Strange Doings: Yahoo Sues, Facebook Arms: Why?

Facebook (NYSE: FB), the No. 1 social network preparing its initial public offering, is spending more on lawyers these days.

On March 12, the Menlo Park, Calif.-based firm was sued by Yahoo (Nasdaq: YHOO) in federal court in San Jose for alleged infringement of 10 critical patents. Several are critical methods by which both companies measure traffic and advertisers.

Facebook issued a statement saying it had not yet had time to review the complaint. It still has not filed its response in federal court.

Last week, the company said it had acquired 750 patents from IBM (NYSE: IBM) for an unspecified amount, bolstering the 56 patents it acknowledged in its Feb. 1 IPO filing with the U.S. Securities and Exchange Commission. Facebook also has applications pending for another 503 U.S. patents.

Considering that Facebook's filing is for $5 billion, and the IPO would value the entire company around $100 billion, or not much less than Cisco Systems' (Nasdaq: CSCO) $112.2 billion, what's the strategy?

Being No. 1

Clearly, it's stature, especially if Facebook wants to conclude the IPO next quarter and carve its niche as the biggest and most profitable social networker, ahead of LinkedIn's (Nasdaq: LNKD) $10.4 billion or Jive Software's (Nasdaq: JIVE) $1.7 billion.

In technology, patents and intellectual property are king. Often, companies sue each other when the time is ripe, either for a new product line, or at the time of an IPO.

Before Google (Nasdaq: GOOG) completed its IPO in mid-2004, Yahoo sued it for similar IP infringement and won shares in the IPO valued at $230 million, an effective admission that the then-smaller Google had appropriated some of Yahoo's IP.

Now, Google is the far bigger player with a market value of $211.2 billion, compared with Yahoo's $18.9 billion. Yahoo, in Sunnyvale, Calif., is also beset by its own problems, including a proxy fight by dissident shareholders Third Point Capital and problems unloading investments abroad such as in China's Alibaba Group (HKG: 1688) and Yahoo Japan (TYO: 4689), which combined could be valued around $20 billion.

Yahoo's placed Facebook in a tight spot, said Lance Lieberman, an IP lawyer with Cozen O'Connor in New York, who predicted a settlement much like Google's.

Needless Lawsuits

What will they settle for? They'll reach a preliminary deal before the IPO, Lieberman suggested.

One reason is that Facebook CEO Mark Zuckerberg doesn't need to be hamstrung by lawsuits around the time of his IPO, the lawyer said.

Another is the company has just raised additional capital from a bank syndicate, doubling its credit line to $5 billion, and will have plenty more assuming the IPO closes soon. It can start its public life with a clean legal slate.

The other reason why Facebook might settle, rather than countersue Yahoo, is that it wants to establish itself as an IP source. For example, IBM last year alone received 6,180 patents, more than any other company in the U.S. or the world.

Microsoft (Nasdaq: MSFT) was the only other U.S. recipient in the top 10, with 2,311 patents received. The others in the top 10 were all South Korean, Japanese or Taiwanese.

Shares of Yahoo Monday closed at $15.54, up 15 cents. They've gained 6.2 percent since filing the Facebook lawsuit.