Means of Highlighting

Merger/Acquisition Targets

2

Introduction

Mergers and acquisitions take place for a variety of reasons, including strategic growth, expansion into new markets, or because the target company is attractively priced and contains know-how the suitor would like to obtain.

In this presentation we will concentrate on the third issue; that is, the use of patent analysis in the valuation of companies.

3

Key Questions in Analyzing Mergers between Technology Based

Companies1. Does the merger make sense in technological terms?

– Are the firms technologically compatible?– Does the merger fill a technological gap?

2. Are the financial terms of the merger appropriate?– Is the buying firm getting a fair price?– Is there a best target in terms of technology and price?

Patent analysis can help frame both issues.

4

Overview

Slide 5: Introduction to patent analysis

Slides 6-9: Traditional uses of patent analysis in M&A Situations

Slides 10-22: Use of patent analysis in valuing companies

5

Patent Analysis Basics

Patent and Patent Family counts can be used to measure the level of R&D activity.

Impact or value of R&D activity can be measured by weighting patent activity against patent indicators such as citation counts, number of equivalent documents, renewal decisions, science linkage, innovation speed, etc.

For more on patent analysis see CHI Publication List: http://www.chiresearch.com/pubs.htm papers 146, 113, 103 among others.

6

Traditional Uses of Patent Analysis in M&A Situations

Targeting

Due Diligence

Technological Compatibility

And now

Valuation

7

Recent Targeting Examples

A large pharmaceutical company wishes to identify small biotech firms with strong genomics capabilities.

A South American cosmetics company wishes to manufacture anti-perspirants in Europe. Which European firms have the technological capabilities and might be viable acquisition targets?

A large semiconductor firm wants to invest in firms doing bioinformatics. Who has the best and are they for sale?

8

Due-Diligence Examples

Is the firm everything it seems technologically? Are the key inventors still with the firm? We once did a due-diligence analysis where the key inventor was moved to the parent company, before the sale of a subsidiary.

We once killed an acquisition of a hearing-aid company. The target had a strong sales network, but its technology was all analog while the competition was going digital.

9

Technological Compatibility Examples

Is the acquisition active in the same areas as the acquiring company? Does the firm fill a technological niche or gap that the acquiring company needs filled?

Recently we showed that the Glaxo-SmithKline merger was a good technological fit because both companies are active in largely the same treatment areas, but Glaxo would gain entry into a number of new areas. Also their strengths are complimentary. SmithKline would strengthen Glaxo’s weaker pharmaceutical technology, while Glaxo’s strong biotechnology and basic chemistry research would strengthen SmithKline’s weaker standing in those areas.

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Basic Idea of Valuation Methodology

Once a target or targets are identified, what is a reasonable price for that target?

Patent analysis can be used in the following way:1. All players in the technology can be identified via patent

activity.

2. A market-to-book value can be identified for the publicly traded subset.

3. Regression analysis can be used to correlate market-to-book values with patent impact indicators.

4. A target price is set based on where the target fits among its peers in patent indicators.

5. If the company is public, and its target price is above its actual price, than it is undervalued, and is a good buy.

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Valuation Example 1 – Who is the best Biotech Target?

Name Ticker

Tech Score

Percentile (1)

Market Price Per

SharePrice/Book

(MTB)

Tech Score MTB

Tech-Score Price

2/28/01 (2)

Value Percentile 2/28/01 (3)

Heska Corp. HSKA 81 1.06 1.21 3.50 3.07 97Emisphere Technologies Inc EMIS 99 23.50 2.11 12.51 139.09 95Ribozyme Pharmaceuticals Inc. RZYM 76 7.88 1.56 3.32 16.79 91Curis Inc CRIS 65 5.50 1.12 3.08 15.05 91Synaptic Pharmaceutical Corp. SNAP 70 4.81 1.37 3.20 11.18 91Caliper Technologies Corp CALP 100 25.50 3.01 58.31 493.89 89Incyte Pharmaceuticals Inc. INCY 48 16.81 1.77 2.77 26.36 69Affymetrix Inc. AFFX 98 57.28 19.29 9.18 27.27 43Chiron Corp CHIR 73 46.81 4.91 3.24 30.95 41Enzon, Inc. ENZN 94 63.56 20.84 4.93 15.05 39Cephalon Inc. CEPH 83 55.06 15.16 3.58 12.99 34Tularik Inc. TLRK 54 26.06 4.65 2.87 16.09 33Genzyme Corp. GENZ 55 87.94 6.03 2.90 42.29 29Genentech Inc DNA 48 52.50 4.87 2.79 30.04 28Corvas International, Inc. CVAS 69 10.06 14.17 3.19 2.26 26ICOS Corp ICOS 73 54.13 34.48 3.23 5.07 25Cell Therapeutics Inc CTIC 28 23.81 3.71 2.45 15.71 19Millenium Pharmaceuticals MLNM 52 33.75 9.10 2.85 10.57 19Immunomedics Inc IMMU 58 12.94 15.40 2.97 2.49 17Biogen Inc. BGEN 39 71.56 9.98 2.62 18.78 10Human Genome Sciences Inc. HGSI 41 54.94 12.72 2.67 11.53 9Invitrogen Corp. IVGN 33 80.50 19.87 2.54 10.29 5

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Footnotes to Previous Slide

1. Technology Score is a linear combination of various patent indicators. These are then percentile ranked by industry so that companies with a percentile score of 100 have the strongest technology indicators within the industry.

2. Regression analysis is used to determine the MTB level for a company with a particular tech. score within an industry. Once an MTB is determined, a price-per-share can be easily determined.

3. By comparing a company's actual price with its tech-score price, one can determine whether a company is over or under-valued in the market.

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Example 2: Glaxo Purchased SmithKline at a Bargain Price

Using Tech Prices: 1 SmithKline share = $3.511 Glaxo share = $6.72

Therefore: 1 SmithKline share = 0.5223 ($3.51/$6.72) Glaxo shares

Terms of merger: 1 SmithKline share = 0.4552 Glaxo shares

SmithKline was overvalued, but not as much as Glaxo. By doing a stock swap, Glaxo used overvalued stock to pay for less overvalued shares of SmithKline.

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Example 3: Acuson Case Study. In Ultrasound Technology Acuson is One of the Most Prolific

Patenters, Its Patents are Highly Influential, and Have the Closest Links to Scientific Research

Number of US Patents 1995-99

0 20 40 60 80 100 120

Toshiba

Boston Scientific

Hewlett Packard/Agilent

Philips/ATL

Siemens

Acuson

General Electric

Current Impact Index

0

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2

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4

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Example 3: Acuson Case Study. Acuson is at the Center of the Latest Developments in Ultrasound

Technology

Company in selected set Company receiving most cites

Company not in selected set Company receiving 2nd most cites

Acuson

Boston Scientific

Hewlett PackardIncl. Agilent

Siemens

GEPhilips

Incl. ATLFujitsu

Toshiba

9

7

170

154

6

2513

10

37

36

13

13

4

8

(Linkage Map shows Citation Relationships Between Companies)

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Example 3: Acuson Case Study. Acuson’s Patents are Influential both Inside and Outside the

Ultrasound Industry

Patent Title: Ultrasonic Harmonic Imaging System and MethodCiting Citing

Year Year

2000 06034922 06036643 06122223 06056943 2000Schering AG 06122222 06036644

06120448 06019960

06117082 Alliance

06116244 Pharmaceutical

06104670

06048316

06042545

06027448

1999 05961464 05908389 06009046 1999Hewlett 05879303 06005827

Packard 05957852

05933389

05897500

05882306

Acuson

Corp.

1998 05833613 1998Koninklijke

Philips

Electronics

Starting 1998 05740128 1998 StartingPatent Acuson Patent

17

Example 3: Acuson Case Study. On August 15th, CHI selected Acuson for inclusion in Nike Securities’

Patent Quality Trust

0

5

10

15

20

25

1/15/00 2/15/00 3/15/00 4/15/00 5/15/00 6/15/00 7/15/00 8/15/00 9/15/00

Acu

son

Sh

are

Pri

ce (

$)

August 15th: CHI Identifies Acuson as an Undervalued Company for Nike's Patent Quality Trust

September 27th: Siemens has $23 a share bid for Acuson accepted

Siemens Purchased Acuson at a 50% Premium on September 27th

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Example 3: Acuson Case Study. Key Facts

Patent analysis showed that Acuson’s ultrasound technology was very good relative to its peers.

Its stock price indicated it was undervalued relative to its industry and its technological quality.

The conclusion at the time (August 2000) was that Acuson was ripe for either a takeover or a substantial rise in stock price.

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Can the Acuson Example be Generalized?

Yes. The method can and has been generalized to identify undervalued companies whose stocks should rise.

The method is the subject of a recently issued and another pending patent.

The basic idea of the method is that once a company’s industry is identified, one can always tell 1) whether its patents are as good or better than its peers and 2) whether this is reflected in its stock price.

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Companies Undervalued Based on Patent Scores are More Likely to Experience Increased Market-to-Book

(and hence increased stock prices).

Percent of Companies with Increased Market to Book2 Years after Patent Evaluation

0

10

20

30

40

50

60

70

80

90

100

1990 1991 1992 1993 1994 1995 1996 1997

Year of Evaluation

undervalued

overall

overvalued

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$100 invested in the most undervalued companies (refreshed each year) would return over 2000% in 10

years.

100

500

900

1300

1700

2100

2500

Dec 90 Dec 91 Dec 92 Dec 93 Dec 94 Dec 95 Dec 96 Dec 97 Dec 98 Dec 99 Dec 00

ITL 20 Undervalued NASDAQ

S&P500 ITL 20 Overvalued

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But how does it perform in a bear market?

Year 2000 % Return

Jan - Mar 27, 2001 % Return

CHI 20 Undervalued 23% 9%NASDAQ -39% -20%

S&P500 -11% -11%Dow Jones Ind. Avg. -6% -8%

The market has been unkind overall so far this year, but the undervalued companies have done well.

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For More Information and Related Papers Visit:

www.Chiresearch.com

Or Contact:

Tony Breitzman VP/CTOCHI Research, Inc.10 White Horse Pike Haddon Heights, NJ 08035

Ph: 856.546.0600 Fax: 856.546.9633E-mail: abreitz@chiresearch.com