Source: Wealth Creator Magazine May/June 2006

The hard truth is that intellectual property is not always valuable.

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Warren Buffetts Secret Formula

Source: Wealth Creator Magazine May/June 2006

Warren Buffetts Secret Formula

In the previous issue of WCM , I explained how an often ignored part of Warren Buffett’s formula is selecting companies with good intellectual property (IP). Many annual reports will rave that the company’s IP can cure cancer.

The hard truth is that intellectual property is not always valuable. Weak companies can’t protect themselves against a seven-year-old copying intellectual property for his lemonade stand.

This is one area where size does not matter. Only two things count:

  • whether the company actually understands how to use IP wisely
  • whether the IP is properly protected

But how can an investor apply this formula to companies on the Australian Stock Exchange? And which companies would pass the test?

Jumbuck Entertainment Ltd

Jumbuck Entertainment specialises in software aimed at mobile phone users: a. dating/chat; and b. games.

It sells its services to a number of international telecommunications companies, which on-sell the services to their customers. These companies include some of the largest in the world – AT&T, Bell, Vodafone – and in Australia, Optus and Telstra .

Jumbuck first came to my attention in August 2004 at IPO stage, when it was listed at 20 cents per share. After some research, I was impressed enough to subscribe for shares. In the last 12 months, investors have enjoyed a staggering increase of 510%!

Looking at the company’s IP

The first step in evaluating the company is to look at its competitive advantage. This step is vital because – apart from identifying the competitive advantage – it ensures that investors do not put their money into companies whose businesses they do not understand. Warren Buffett has stressed that one of the key strategies is avoiding businesses which he cannot understand. He has avoided technology stocks, saying that while they may be fabulous and potential goldmines, if he can’t value it, they are gambles. Warren doesn’t gamble.

In Jumbuck’s case, they developed a range of games based on well-known movies, for which they had licensed the rights – Star Trek, Black Rain, Shaft. This was a good decision:

a. movies were well chosen and well known to their target market (not just blockbusters with ridiculously high licensing fees).

b. copycats would hesitate to copy a Black Rain game, knowing they would face legal proc- eedings not just from a small company like Jumbuck, but a Hollywood giant like rights owner Paramount .

c. telco customers would be much more willing to buy a Star Trek game than an unbranded game called Space Battle.

Having used well-known names as Trojan horses to get contracts with leading telcos, Jumbuck had wisely chosen to launch its own range of games.

Many technology companies rely too heavily on pure technology as a competitive advantage. This can be a weakness: technology in the early 21st century changes so quickly that ideas are out-of-date within six months. Instead of making this mistake, Jumbuck’s reliance on well-known movies is much wiser. Importantly, competitors cannot get a licence to develop a Star Trek game now that Jumbuck has sewn up the rights.

Jumbuck’s weaknesses

The analysis showed that a competitor could sell games with a similar style, but they could not copy the game brands – in other words, they had to compete on price.

Looking at the market, it is important to ask: what is the likely consumer response to an offering without the same brand? Anyone who says that young people do not care about brands is kidding themselves.

Conclusion

Intellectual property is a great indicator of the potential growth of a company. In conjunction with normal checks to ensure that a company is well run, has good earnings and a healthy balance sheet, it can lead your investments to a steep share price climb.

Written by:

Trevor Choy is the principal of Choy Lawyers, the winner of Best Intellectual Property Law Firm at the Australian Law Awards 2005. Choy Lawyers looks after the brands of several companies from the BRW top 1000 and BRW 100 fastest-growing companies lists. www.choylawyers.com.au