Wednesday, October 28, 2009

Value of Intangibles as % of Market Capitalisation Crashes in 2008

An article in Issue 34 of the IAM Magazine carries this sobering observation. 

It traces the growth of this metric from less than 20% in 1972 to hover between 60 and 70% for a decade and a half beginning 1995, to touch a high of 70% by end of 2007, only to see an abrupt about-turn in 2008 to touch 45%.  It also traces the several Accounting and Compliances relating to Intangibles from FAS 141 and 142 in 2001 and SARBOX 302, 404 and 409 in 2002 in the US and IAS 36 and 38 in 2003 and IFRS 3 in 2004 in Europe. These developments coincided with the period when this metric hovered around 70%. All these are projected as attempts to standardize the valuation of this pre-dominant part of the Balance Sheet that few knew much about. However, in hindsight, I cannot help but wonder: Could it be that these accounting standards and compliance developments fuelled boosted valuations and hence income figures?  This is fuelled by another article in the same Issue by Dr. Patrick Sullivan, one of the Gurus of Intellectual Asset Management where he observes: "Valuing IP is complex, with more than 50 different methods currently in use. Given the growing importance of IP to so many organisations, perhaps now is the time to re-think whether global valuation standards make sense".

The article that traces the value of Intangibles as % of M Cap employs a simple-to-understand definition of "reputation" as "the impression formed by stakeholders of how a company manages its intangible assets", and this reputation took a beating in 2008. It observes that financially, the values of most intangible assets are closely linked to one another like the stones in a Roman arch, so that collectively the intangible assets comprise an enterprise’s reputation value – the difference between market capitalisation and book value. The loss of any one key intangible asset, it observes, may destroy a disproportionate amount of reputation value.

Finally, the article ends with two sobering observations: 
  • Reputation restoration, including superior cash management, is the most promising path for creating enterprise value for the near term.
  • For many companies today, surviving the near term is an existential imperative.

1 comment:

  1. While the calculation of the "intangible" portion of corporate value using stock market data is a nice way to show the relative importance of intangibles in our economy, it is not a true measurement of intangibles or reputation. It's mostly just an indicator of the failure of the accounting model to capture value in the knowledge era. So it is ridiculous to say that the value of intangibles crashed. The value of companies crashed because their earnings expectatons crashed. Here's an alternative view: