How to value brands correctly? A case study on adidas Charlotte Carpentier 28659 Under the supervision of Patrick Legland June 2014 Abstract Brands are both seen as the most strategic assets of many firms, and the least identifiable when looking at financial statements, due to their absence from balance sheet (in case of non-acquisition). The main reason for that is that their valuation leads to high discrepancies depending on the valuator, the method used and the valuation date. The objective of this study is to gather and classify the main brand valuation methods used by both academics and practitioners, before applying them to the practical case of adidas in order to isolate the one leading to apparently most accurate results compared to benchmark valuations from third parties. Based on the study of adidas, we noted that even if the methods lead to very diverse results, the determination of a valuation range is still feasible to get a first idea of brand value. The methods leading to the most consensual results for the adidas case were the royalty relief approach and the demand driver approach, which are the ones mostly used by practitioners as stated by Salinas (2009). The attributes of methods leading to reasonable values seem to be having a mixed approach (both market-based and income-based), and being simple i.e. requiring neither many hypotheses nor deep delving into details. Nevertheless, the attribution of a precise figure is still difficult to rationalise, and mostly based on negotiation features or valuator’s perception of the brand. 2 Table of contents Abstract ..................................................................................................................................... 2 Introduction .............................................................................................................................. 5 I – A first step ........................................................................................................................... 6 1. Definition of the scope of analysis .................................................................................................... 6 2. Why to value brands? ........................................................................................................................ 7 II – Review of the main existing methods of brand valuation .............................................. 8 1. Income-based / contribution methods – DCF-based approaches .................................................... 10 1.1. How to choose the discount rate and the lifetime length of the DCF performed? ..................... 10 1.2. Royalty relief approach ............................................................................................................... 13 1.3. Price/volume premium approach ................................................................................................ 17 1.4. Margins comparison ................................................................................................................... 20 1.5. Excess cash flow method ............................................................................................................. 22 2. Costs based methods ....................................................................................................................... 24 2.1. Historical costs of creation ......................................................................................................... 24 2.2. Replacement costs ....................................................................................................................... 26 3. Market based methods .................................................................................................................... 27 3.1. Transaction multiples .................................................................................................................. 27 3.2. Demand driver/brand strength analysis ..................................................................................... 29 3.3. Differential of price to sales ratios ............................................................................................. 32 3.4. Stock price movements ................................................................................................................ 34 4. Real options approach ..................................................................................................................... 36 4.1. General case ............................................................................................................................... 36 4.2. Pros, cons and key hypotheses in using this technique ............................................................... 39 5. Choosing the best method to use – a synthesis on the methods reviewed ......................................... 40 III – A case study on Adidas – one brand, one value? ........................................................ 42 1. Why the choice of Adidas? ............................................................................................................. 42 2. Business highlights - Brand history and strategy ............................................................................ 42 Key information .................................................................................................................................. 42 Market penetration ............................................................................................................................. 44 Adidas brand SWOT analysis ............................................................................................................ 44 Adidas AG financial elements ............................................................................................................ 45 3. Valuation preliminary analyses ....................................................................................................... 47 Common hypotheses ........................................................................................................................... 47 Company forecasts and WACC computation ..................................................................................... 48 Comparable “non-branded” firm ...................................................................................................... 49 4. Adidas brand valuations .................................................................................................................. 50 4.1. Benchmark valuations .............................................................................................................. 50 4.2. Royalty relief method ............................................................................................................... 51 4.3. Price premium method ............................................................................................................. 53 4.4. Margin comparison method ..................................................................................................... 55 4.5. Excess cash flow method .......................................................................................................... 56 4.6. Historical costs method ............................................................................................................ 58 4.7. Replacement costs method ....................................................................................................... 58 4.8. Transaction multiple method ................................................................................................... 59 4.9. Demand driver approach ......................................................................................................... 60 4.10. Price-to-sales difference ratio ................................................................................................. 64 4.11. And what about considering real options? .............................................................................. 66 5. Result comparisons and comments ................................................................................................. 72 Results summary ................................................................................................................................ 72 Observed trends and comments ......................................................................................................... 74 3 Attributes for a method to value brands correctly ............................................................................. 77 6. Brand valuation: “An Art, not a science”? ...................................................................................... 78 Conclusion ............................................................................................................................... 79 References ............................................................................................................................... 80 Appendices .............................................................................................................................. 83 Appendix 1 – Adidas AG balance sheet – accounting view .................................................................. 83 Appendix 2 – Adidas AG 2013 Annual report – impairment on intangible assets ................................ 84 Appendix 3 – Market shares by geography ............................................................................................ 85 Appendix 4 – Adidas AG Free cash flow forecast ................................................................................