The market in copyrighted images

Excited about billion dollar patent sales? How about a copyright valuation at $3.3 billion? That is what the Carlyle Group is paying to buy Getty Image. And just what are they buying? As the AP story puts it, Getty Images “creates and distributes still images, video and multimedia products for customers to use in brochures, websites and other outlets.” In other words, copyrights.
Interestingly, this is not a pure IP play, however. Getty is not just a holding company of images. They are an operating company that Reuters report on the deal noted that Getty “for the first time shot images at the Summer Olympic Games in London in 3-D and 360-degree formats using robotic cameras” and have “adapted to a shift in the media industry to online from print.”
So that $3.3 billion is based not just for the existing portfolio but on the ability of the company to continue to update and rejuvenate the portfolio and continue to keep it relevant to today’s market. That is something that analysts of patent portfolios should keep in mind as well.

What do we mean by "intangible assets"

There is a problem with our language. Specifically with the use of the phrase that is the cornerstone of this blog: “intangibles”. It is a word that gets used sometimes without a specific meaning but a general sense that can mean different things in different circumstances and to different people. Take for example this piece from the Wall Street Journal – “Paul Ryan’s Intangible Assets.” According to this analysis, Ryan’s popularity with conservatives and the fact that he is from a swing state are seen as his “tangible” assets. His intangibles are the average-man touch, the sportsman reputation, the Catholic factor and the energy he brings to the campaign.
Not what we normally see as the division between tangible and intangible assets. But one from a political analysis point of view makes perfect sense. Being from a swing state is about as tangible an asset as one can get in the Presidential race. One could, however, easily see all of these characteristics being called intangibles.
The problem with the phrase “intangibles” is that it is, well, intangible. It connotes something that is not quite real. Just like the concept of goodwill (see yesterday’s posting) and design thinking (see earlier posting), the words “intangibles” don’t necessarily completely capture the meaning.
The long standing alternative is “intellectual capital.” But that often gets confused with the narrower term “intellectual property.” The OECD has started using the phrase “knowledge-based capital.” However, as I showed in an earlier posting using Google’s Books Ngram Viewer, the phrase “intangible asset” has a much stronger usage history than either “intellectual capital” or “intellectual property” — although both of those phrases show up earlier. “Knowledge-based capital” is too new to have much of a usage history.
My real concern is that none of these really convey the meaning I think we wish to ascribe to the phrase. Is a customer list “intellectual”? Is reputation “knowledge-based”?
Over the long run, we need to develop a new vocabulary for this new economy. This will take time but will happen. I note that Arnold Toynbee’s lectures on “The Industrial Revolution” which popularized that phrase were in the 1880’s — over a century after the beginning of the Industrial Revolution but still while the process was ongoing. I would also note that words do change over time. For example, factory originally meant a trading post, not a place where goods were produced.
So, let’s work on crafting a new language. In the meantime, I plan on continuing to use the term “intangibles” — even though it may not be perfect.

The problem with "Goodwill"

Is it real or is it … (to paraphrase an old commercial).
The Wall Street Journal has a piece today about accounting and “goodwill” (“Buyers Beware: The Goodwill Games“). Goodwill is considered that part of the purchase price of a company that is left over once you accounted for everything you can account for. Usually that means once you have subtracted out “hard assets” and those intangibles that you can put a value on (e.g. patents). According to the Journal, a number of companies have high levels of goodwill including six where the value of the goodwill on the books is greater than the market capitalization. The story says that this is an indicator of a future loss in the value of the company as the goodwill is written off.
Not so fast.
There is a lot going on in goodwill accounting. Yes, there have been some big write downs lately (such as HP’s $8 billion write off). But large good will doesn’t necessarily mean write downs are coming. Maybe the company is simply undervalued in the market and is a candidate for value investors. On the other hand, what gets thrown into the category of goodwill is mishmash. Some of it is intangibles that accountants don’t bother to break out. Some of it is important intangibles that are difficult to break out. Some of it is just buyer expectations (from “synergy”) that may or may not play out. Some of it is simply overpaying.
As I noted in an earlier posting, accountants routine attribute most of the cost of an acquisition to goodwill. A study from Ernst & Young (Acquisition accounting: What’s next for you) of over 700 acquisitions across a variety of industries as reported in 2007 annual reports noted 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. In almost a quarter of the transactions, goodwill was the only type of intangible — no other type of intangible was reported.
So I take the Journal’s finding of a high level of goodwill not as a sign of pending doom — but as an indictment of the failure of our accounting system. Solving the problem of accurate accounting for intangibles will go a long way to solving the “problem” of goodwill. Granted there will always be over expectations/overpayment. And not all intangibles that make up an acquisition can necessarily be valued in dollars and cents. But being able to understand the difference between monetizable intangibles, other intangibles and market froth will help investors and others (i.e. managers) better understand what the company is really worth.

Tacit knowledge in the standardized production process

The New Yorker has a great article by Atul Gawande (“Can Hospital Chains Improve the Medical Industry?”) that looks at whether standardization of processes is possible and worthwhile in hospitals. The answer is yes. For example, knee replacement surgery was standardized by a group at Brigham and Women’s Hospital in Boston:

A few years ago, [Dr. John Wright] gathered a group of people from every specialty involved–surgery, anesthesia, nursing, physical therapy–to formulate a single default way of doing knee replacements. They examined every detail, arguing their way through their past experiences and whatever evidence they could find. . . . they studied what the best people were doing, figured out how to standardize it, and then tried to get everyone to follow suit.

Wright is quotes as saying “Customization should be five per cent, not ninety-five per cent, of what we do.”
What is especially fascinating about the article is that the author (himself a physician) went looking at the restaurant industry for insight as to how thousands of meals at casual dining chains come out both affordable and tasty:

It’s easy to mock places like the Cheesecake Factory–restaurants that have brought chain production to complicated sit-down meals. But the “casual dining sector,” as it is known, plays a central role in the ecosystem of eating, providing three-course, fork-and-knife restaurant meals that most people across the country couldn’t previously find or afford. The ideas start out in √©lite, upscale restaurants in major cities. You could think of them as research restaurants, akin to research hospitals. Some of their enthusiasms–miso salmon, Chianti-braised short ribs, flourless chocolate espresso cake–spread to other high-end restaurants. Then the casual-dining chains reengineer them for affordable delivery to millions.

But least you think that this is strict mindless assembly line type of work, Gawande gives us this description of watching grill chef Mauricio Gaviria at work in one Cheesecake Factory restaurant. Each work station has a computer monitor that displays both the order and the recipe for that order:

I brought up the hibachi-steak recipe on the screen. There were instructions to season the steak, sauté the onions, grill some mushrooms, slice the meat, place it on the bed of onions, pile the mushrooms on top, garnish with parsley and sesame seeds, heap a stack of asparagus tempura next to it, shape a tower of mashed potatoes alongside, drop a pat of wasabi butter on top, and serve.
Two things struck me. First, the instructions were precise about the ingredients and the objectives (the steak slices were to be a quarter of an inch thick, the presentation just so), but not about how to get there. The cook has to decide how much to salt and baste, how to sequence the onions and mushrooms and meat so they’re done at the same time, how to swivel from grill to countertop and back, sprinkling a pinch of salt here, flipping a burger there, sending word to the fry cook for the asparagus tempura, all the while keeping an eye on the steak. In producing complicated food, there might be recipes, but there was also a substantial amount of what’s called “tacit knowledge”–knowledge that has not been reduced to instructions.
Second, Mauricio never looked at the instructions anyway. By the time I’d finished reading the steak recipe, he was done with the dish and had plated half a dozen others. “Do you use this recipe screen?” I asked.
“No. I have the recipes right here,” he said, pointing to his baseball-capped head.

That is a great description of work in a great number of areas that combine standardization with worker tacit knowledge. But the system doesn’t completely rely on tacit knowledge. The Cheesecake factory has a kitchen manager who makes sure that every order is right before it goes out to the customer – thus insuring the standard is maintained. Thus, tacit knowledge works in conjunction with the standardization, not against it.
A good example that many other industries have and should follow.

June trade in intangibles

The trade data for June released this morning by BEA has some unexpected good news. The deficit fell by $5.1 billion to a total of $42.9 billion. Economists had expected only a slight decline to $47.6 billion. Exports were up by $1.7 billion and imports were down by $3.5 billion. In May export had also risen and imports declined. Unlike last month when the improvement was due to lower oil imports, June saw an improvement in both petroleum and non-petroleum goods with imports down and exports up in both categories. The largest improvements in the deficit was due to oil imports being down and goods exports rising. That is a very good trend. (And, by the way, may result in an upward revision of the latest GDP numbers as the estimate was based on the expected size of the trade deficit.)
The not-so-good news is that our trade surplus in intangibles declined slightly in June after rising in May and declining in April. The intangibles surplus was down by $69 million to just under $13 billion. Interestingly, there was a major revision to the May data which originally showed an increase of $99 million but was revised to an increase of $255 billion. In June, royalty payments were essentially unchanged (down by $5 million) with both exports (payments received) and imports (payments paid out) up. The overall decline was due to business services where exports declined and imports grew.
The good news also carried over to the deficit in Advanced Technology Products, which dropped by over $1.5 billion in June to $7.2 billion. While almost every category saw an improvement in the deficit, information and communications technology (ICT) and electronics deficits increased, led by an almost $1 billion increase in ICT imports. 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.
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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.

Return of intangible securitization?

Are we seeing a return of the Bowie Bonds? According to a story in the Wall Street Journal (“Bob Dylan and Neil Diamond Become a Selling Point for Bonds“) there is a new bond offering similar to the Bowie Bonds of the late 1990s:

A privately held Nashville, Tenn., company is preparing a $300 million bond backed by the cut it receives as a middleman between music companies and songwriters and the outlets that broadcast their music.
The company, Sesac Inc., has the exclusive rights to the public broadcast or performance of the music of Mr. Dylan, pop singer Neil Diamond, Canadian rock band Rush and jazz singer Cassandra Wilson.

However, don’t expect a major rush to the bond market. S&P gave the bonds a BBB- rating and expect to have a yield of 5.25% (compared to Treasurys at 0.7%). That makes it enticing for investors but expensive for the borrowers.
And, as another story in the WSJ notes, rating agencies continue to be skeptical of unorthodox deals:

Fitch Ratings analysts say they are unlikely to grant high credit ratings to a first wave of Wall Street deals backed by rental payments on single-family homes, citing the lack of data on how often tenants pay their rent on time.

Still, intangible-backed securities could be making some headway in the market as investors look for higher returns. But remember, these deals are based on the royalty stream associated with the intangible. As we noted in our earlier reports (Intangible Asset Monetization: The Promise and the Reality and Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance), the evolution of robust capital markets that both utilize and support intangibles has been slow. The Sesac deal builds on the previous wave of monetization; it does not appear to break new ground.