Crash of 2008

The and intangible asset value crash of 2008

a number of efforts to standardise and Over the last 12 to 18 months the codify if not valuation methods, then at percentage of listed company least public disclosure obligations about values that can be attributed to that value. The latter found their broadest expression in the US in the Sarbox intangibles has fallen rapidly, to legislation, the Public Company Accounting stand at under 50%. Serious Reform and the Investor Protection Act of rebuilding work is needed 2002 which was promulgated after several major accounting scandals. By Nir Kossovsky Paralleling the efforts of bureaucrats and regulators, investors increasingly evolved Reputation is the impression formed by into consumers of intangible asset financial stakeholders of how a company manages its information and created a demand for intangible assets. The median value of those market-driven indicators of value. An early assets among traded US companies has respondent was The Patent & License hovered around 70% for the past few years. Exchange, which in 1999 released the first At the end of the fourth quarter of 2008, the commercially available algorithmically median value was below 50%. This article driven indicator of intangible asset value reviews market phenomena that accompanied that used current market data to reprice the historic growth in intangible asset value, indicated IP value and technology sector explores factors associated with the recent beta (β) values daily. In 2000, the collapse in value and considers the future reinsurance giant Swiss Re set aside implications for reputation management and primary risk capital for previously the world of intangible assets. uncovered/uncoverable intangible asset Since the end of World War II, Western (patent title) risk. In the same year, Inspire have been decreasing their Invest, an investment advisory, began dependence upon manufacturing and providing investment advice based on target increasing their reliance upon the creation valuations drawn from extra-financial data. This article is sponsored by the Intangible and manipulation of information, knowledge CHI Research, a valuation firm, launched an Asset Society’s Secretariat. The and technology as the means by which IP investment pool called the Patent Quality objectives of the Society (www.iafinance.org) companies generate profits. The resulting Select Trust in cooperation with Nike are to increase the visibility, transparency, disposal or at least de-emphasis of physical Securities, and The Patent & License and value of intangible assets through assets and the increasing development of Exchange released the Intangible Asset education, advocacy and the promulgation technology-based innovations in business Market Index in cooperation with The Deal, of standards. The Secretariat of the Society processes transformed intangible assets a leading mainstream financial publication. is concerned with broad market and collectively into 70% of (median) corporate In 2001, investment advisers increasingly managerial issues that have an impact on value. In 2008, this decades-long trend turned to extra-financial data for indicators intangible asset value at an operational level. abruptly reversed course. of intangible asset value. Institutional IAM magazine, a Globe White Page Ltd Shareholder Services, a large investment publication, is the media partner of the Market events accompanying the rise in advisory firm, launched an extra-financial Society. IAM magazine publishes in each intangible asset value data index on intangible assets and corporate issue a contribution from the Society on a The rise in median intangible asset value governance; meanwhile, Vigeo Group, noteworthy intangible asset finance matter. shown in Figure 2 from 20% to a maximum another investment advisory, began Visit the Society at www.iafinance.org. of about 70% of traded companies triggered providing investment advice based on target

38 Intellectual Asset Management March/April 2009 www.iam-magazine.com Crash of 2008

Intangible assets and brand, reputation and value

Notwithstanding ongoing efforts by the employees, suppliers, customers, Intangible Asset Finance Society, competitors and investors. The first four cast nomenclature in the field of intangible finance their votes through wages, cost of goods and is not standardised. In this article, three pricing; investors cast their votes through phrases are defined as follows: earnings multiples and price volatility. Intangible assets. Assets with no formal Value. In the absence of an arm’s-length home on the corporate balance sheet. market transaction for an asset such as a Except for certain circumstances, their value patent, or business process, the is neither recorded nor reported according to value of intangible assets cannot be Generally Accepted Accounting Principles determined according to GAAP. There are (GAAP). They comprise the intellectual many proprietary non-GAAP methods that products, including patents and , provide indications of value. Financially, the that enable companies to provide goods and values of most intangible assets are closely services; the customer promises embedded linked to one another like the stones in a in brand; and the ability to deliver on those Roman arch, so that collectively the intangible promises through the business processes assets comprise an enterprise’s reputation that govern quality, safety, security, integrity, value – the difference between market sustainability, risk management etc. capitalisation and book value. To continue the Reputation. The impression formed by analogy, like a Roman arch, the loss of any stakeholders of how a company manages its one key intangible asset may destroy a intangible assets. Stakeholders comprise disproportionate amount of reputation value.

Reputations take shape from perceptions valuations drawn from extra-financial data. its ratings and corporate value. Also that stakeholders have about an enterprise’s Intangible asset finance activity year, the Vigeo Group was retained by ABP intangible assets. Intangible assets comprise increasingly involved larger institutions. In Fund with €200 billion worth of assets business processes governing ethics and 2005, Thomson Extel reported that 6% of under management and Munich Re set aside integrity; quality, safety, sustainability, security buy-side brokerages were devoting material US$200 million in primary risk capital for and innovation; patents, trademarks. Each resources to extra-financial data to previously uncovered/uncoverable risks. asset supports the enterprise’s value, but determine intangible asset value. PwC Last, the Enhanced Analytics Initiative, an neglect or removal of one stone weakens – reported a controlled experiment showing international extra-financial investment and may topple – the organisation. that extra-financial data, and intangible asset information cooperative, reported value calculations arising, swayed 40% of membership had a total of US$2.4 trillion of analysts to change their target valuations of assets under management. public companies. That year, Inspire Invest was retained as an investment adviser by The crash of 2008 Credit Agricole Asset Management Group. As the investment community produced In 2006, Thomson Extel reported that and consumed an increasing amount of 32% of buy-side brokerages were devoting extra-financial data, cracks began to appear material resources to extra-financial data to in the Roman arch of intangible asset value. determine intangible asset value, a year-on- After peaking in June 2007, the accelerated year growth of more than 500%. Also that decline became a noticeable trend by year, Goldman Sachs invested in, and December 2007 and moved into a full became a distributor for, Asset4, a major collapse by mid-summer 2008 (Figure 3). provider of extra-financial data and Our ongoing analysis of the tangible and algorithmically driven indications of intangible drivers of market value suggests intangible asset value. On the American that two parallel events can explain the , replicating the structure of relative decrease in intangible asset value the Patent Quality Select Trust, the OT300 and the concomitant relative rise in tangible was created in cooperation with Ocean asset value. Turning first to the intangible Tomo. Last, the sponsor of this series of assets, the most likely proximate cause of articles in IAM magazine, the Intangible this drop was a growing lack of confidence in Asset Finance Society, was founded. their value. Confidence, a perception held by As intangible asset value neared its peak a stakeholder that is a cousin to reputation, in 2007, Institutional Shareholder Services is the friction between and among the launched a new extra-financial data index stones in the Roman arch that hold them in on the sustainability intangible and place. Confidence is reflected in stock price suggested there was a correlation between volatility. Confidence took an acute turn for www.iam-magazine.com Intellectual Asset Management March/April 2009 39 Crash of 2008

Figure 2. Growth in intangible assets as % of market capitalisation 1975-2008

20 30 60 70 45 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Growth in intangible asset regulatory guidelines 1972-2004 2008 SARBOX 302 FAS 141 SARBOX 404 IAS 36 SFAS 2 FAS 142 SARBOX 409 IAS 38 IFRS 3

1972 2000 2001 2002 2003 2004 2005 2006 2007 the worse over the summer of 2007 as The quickest path to value creation in 2009, As corporate value became increasingly evidenced by the sudden loss of stock price therefore, will be reputation restoration and dominated by intangible assets in the new stability (increased volatility) (Figure 4). superior cash management. millennium, the accounting standards bodies Turning now to the tangible assets, a Reputation restoration – that is, the and regulatory watchdogs made efforts to possible precipitator of loss of confidence rebuilding of confidence in the value of key increase transparency through standards and was the slow but progressive freezing of the intangible assets for the purpose of disclosure guidelines credit markets. This was demonstrated by restoring corporate enterprise value – is a the concomitant rise in the importance of business process that requires total cash on the balance sheet as reflected in our institutional commitment. Our risk and mean-variance models. Cash is a critical value forecasting models indicate that to enabler when credit is unavailable. restore corporate , five general Companies with relatively more cash on areas of activity are currently worthy of their balance sheets were rewarded in investments in time and resources. enterprise value in excess of the value of the cash because investors saw evidence of Intangible asset awareness superior cash management, a business Senior managers need to be aware of the process and intangible asset. Conversely, primary intangible assets that support their companies that had heavily leveraged company’s reputation. If managers are not themselves through mergers, acquisitions or aware, then they should become aware lest equity repurchases and found themselves they invest resources that build up assets short of cash were discounted. for which they will receive no support from Reconstructing the events beginning in the market. mid-2007, as investors collected, analysed and What might be the primary intangible made decisions on the basis of extra-financial assets? To generalise: in the food and drug information and balance-sheet cash, sector, it is safety; in communications favourable opinions on the reputations of the technology, it is customer-centric innovation; majority of traded companies were rapidly in retail, it is sustainability and product safety; offset by unfavourable ones. Confidence in computer hardware, it is security; and in waned. It was therefore only natural for financial services, it is integrity. Managers reputation value to decline and cash value to should also be aware of secondary and tertiary rise. As the economist Alan Greenspan, value supporters, since they reinforce each Chairman of the Federal Reserve of the United other like the stones of a Roman arch. States from 1987 to 2006, noted in October 2008: “In a market system based on trust, Managing to best practices reputation has significant economic value.” The intangible assets are business processes that link people, facilities and technology. As Management implications for 2009 is the case with production engineering Lack of confidence in the reputation processes, many of these intangible assets- integrity of the majority of companies, linked business processes can be codified and exacerbated by cash shortages and frozen institutionalised so that they yield reliable, credit markets, appears to be the root cause repeatable and reproducible outcomes. of the intangible asset value crash of 2008. If managers are not yet aware of best

40 Intellectual Asset Management March/April 2009 www.iam-magazine.com Crash of 2008

Figure 3. Median intangible asset percentage practices, this would be a good time to Signalling is at least in part a marketing rectify the discrepancy. There are a number function. Because the stakeholders are 100% of working committees at the Intangible myriad, superior intangible asset management Asset Finance Society dedicated to helping entails coordinates signalling to employees, companies identify and, if needed, codify customers, vendors and investors. 75% ation

s best practice standards. Management requires measurement. Superior cash management 50% Non-GAAP measures can be used to Many companies have built equity value in provide controls. At Steel City Re, we have their intangible assets over the years. These et capitali k found the Intangible Asset Financial are iconic firms with valuable brands. They 25%

Mar Performance Index to be a useful metric to may consider this an ideal time to deploy

% support management. This instrument their non-cash assets in lieu of cash 0% operates at the enterprise level and signals payments and spend their reputation 24 Nov 05 23 Feb 07 10 Jul 06 24 May 08 07 Jan 09 09 Oct 07 the effects of reputation in four key currency. Endorsements, partnerships, IP stakeholder domains: customer, employee, licences and beta-test participation to access vendor and investor. Data reported innovation – to name only a few options – previously in IAM magazine shows that will allow companies to monetise their irrespective of business sector, companies intangible assets creatively and conserve The great intangible asset value crash of 2008 that are superior intangible asset managers cash. And with the importance of cash being began mid-autumn 2007. The material as indicated by the Index reward their what it is today, superior cash management inflection, however, began mid-summer 2008. shareholders with superior returns. can only enhance their reputations. Intangible asset value as a % of market cap reached its nadir in December 2008 Monitoring and enforcing compliance Reputation restoration Business processes comprise numerous At the end of the fourth quarter of 2008, the steps. Monitoring compliance with best median value for intangible assets was below Figure 4. Median relative stock price stability practices is, of itself, a best practice. Both 50% of market cap after years of hovering monitoring and enforcing are especially around 70%. The data suggests that this drop 0.04 important in companies where the products was most probably triggered by a growing lack and services depend on complex supply of confidence in the value of the intangible chains, subcontractors or other types of assets and the sudden rise in the value of 0.03 business network. cash. The consequence of this perfect storm There are numerous technology systems is a widespread corporate reputation problem. 0.02 that can yield non-intrusive, low-cost Reputation restoration, including superior e volatility

s compliance monitoring solutions. In cash management, is the most promising path addition to monitoring, some of these for creating enterprise value for the near term. Inver 0.01 provide both management decision support For many companies today, surviving the near and Sarbox-related control and compliance term is an existential imperative. 0 reports. IT security is a critical feature of 24 Nov 05 23 Feb 07 10 Jul 06 24 May 08 07 Jan 09 09 Oct 07 these systems. Nir Kossovsky is chief executive of Steel There are fewer options for enforcing City Re, Pittsburgh. He also serves as the compliance. Insurance products could be Executive Secretary of the Intangible Asset useful and cost-effective. Other options Finance Society (www.iafinance.org) include contractual indemnifications, [email protected] Intangible asset price uncertainty. Chart of penalty clauses and threats of termination. stock price stability measuring the median The opinions expressed in this article are solely reciprocal of the 45-day exponentially Signalling value to the markets those current opinions of the author and should not weighted moving price average Because the markets now demand a steady be construed to reflect the opinions, policies or diet of extra-financial information, positions of any entity other than the author. The opinions do not represent a recommendation of any transparency into the processes being particular security strategy or investment product. adopted and sharing non-GAAP metrics can The author’s opinions are subject to change without help to restore confidence. For example, in notice. Information contained herein has been the retail sector, one of the most frequently obtained from sources believed to be reliable, but shared and closely watched non-GAAP not guaranteed. Statements concerning financial metric is same-store sales. market trends are based on current market Certain insurances can also be useful conditions, which will fluctuate. References to specific securities and issuers are for illustrative signalling instruments. One advantage of purposes only and are not intended to be, and insurance instruments as tools for should not be interpreted as, recommendations to signalling extra-financial information is purchase or sell such securities. This article has that the actuarial relationships between risk been produced for educational purposes and should frequency, severity and premium pricing not be considered as investment advice or an offer provide quantitative signals that are more of any security for sale. accessible to financial analysts. www.iam-magazine.com Intellectual Asset Management March/April 2009 41