END OF A GOOD NUMBER: INTANGIBLES NO LONGER MAKE UP 70% OF CORPORATE VALUE

May 10, 2009 at 2:02 pm

The End Or do they? The Great Meltdown of 2008 has disturbed a great many long-held assumptions. One of them is a legendary business chestnut: intangible assets make up the majority of a company’s market value. 70% or more.

Even those not previously familiar with this number probably find it somewhat intuitively true. It is clear to most people that the $2.1 or so billion that Google paid in order to own YouTube far exceeds the cost of all the servers and other “machinery” that keeps the site running. If you asked a lay person to explain why it cost so much more than all the physical stuff YouTube has, most would cite things like “the idea,” “the name,” or “familiarity.” Same easy nodding of heads would also greet the news that market value of say Harley Davidson Co. is a lot more than the cost of its factories and engineering shops. Still, people usually tend to be stunned and helplessly impressed when they are told that most of corporate value is intangible – non-physical, something you can’t see or touch.

One of the classic examples used to demonstrate what this 70%-or-more number means – in textbooks, powerpoints, executive seminars – has been the purchase of Kraft by Philip Morris Co. (before it became the Altria Group). You must admit, as numbers go, this is impressive:

In 1988 Philip Morris purchased Kraft, the world’s second largest food company, (Nestle holds the top spot, if you’re wondering) for, at that time, a staggering sum of $12.9 billion. Kraft makes everything under the sun, from cheese and cookies, to veggie burgers and salad dressings. Next time you are grocery shopping, take a notice of how many products you have known and used for years are actually Kraft brands. This is a conglomerate of thousands of buildings and distributions centers in about 155! countries . If you put everything physical that Kraft owns – truck fleets, machines, factories, processing plants, etc. in one spot, it might take up the space of a small-sized country, let’s say Belgium. To top it off, Kraft employs more than 100,000 souls.

So, how much of that $12.9 billion Philip Morris paid covered all of the actual physical property Kraft owned around the world, its tangible assets? If you can believe, it was $1.3 billion. The rest, $11.6 billion!, was the cost of Kraft’s intangible assets – its intellectual property portfolio consisting of trademarks, trade secrets, distribution agreements, patents, licenses. And that is the story in a nutshell, illustrated in the graphic below – the story that in the midst of this recession appears to be challenged.

intangible v. tangible Intangible asset valuation has over the decades grown into an industry that is tiny in the number of players but enormous in influence as its standards have decided the value of pretty much everything. When companies are bought, sold or merged, people who analyze intellectual property (IP) portfolios and put a dollar number on them are kind of important. But IP asset valuation has always remained hanging somewhere between art and science. The current economic vows have kick-started a broad discussion that seems to have been waiting to happen.

Over the last 25 years or so the gap between tangible assets, such as plant and machinery, and market capitalisation has grown, leaving a very big space in the middle that not infrequently accounted for over 80% of listed companies’ values. By putting IP in that space and saying it explained a large part of the gap, then you had an instant, attention-grabbing calling card when you went to speak with corporate executives and investors. People who, in the usual course of things, may not have had much interest in discussing patents, trademarks or copyrights.

This is Joff Wild of the IAM (Intangible Asset Magazine) who earlier in the year initiated an ongoing conversation among IP practitioners by highlighting some new findings.

But as the old saying goes, those who live by the sword will die by the sword. … Intangible Asset Finance Society reveals that corporate intangible values in the US … have collapsed over the last 12 to 18 months, from a median of 70% of market capitalisation to under 50% now. To put it starkly: nobody can now claim that the majority of American corporate value is composed of intangibles or IP, it is not (remember as well that IP rights are types of intangible, but they are not the only ones). And although I am not aware that anyone has done similar research that looks at stock markets in other parts of the world, my guess is that the same would apply to these as well.

IAM blog seems to try to avoid the nerdiest edges of IP discussions and is one of the more accessible “big” IP blogs. For all us lay folk, it is recommended. This very interesting debate is far from being over. Despite the pessimism that is caused by uttering the phrase “need for standards,” Mr. Wild doesn’t doesn’t see a way around it:

[T]here are currently more than 50 IP valuation methodologies in use. That just seems far too many to me if IP is to be regarded by the business world in general as anything more than a vaguely interesting niche area. …  In other words, the current IP narrative needs to change so that it becomes not only more accessible, but also more credible to those who have not spent years inside the IP bubble.

That would be most of us.

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