Valuation of Intellectual Property Assets Professor Derek Bosworth Intellectual Property Research Institute of Australia Melbourne University Coverage of the presentation • • • • • • • • IP as a component of IC Nature of the management problem The Diageo problem Nature of the accounting problem Accounting issues surrounding intangibles Accounting methods for intangible assets Options pricing and optimal stopping [Other strategic issues] Not covered in the presentation • Economic approaches to valuation Production function and market valuation – dealt with in a previous presentation Patent valuation analysis – using renewal data • Methods of valuing product characteristics Conjoint analysis (marketing) Hedonic analysis (economics) IP as a component of IC Intellectual Capital Human Capital “Technological” Skills and Competencies Relational Capital “Sociological” Skills and Capital Organisational Capital Intellectual Property Infrastructure Capital Organisational (structural) capital: examples of IP/IPRs • patents • copyrights • design rights • trade secrets • trade marks • service marks • trade dress • utility models • plant & seed varieties Nature of the management problem Why Value Intellectual Capital • Measurement of IC - enables a more efficient management of the company - i.e. to: understand where value lies in the company have a metric for assessing success and growth provide a basis for raising finance or loans • If borrowing can only be secured against tangible assets, then knowledge-based companies will be disadvantaged in investment and growth. The Diageo problem Diageo: the company • Grand Metropolitan - formed as a hotel company in 1962 • by mid-1980s strengths in variety of branded products • became known as Diageo in 1997, on merger with Guiness Previous accounting practice • GrandMet – often bought and sold brands • Acquired Heublein from Nabisco in 1987 • Paid £800 million, of which over £500 million was for the Heublein brands (i.e. intangibles) • Given the accounting procedures at the time, GrandMet published its next set of accounts in January 1988 the Heublin brands were not valued £565 million of the £800 million paid for the company was written off as goodwill against reserves as a result, the balance sheet net assets fell, giving the impression than £565 million had been wasted Changed accounting practices • Subsequently GrandMet introduced brand capitalisation • after acquiring Pilsbury in 1989, the balance sheet showed the importance of brands brands other assets liabilities (mainly debt) net assets £2.7 billion £6.9 billion (£6.7 billion) £2.9 billion • Without brand capitalisation the balance sheet would have shown net assets of only £0.2 billion • Corbett (1997) argues that this would have been an absurd situation Further example of brand aquisition • GrandMet acquired Pet in 1995 at a cost of £1.8 billion • Again, the acquisition affected GrandMet's balance sheet brands other assets liabilities net assets £3.8 billion £7.3 billion ( 7.7 billion) £3.4 billion Accounting issues surrounding intangibles Accounting concerns • Is the intangible asset clearly identifiable • Does the company hold an unambiguous title to the asset • Could the intangible asset be sold separately from the business • Does the intangible give rise to a “premium” not earned by other companies? Tangibility and uncertainty Replicated plant and equipment Product modification New factory Most certain Innovation Staff training Research and development Most uncertain Source: Webster Tangibility and Separability: the Spectrum of Assets Separable Wholly tangible (i.e. machine tool) Not separable Highly intangible (i.e. goodwill) Source: Wild and Secluna Accounting methods for intangible assets Accounting approaches to valuation • Cost based valuation historical creation cost - how much did it cost to create? current recreation cost - how much would it cost to recreate an identical intangible? • Market based valuation - evidence from sale or purchase of similar assets (i.e. individual brands, branded divisions or whole companies) • Income based valuation looks at the stream of income attributable to the intangible asset, based on: historical earnings (i.e. multiple of earnings) expected future earnings (i.e. discounted cash flow) External influences on IC measurement and disclosure • Writing off expenditures on intangibles against profits or reserves seems wrong • Thus, there is considerable pressure on accounting bodies devise new accounting codes of practice (SSAPs/GAAPs) • Examples: SSAP 13, 1989 - covers the treatment of R&D expenditure Draft SSAP 22, “Accounting for Goodwill” IC audits Towards an IC audit • Various authors suggest an IP audit – see e.g. Brooking 1997 • Each company produces a taxonomy and set of checklists similar to Slide 3 above • Weights are applied to each item on the checklist – reflecting importance in achieving company goals • Large “dots” reflect very important and small less important • Position within the target reflects the perceived strengths (close to “bull”) and weaknesses (far from “bull”) of each asset. Brooking’s “target” Conclusions on IC audits • Majority of the 8 large dots (more) and 22 small dots (less important), in IP quadrant • Brooking argues target is consistent with an IP dominant company (40% of listed assets are IP assets) if the company is not intended to be IP dominant, then “severe changes are required” 66% of the IP assets are below average in value, including the significant ones • Tracking likely changes over time, she argues “The IC of this company looks like its in pretty bad shape and likely to get worse.” Options valuation and optimal stopping techniques Options values • Options pricing methods are potentially the way forward • Only method that really deals with risk • Applicable to every stage of creative process: investment in R&D decision to patent, etc. decision to commercialise the invention • But: Need information about wide range variables Inventive process is a multi-stage decision – which makes the calculation very complex Underlying principle • Black-Scholes→Merton→Dixit & Pindyck • equations that allow for changes in the degree of risk over time • in the D&P model the benefits of waiting one more period minus costs of waiting = value of the option • often called optimal waiting models Value of a real option The value of real option is determined by: • present value of project cash flows (+) • investment cost of project (-) • time remaining to invest in the project (+) • standard deviation of the project value (+) • risk free interest rate (+) Pitkethly (2002) Optimal stopping rules • Use the distribution of possible returns to decide: how much to do how long to go on doing it • Uses the distribution to calculate a “reservation return” R* which indicates: whether to do any R&D whether to accept a given result, R, and exploit, R>R* or carry on doing research