Adding up the valuation numbers for Nokia – but not adding up

Here is a great example of the pitfalls of valuation of intangibles — and of what the stock market says a company is worth. Let’s go through the numbers for Nokia according to a story in Sunday’s Washington Post – “How Nokia put itself at risk for a takeover bid”.
According to the Post story, as of last Thursday, Nokia’s market capitalization was $8.6 billion. It had a net cash position (cash on hand minus debt) of
$5.9 billion. It is sitting on a patent portfolio that some have estimated to be worth $7.5 billion. So all Nokia’s other tangibles and intangibles (tangibles — plant and equipment; intangibles — brand, manufacturing know-how, distribution channels, etc) are worth a negative $4.8 billion.
It seems that sometimes the parts are worth more than the sum of the whole.
The key point is that Nokia is grossly undervalued by the stock market — and is ripe for someone to buy. But there doesn’t seem to be anyone rushing out to buy. The problem is that no one necessarily knows how to make use of all those parts. And no one seems to want to buy the whole, either. As the Post story notes:

Michael Genovese, managing director at MKM Partners, said an acquirer is unlikely to step forward now while the company is still losing market share.
“I’ve been in the stores, and no one is buying Nokia’s Windows Phones,” Genovese said. “I don’t think anyone will be buying them any time soon. Microsoft may eventually end up buying Nokia, but that’s at least a year away.”
. . .
“Who would buy them at this point?” said Lars Soederfjell, a Stockholm-based analyst with Bank of Aaland. “You need to stabilize the business. There’s too much uncertainty. It’s more like buying a lottery ticket than anything else.”

At least with a lottery ticket you know the odds, the payoff and the date of the drawing. With Nokia everything seems to be still up in the air. We will have to keep an eye on the Nokia case to see if someone can engineer an intangible-based turn-around. If the business does not stabilize, we may be looking at a very different case study: how to liquidate an intangible-based company.

Select tweets 6/11/12 – 6/17/12

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Germany exports its belief in an intangible: the workers

I’ve posted a number of pieces in the past about the German Mittelstand companies. Specifically, I have noted how German companies have built their competitive edge on essentially selling their know-how. Now comes a story in the Wall Street Journal on how something else Germany is doing with their know-how: “Germany’s New Export: Jobs Training”.
The story describes how German companies in the U.S. are setting up German-like apprenticeships and training programs. In this case, however, it is not the Mittelstand companies, but the larger German firms like Siemens, VW and Bosch. Once the programs are up and running successfully, local U.S. companies are joining in.
This sounds like a great program — something that the U.S. labor force needs. My one question is this: why did it take German transplants to start this? This is an indication of two things: the poor state of job training in the U.S. and the lack of commitment by U.S. companies to their workforce. Apparently, in the U.S., we mouth the words, “our workforce is our greatest asset”; the Germans really believe it. And act on it even when others don’t.

That Fed survey on drop in US wealth – and investment in education

By now, you have probably read the stories about the new survey of income and wealth by the Federal Reserve “Changes in U.S. Family Finances from 2007 to 2010” from the 2010 Survey of Consumer Finances. The headline is that family wealth has dropped dramatically to levels of decades ago, mostly due to the drop in housing prices. Obviously, the survey covers tangible and financial assets, such as houses and stocks/bonds. But there are some hints at intangible assets.
For example, here is what the survey says about what people are saving for, “Education-related motives also appear to be important, but less so than in 2007; in 2010, 8.2 percent of families reported it as their primary motive, down only slightly from 2007 but down 3.4 percentage points since 2004.” While saving for education has dropped in the last decade, education as a reason for incurring debt rose from 3.1% of all family debt to 5.2%. In other words, education is still seen as a valuable intangible asset but the means of financing it has shifted from saving to debt. That may be a function of people seeing a return on investment in education (i.e. thinking that they can pay off the debt with future earnings). Or it may be the result of a more damaging trend of ever-higher educational costs (beyond what families could save for) coupled with relatively easy credit.
In any event, it does give one pause about the process of paying for education – and the need to confront the system of investing in intangible assets.

Breakthrough moment: intangible assets as collateral?

Use of intangibles as loan collateral might finally be at a breakthrough point. A story in today’s Financial Times (“Banks eye intangible assets as collateral“) discusses efforts to create IP recognized as collateral for purposes of Basel III bank regulation. At issue is whether these intangible assets count toward the required level of capital a bank must have. As the story notes:

Under the terms of many loans, banks have the right to seize a borrower’s patents and trademarks as part of a foreclosure proceeding. But these intangible assets cannot generally be counted towards the loan’s security for regulatory capital assets because they are considered too difficult to value.

The work around on the knotty valuation problem being proposed is insurance, where the insurance company would buy the IP at a fixed price in case of default. Details, including the pricing model, are, according to the story, still being worked out. Apparently, however, one deal may be going to regulators for approval soon. Obviously getting the pricing models right is the key step. It was the failure of those models for credit default swaps and other synthetic financial instruments that helped created the recent financial debacle.
I would note that insurance was a major player in the earlier intangibles-backed securities wave of a decade or so ago. As we described in our two working papers (Intangible Asset Monetization: The Promise and the Reality and Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance), many of those intangible-backed bonds were insured by the so-called monoline insurers. These companies originally specialized in insuring state and local government bonds, and subsequently got drawn into the financial meltdown (although intangible-backed securities were not the problem).
So guarding against abuse of the system (and a repeat of the recent crash) will be important.
Two steps might help in guarding against abuses. First is transparency. Banks don’t necessarily have an inventory of the IP collateral in their loan portfolios. Standard terms of loans are often all inclusive liens, which cover everything including the kitchen sink. IP is not necessarily explicitly listed. In some case, there may actually be a “negative pledge agreement” — where the borrower is explicitly forbidden from using their IP as collateral (a condition a VC investor might put on a company in order to protect their investment). Likewise, the IP might be already somehow encumbered by previous liens or licensing agreements. Thus, a requirement for disclosure of the IP included as collateral would be important for the market to understand the risk/reward calculation of any insurance product.
The second step is further development of the market in IP. Lenders, including the entity underwriting the insurance, need to have a place where they can dispose of the asset (the IP) at a fair price and with reasonable transaction costs. Currently, the IP market place is still evolving. One of the evolutions that needs to continue is the creation of valuation standards. Some work is being done in this area, but this is an area where the regulators could help spur faster action. For example, the SEC, in conjunction with FASB, could establish a task force on valuation to report back guidelines. And/or companies could create an intangibles reporting and valuation guideline association/group, similar to the International Private Equity and Venture Capital Valuation Group and the Enhanced Business Reporting Consortium. The International Standards Organization could step up efforts to set brand and patent valuation standards to ensure that relevant expertise and stakeholders are engaged.
In any event, the news about efforts to include intangible assets in regulatory capital for banks is heartening. We need to seize the moment and continue to efforts to better integrate intangibles into the financial system. As we know from experience, intangibles are already in the system — we need to better recognize and regularize that fact.
– – –
For more on the issue and public policies, see various papers on the Athena Alliance website, including our two working papers: Intangible Asset Monetization: The Promise and the Reality and Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance and the following articles: “Building a Capital Market for Intangibles,” “Intangible Assets: Innovative Financing for Innovation,” and “Intangible Assets in Capital Markets.” Also see a previous posting on recent work by the OECD on the IP marketplace.

Innovation, government procurement and the National Bioeconomy Blueprint

I’m just catching up on the Obama Administration’s National Bioeconomy Blueprint released in April. The document defines and discusses the importance of the “bioeconomy” which encompasses health, energy, agriculture and environment. It then outlines of 5 part policy strategy:
1. Support R&D investments that will provide the foundation for the future U.S. bioeconomy.
2. Facilitate the transition of bioinventions from research lab to market, including an increased focus on translational and regulatory sciences.
3. Develop and reform regulations to reduce barriers, increase the speed and predictability of regulatory processes, and reduce costs while protecting human and environmental health.
4. Update training programs and align academic institution incentives with student training for national workforce needs.
5. Identify and support opportunities for the development of public-private partnerships and precompetitive collaborations–where competitors pool resources, knowledge, and expertise to learn from successes and failures.
Most of these are straightforward (and needed) technology policy initiatives. One recommendation, however, jumped out at me. Under the topic of point #2 (“research to market”) is the following discussion of government procurement:

Driving Innovation with the Procurement Power of the Federal Government
Advancing Biofuels for Military and Commercial Transportation: As stated in its Blueprint for a Secure Energy Future, the Administration recognizes the need for the Federal government to lead by example to help move the Nation toward a clean energy economy, given the government’s status as the largest energy consumer in the U.S. economy. In August 2011, the Secretaries of Agriculture, Energy, and the Navy announced the creation of a cooperative effort to develop drop-in advanced biofuels. Drop-in biofuels are direct replacements to existing gasoline, diesel, and jet fuels that do not require changes to existing fuel distribution networks or engines. This collaboration by the three Departments was developed in response to the Blueprint for a Secure Energy Future, and promises to advance U.S. efforts to reduce dependence on oil.
Driving Innovation and Creating Jobs in Rural America through Biobased and Sustainable Product Procurement: As part of a commitment to leading the way in procurement of biobased products to create jobs and open new markets in rural America, the President signed the Presidential Memorandum on Driving Innovation and Creating Jobs in Rural America through Biobased and Sustainable Product Procurement. Biobased product materials are typically grown and manufactured in rural areas. Their increased procurement will lead to increased jobs in rural areas, benefits to the environment, and overall use of fewer petroleum-based products. The Presidential Memorandum provides guidance to increase and better track biobased procurement as well as expand the list of designated biobased products available to the Federal government.

Bringing the topic of government procurement directly into the discussion on innovation policy is welcome step forward. I has long argued for a more pro-active role for procurement as an innovation policy (see earlier posting). As I noted before, government as a demanding customer can create the “thin opening wedge” — new products and services that have a specialized use. Once that specialized use is established, the product or service can be refined and adopted to a broader customer base. The demanding customer in fact becomes a co-creator.
There have been some examples of the Federal government, especially the Defense Department, using procurement to drive innovation. For example, DARPA is using the Experimental Crowd-derived Combat-support Vehicle (XC2V) Design Challenge as a means to foster innovation (see earlier posting). There are have also been some successes in government procurement in IT fostering innovative software solutions — although this has also provoked some skepticism.
But in general, the procurement tool has been left out of the innovation toolbox. The discussion of the role of government procurement in bioeconomy innovation may help spur a broader discussion — and a better development of this important policy tool.

Select tweets 6/4/12 – 6/10/12

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April trade in intangibles – and revisions

The U.S. trade deficit shrank by $2.5 billion in April to $50.1 billion, according to BEA data released this morning. Exports fell by $1.5 billion while imports were down by $4.1 billion. Imports of petroleum and non-petroleum goods were down, as were exports of non-petroleum goods. Curiously, exports of petroleum goods were up slightly. The decline was in line with economists’ expectation of a $49.4 billion dropped (according the Wall Street Journal). But the data suggest continued weakness in the global economy.
Our trade surplus in intangibles declined slightly in April, dropping by $157 million (from March’s revised level) to just over $13 billion. [Note that is about $1 billion less than reported last month – the change is due to the annual data revisions – see below]. The surplus in royalty payments increased slightly, with both exports (payments received) and imports (payments paid out) up. But business services saw a more than offsetting decline, with exports down and imports up.
Consistent with the overall trend, the deficit in Advanced Technology Products also dropped somewhat in April to $6.7 billion. The improvement was mostly due $2.4 billion drop in information and communications technology (ICT) imports — which offset a decline in aerospace exports. 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.
Also released today were the annual revisions going back to 2009. In general, the revision increase the size of the surplus in the mid-2009 to mid-2011 time period and reduce the surplus in the latter part of 2011. That description holds true for both imports and exports and for royalty payments and business services. Revised chart of the annual data are presented below.
Intangibles trade-Apr12.gif
Intangibles and goods-Apr12.gif
Oil good intangibles-Apr12.gif
Intangibles trade-2011 - April 2012 revision.gif
Annual - intangibles v goods 2011  after April 2012 revision.gif

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.

Intangible capital and creative destruction

I want to repeat and follow up on a point I made in yesterday’s posting. In that post I including the following quote from a Bloomberg story (“Zipcar Now Sees Enterprise in Rear Window”):

Enterprise is betting that its network of neighborhood branches will be a differentiator. With 5,500 locations, the company says 90 percent of the U.S. population is within 15 miles of one. Zipcar says about 10 million people live within a 10-minute walk of its cars.

I went on to note that Enterprise’s network of neighborhood branches might not be a competitive advantage, since one of the innovations in the car sharing model is by-passing the office and having close and easy access to the car. I also noted that fast-followers can run into difficulty adopting an innovation if it means changing their organizational model.
In other words, a company may have to abandon existing intangible assets in order to move forward. For example, the skills you have now may not be the skills you need tomorrow. The organizational set up you have now may not work tomorrow. The relational capital you have now may not be what you need to move into tomorrow’s markets.
In the case of Enterprise, their car sharing business probably will need a different distribution model. That is not to say that the neighborhood branches might not continue servicing the traditional market (which of course assumes that the car sharing market does not subsume the current rental car market). Or that the neighborhood branches somehow become useful in supporting the car sharing market. But the intangible asset created by the network of neighborhood branches may not be useful in the new model.
There are two take-away’s from this point:
1) the value of an intangible is contextual. In the case of the Enterprise branch network, it has value in the traditional rental car model. It may not have any value (or reduced value) in the car sharing model. Knowledge may be a “non-rival good,” meaning that it can be utilized by more than person simultaneously. But the value of the knowledge to each of those individuals might be vastly different.
2) the utility of an intangible asset needs to be constantly assessed and the asset upgraded or abandoned as necessary. Intangible assets are not fixed in time and space. They are subject to the forces of creative destruction and need to be reassessed and refreshed on a regular basis.
Intangibles need to be treated as a flexible resource rather than an immutable treasure. Knowledge and other intangibles may be precious, but they are existing in a changeable environment as well.