Get ready for the next patent auction. Kodak is the latest company to sell its patents, according to the Wall Street Journal:
Investment bank Lazard Ltd. began marketing the portfolio this week, reaching out to companies that may be interested, said a person familiar with the matter. The auction will be conducted over two stages, according to a person advising a company interested in buying Kodak’s digital-imaging patents.
This person says the interested company is a large, strategic buyer in the wireless industry looking to use the patents for defensive protection.
The news apparently sent Kodak stock up by 24%.
The sale is the second part of Kodak’s IP strategy. The company has already licensed a number of their digital imaging patents to mobile phone companies. According to the Journal story:
The licensing strategy brought in $1.9 billion from 2008 to 2010, but the flow of settlements dried up this year, prompting the company to look more seriously at selling patents, one board member said.
One wonders how many boards are asking the same questions and how many other companies are now scouring their patent portfolios looking for anything remotely associated with wireless technologies.
The near-frenzy over wireless patents has also sparked action in another area. The Journal also reports that Canadian patent licensing company Wi-LAN has launched a hostile bid for another Canadian technology company, MOSAID Technologies:
“Combining the patent portfolios will provide a more efficient and rapid path to establishing a larger and more valuable aggregate portfolio given the combined management team’s expertise and increased business scale,” Wi-Lan said in a statement. It will also allow the combined entity to access capital to grow the business and fund litigation to enforce its patents, if necessary, Wi-Lan said.
Who will be next?
In a couple of recent postings, I mentioned that for an intangible asset acquired from outside, accountants try to separate out the value of particular intangibles from the overall sales price. Here is a study from Ernst & Young – Acquisition accounting: What’s next for you – that describes exactly how intangibles get counted. Published in February 2009, the study looked at over 700 acquisitions across a variety of industries as reported in 2007 annual reports.
In general, the story is not necessary very flattering. The report begins but noting the difficulties in getting the data, noting that “many companies were reluctant to fair value tangible assets bought and to provide detailed information on intangible assets they acquired and how they were valued.” That insight is borne out by the fact that “goodwill” continues to be the convenient catch all category for acquired assets. Goodwill accounted for 47% of total enterprise value, compared with 23% for recognized intangible assets and 30% for tangible and financial assets. In other words, almost half of the total value of the acquisitions and over two-thirds of the intangible portion of the acquisition where labeled as goodwill. So much for accountants making process in accounting for intangibles. In almost a quarter of the transactions, goodwill was the only type of intangible — no other type of intangible was reported.
On the other hand, the report seems to indicate that the category of goodwill is used extensively to capture the value of intangibles that GAAP accounting rules do not allow. For example, descriptions of goodwill include brief discussions of workforce skills and business processes.
The uses of goodwill versus GAAP recognized intangibles varies by industry. Not surprisingly, the patent heavy industries of biotechnology and pharmaceuticals have a larger percentage of intangibles in GAAP recognized categories and less in goodwill. The consumer products industry has the largest percentage of total value (and of intangibles) in goodwill at 65%. Interestingly, this is followed by the technology industry at 60% goodwill. Telecommunications had 48% in goodwill.
A breakdown of the telecommunications industry’s recognized intangibles shows that 40% of recognized intangibles were in customer contracts and relationship. For consumer products, the largest recognized intangible was brands and trademarks, at 39% of recognized intangibles (which was only 27% of total enterprise value — meaning brand and trademarks accounted for only 10.5% of total enterprise value of the acquisitions).
All in all, an interesting look at how accountants are allocating among intangibles. And a clear indication of how far we still need to go in accounting for and reporting of intangible assets.
In a posting last month I noted that Carl Icahn wanted Motorola Mobility to sell off its patents which he apparently estimates have a higher value than the $4.5 billion paid for the Nortel patents. Well, Motorola Mobility decided not to sell of their patents, but to sell the entire company to Google for $12.5 billion (see stories in the Wall Street Journal and New York Times, as well as Larry Page’s official Google blog posting on the deal).
Given that the accounting rules require companies to account for intangibles purchased from outside, we might actually get to see what they assign as the value of the patents.
One of the nagging issues about intangibles is the valuation problem. How can you assign a value to an intangible asset? In the case of a market transaction — i.e. an intangible acquired from outside, accountants try to separate out the value of particular intangibles from the overall sales price. For internally generated intangibles, they don’t even try. It is easy to simply dismiss valuation of intangible assets as not precise.
I would argue, however, that precision is a function of the valuation process itself not just the nature of the asset. Take, for example, that most tangible of assets — real estate. It has been claimed that inflated valuations were a contributing factor to the housing finance bubble. Now come the concern from the other side, as illustrated in this piece in today’s Wall Street Journal – “Judgment Call: Appraisals Weigh Down Housing Sales”.
William Maxwell is an expert in finance. He’s a professor at Southern Methodist University’s business school, has co-authored a book on high-yield debt and spent years calculating values of financial markets.
Yet there’s one valuation he can’t understand: the appraisal of his Dallas home.
In August 2010, Mr. Maxwell’s home was appraised at $790,000 as part of a mortgage refinancing. Yet this past spring, when he tried to sell the four-bedroom home for $756,500, the appraisal commissioned by the buyer’s lender, Bank of America Corp., came up with a value of $730,000. Mr. Maxwell said the appraisal killed the sale.
The conclusion: the appraisal system is broken. Of course, not everyone agrees. As the article notes:
The Mortgage Bankers Association, an industry trade group, concedes that appraisals are conservative but says they need to be, partly to protect the banks from future problems with investors who buy mortgages. “There’s an extra note of caution,” said Steve O’Connor, a senior vice president at the association.
And some appraisers say homeowners are just having trouble facing reality. “It’s the market. It’s not the changes” in the appraisal process, says Charles MacPhee, a partner with Buttler Appraisals LLC.
The article goes on to cite a number of concerns with the appraisal process: less experienced appraisers; using distressed sales as part of determining comparable prices; use of automated valuation models; processes that don’t capture all of the specific features of a property.
As we look at the issue of intangible asset valuation, let us keep in mind the lessons from real estate. Valuation includes a degree of judgment. The system will never be totally precise. We need to understand and accept that fact and move on.
The trade deficit rose by $2.3 billion in June to $53.1 billion, according to data released this morning by the BEA. Both exports and imports were down, compared with May. However, exports dropping by $4.1 billion while imports were down only $1.9 billion. The increased deficit was due completely to goods, as the deficit in petroleum products narrowed.
Our intangible trade surplus increased very slightly in June — up by $98 million. Imports and exports of both business services and royalties increased, with exports of business services rising slightly faster than imports.
Our Advanced Technology Products deficit also grew in June to $8.8 billion as imports grew faster than exports generally across almost all sectors. One exception was biotechnology, where exports surged in June. The last monthly surplus in Advanced Technology Products was in June 2002 and the last sustained series of monthly surpluses were in the first half of 2001.
Note: we define trade in intangibles as the sum of “royalties and license fees” and “other private services”. The BEA/Census Bureau definitions of those categories are as follows:
Royalties and License Fees – Transactions with foreign residents involving intangible assets and proprietary rights, such as the use of patents, techniques, processes, formulas, designs, know-how, trademarks, copyrights, franchises, and manufacturing rights. The term “royalties” generally refers to payments for the utilization of copyrights or trademarks, and the term “license fees” generally refers to payments for the use of patents or industrial processes.
Other Private Services – Transactions with affiliated foreigners, for which no identification by type is available, and of transactions with unaffiliated foreigners. (The term “affiliated” refers to a direct investment relationship, which exists when a U.S. person has ownership or control, directly or indirectly, of 10 percent or more of a foreign business enterprise’s voting securities or the equivalent, or when a foreign person has a similar interest in a U.S. enterprise.) Transactions with unaffiliated foreigners consist of education services; financial services (includes commissions and other transactions fees associated with the purchase and sale of securities and noninterest income of banks, and excludes investment income); insurance services; telecommunications services (includes transmission services and value-added services); and business, professional, and technical services. Included in the last group are advertising services; computer and data processing services; database and other information services; research, development, and testing services; management, consulting, and public relations services; legal services; construction, engineering, architectural, and mining services; industrial engineering services; installation, maintenance, and repair of equipment; and other services, including medical services and film and tape rentals.
One of the things I am continually skeptical of is our measures of innovation — who is innovative and by how much. I understand the importance of the metrics – and the difficulty of getting good data. But I think we should be careful of making blanket statements about how we are going based on a select set of measures
Here is a perfect example concerning innovation and R&D spending — taken from an IndustryWeek case study (The Nordson Challenge: Make ‘Really Good’ Better). Nordson is a manufacturer of machines that apply adhesives, sealants, coating and paints. For example, they make machines that glue the layers of diapers together and apply glues to box tops. According to the case study:
To make sure it maintains its technology position, Nordson spends about 3% of its revenue on research and development. While that is the reported figure, [Nordson CEO Mike] Hilton says it is actually more like 5% to 10% because the company has a large engineering organization that is working on either applications or products, but not recognized in the R&D figures. Moreover, Hilton is working on leveraging the company’s field service organization because they are “out in our customers’ facilities all the time, understanding what their issues are, what are their opportunities, what they are trying to do.” The company also promotes innovation through formal processes to solicit customer feedback and by conducting development programs with key customers recognized as technology leaders.
Nordson also grows by applying its core technologies to new applications. For example, much of the company’s technology business is focused on the electronics industry, where its machines are used to apply adhesives and substrates for printed circuit boards, semiconductors and other products. The company is now working with lighting companies as they develop more LED (light emitting diode) products. Similarly, the company is expanding into medical applications, where it is taking its industrial technology and applying it to the dispensing of biomaterials in surgical procedure.
Here is the issue I have with the numbers: at a level of an R&D investment of 3% of revenues, Nordson is not considered an innovative company. But the description above clearly indicates that innovation is a key part of Nordson’s strategy.
So how do we create innovation metrics that capture the Nordsons?
BTW — Hilton also talked about how impressed he is with the German apprenticeship programs and had this to say about government policy:
Hilton says the United States could also learn some lessons from other countries about supporting industry. He says there is too much focus on labor costs and not enough on investment. “Why don’t we make any TVs in this country? It is not because labor is cheaper in Asia. It is because their governments went in and supported the investment because it costs $3 billion to build a facility today to make flat-panel TVs.”
Hilton knows that arguments against “government subsidies,” particularly in these cash-strapped times, but he says that kind of investment results in jobs. “We need to find a way to move away from a 100% service economy,” he says. “We need to make stuff to continue to provide the kinds of jobs that are really good-paying jobs and help support our middle class, where we want growth instead of decline.”
Here is an interesting talk by Margaret Levenstein of the U of M on how the innovative networks in Cleveland fell apart. Cleveland was a Silicon Valley type location during the industrial age. But it all came to a halt with the Great Depression. Could it happen again?
This is part of the Institute for New Economic Thinking‘s series on 30 Ways to be an Economist.
One of the more difficult intangible valuation issues is human capital. A standard methodology for “assembled workforce” is replacement cost — how much would it cost to hire everyone. Another method that has come about indirectly is “key man” insurance — essential life insurance of the top talent drops dead. How much the company is willing to insure that person is a rough proxy for the value of their services — at least the value of avoiding the disruption that the lose of their services would entail.
Here is another version, from the Economist, “The Corzine put”:
MF Global, a smallish broker with big ambitions, is breaking new ground when it comes to pricing this risk. It is offering an extra percentage point of interest to investors in its latest bond issue, should Jon Corzine, MF’s chief executive, quit to take a government job before July 2013.
. . .
Buyers of the $300m debt issue stand to make an extra $15m over its five-year life if Mr Corzine leaves soon.
Not sure that this is the right level. This is the company setting a level of one percentage point. It would be interesting to see how the market reacts as it sets its own valuation of Mr. Corzine’s worth through trading of these bonds. Or better yet, some one could set up a market on the risk premium itself. That would be very interesting.
Groupon has decided to drop the use of the controversial accounting metric, according to a story from Reuters. As noted in earlier postings, Groupon’s use of ACSOI (adjusted consolidated segment operating income) was questionable and under scrutiny by the SEC. This measure basically dropped out any marketing and acquisition costs from expenses — claiming that they were temporary costs, not long term operating costs. Not many people seemed to be buying it, however.
With the change, let us hope that more rationale alternative measures might be considered. For example, marketing is not a “temporary” cost. But it is a cost that has longer term implications, rather than just an immediate expense. Thus, there is a rationale for amortizing marketing (and other intangible assets costs) over some appropriate time frame. It would be interesting to see if someone is willing to use that alternative metrics — or has Groupon messed it up for everyone.
Late Friday afternoon, Standard and Poor’s issued the following statement:
Standard & Poor’s Ratings Services said today that it lowered its long-term sovereign credit rating on the United States of America to ‘AA+’ from ‘AAA’.
As I write this on Monday morning, the ramifications of this decision are beginning to be played out. The Dow Jones Industrial Average immediately dropped and the financial system is trying to figure out what it all means and what to do — if anything. For the first time ever, the sovereign debt of the United States of America is rated at less than the highest possible rating. That may or may not end up mattering that much in the long term. But the reasons given for the downgrading is especially ominous:
the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges
In other words, it is not just the debt that is the problem; it is our dysfunctional politics that leaves us unable to confront our economic problems. That is a pretty damning statement about what used to be a positive intangible asset of the United States. And in S&P’s view, things are likely to get worse.