BEA’s first estimate of GDP growth in the 1Q 2014 shows a marked slowdown in economic activity with a growth rate of only 0.1% compared with a growth rate of 2.6% in 4Q. Economists had been expecting a more modest 1.2% growth rate. Keep in mind, however, that this is an advanced estimate subject to revision as more data become available in the next two months.
Intellectual property products (IPP), i.e. research and development; entertainment, literary, and artistic originals; and software, grew by 1.5% compared with 4.0% in 4Q13. While the severe winter weather was a factor in the overall slowdown in economic activity, it is unclear how much the weather affected IPP activity.
A new model of monetizing human capital has just opened for business. Yesterday, Fantex began trading shares backed by the future earning of football player Vernon Davis of the San Francisco 49ers. Unlike the standard asset-backed securitization (like the Bowie Bonds – see earlier posting) where the bonds are backed by future royalties, this linkage is indirect. As the New York Times (“I.P.O. Linked to Football Player Opens for Trading”) notes:
The investment does not give buyers a direct legal right to the athlete’s income. Investors accept a range of risks, even beyond the possibility that the player could become injured.
While the stock simulates owning a portion of an athlete’s brand, it is actually an ownership interest in Fantex itself, and the company is allowed after two years to dissolve the tracking stocks and convert them into shares of the management company.
Fantex explains that they are an brand building company and that this is a tracking stock, not an asset-backed security:
To finance the acquisition of the contracts, Fantex, Inc. intends to offer equity securities in Fantex, Inc. and establish a tracking stock linked to the separate economic performance and value of the brand associated with the tracking stock – such as income earned from contracts, endorsements and appearance fees. Fantex, Inc. will typically attribute 95% of the acquired brand income under the brand contract to the tracking stock. In addition Fantex, Inc. will attribute to the brand certain expenses of Fantex, Inc. including in certain cases specified expenses related to other tracking stocks that may be issued in the future. Holders of shares of a tracking stock will have no direct investment in the business or assets attributed to the brand contract, associated brand or athlete. Rather an investment in a tracking stock will represent an ownership interest in Fantex, Inc. as a whole.
The tracking stocks have been around for some time but idea of tracking a person’s future income is an new twist to the monetization process. These types of financial instruments allow for very specialized investments but are subject to portfolio problems and therefore high risk since they essentially bet on one particular asset. For this reason, most intangible-backed securitizations contain a pool of patents to spread the risk – such as Royalty Pharma’ patents portfolio.
It will be interesting to see whether this tracking stock model become a more wide spread means of intangible monetization.
A recent review in the Washington Post of Nikil Saval’s new book, Cubed: A Secret History of the Workplace, contains a great example of how Industrial Policy really works in the United States. It utilizes the tax code and is often inadvertent. The book is about the creation and spread of the open office concept — aka cubicles — and technically know as Herman Miller’s “Action Office.” The Post story (“9 Things You Didn’t Know About the Office Cubicle“) includes this little know fact:
6. The tax code is partly to blame for the cubicle’s spread.
Sales for Herman Miller’s design didn’t really take off, Saval writes, until other competitors started producing such “workstations” themselves. Yet the federal government played a role, too: “the Treasury in the 1960s made a slight but powerfully significant change in the tax code,” Saval writes, “making it easier for companies to write off depreciating assets. A shorter shelf life was established for furniture and equipment, while more permanent features of buildings had a longer range. In other words, it became cheaper to have an Action Office than an actual office.”
I have long argued that one only need to look carefully at the tax code to find the U.S. industrial policy. And that it is one of the worse type of industrial policy: non-transparent, generally not subject to any periodic review, and targeting specific industries/companies rather than promoting structural adaption and change.
One exception to that description is the so-called extenders — those specific tax breaks that Congress routinely extends for a limited time period. These include the R&D tax credit, mortgage debt tax relief and the deduction for mortgage interest payments, tax credits for employer paid mass-transit benefits, mine rescue team training credit, provisions on restaurant and retail store improvements, and various alternative energy tax credits – to name a few.
The Congress is currently in the process of once again addressing these tax provisions. Earlier this month, the Senate Finance Committee marked up the Expiring Provisions Improvement Reform and Efficiency (EXPIRE) Act. While the debate will be pointed on some of these provisions, I doubt there will be much discussion of the nature of the structural policy that emerges from the sum of these and all the other industry-specific provisions. To his credit, the new Finance Committee Chairman, Senator Ron Wyden, D-OR, sees the extenders bill as a stop-gap measure on the way to broader tax reform.
We will see whether that broader bill can take a more strategic and structural view of the tax code – if and when that broader bill ever emerges.
Today we are getting back to the theme of our short posting earlier this week on IP monetization. Specifically, let us look at a new briefing paper from the World Bank/OECD’s Innovation Policy Platform on Using intellectual property to raise finance for innovation.
The report looks at the dual role that intangibles (specifically intellectual property – IP) play in the financial system – in this case dual meaning both debt and equity financing. As a factor in debt financing, IP assets can serve four functions. IP can serve as a risk-mitigator — essentially a signally function to lenders that the business has a reasonable chance of surviving as an ongoing enterprise and therefore can pay back the loan. IP can service directly as collateral for a loan. IP can be used in a sale/lease-back arrangement with the lender that provides a secure cash flow. Finally, IP can be used in an asset-backed securitization to tap direct into the bond markets. In equity financing, IP serves as signaling function for investors (e.g. venture capital). IP can also generate direct cash flow to the company and shareholders in the form of licensing revenue and/or litigation awards.
The report goes on to cite various obstacles. From the point of view of companies, there is both a lack of awareness/capacity and barriers to access to IP in general. Markets for IP have problems with valuation, liquidity and uncertainty. Lenders and investors lack expertise and incentives to deal with IP as part of lending decisions.
The World Bank report comes to similar conclusions and recommendations as our various reports (see Intangible Asset Monetization: The Promise and the Reality, Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance, “Intangible Assets in Capital Markets”, “Intangible Assets: Innovative Financing for Innovation”, and “Building a capital market for intangibles”). It is also in line with the recent report from the UK Intellectual Property Office on Banking on IP? The role of intellectual property and intangible assets in facilitating business finance (see also earlier posting).
Policies to raise awareness and use of IP systems, such as:
• Subsidize the use of the IP system to reduce costs of gaining a patent;
• Build up IP awareness and business capacity in innovative firms;
• Improve access to IP services; and,
• Insure innovative firms against IP risks.
Policies to lower transaction costs in IP-based financing markets, such as:
• Improve the measurement and reporting of intangible and IP assets;
• Standardize the valuation of IP assets, such as patents;
• Improve access to information about IP assets;
• Remove uncertainties about patent quality; and,
• Create marketplaces to make IP assets more liquid.
Policies to raise awareness and use of IP by financiers, such as:
• Accept IP as collateral for lending by development banks and government guarantee schemes;
• Develop a culture and systems that allow banks to incorporate IP assets into their lending decisions; and
• Create incentives for banks to consider IP as collateral for loans under Basel III rules.
The briefing paper does not go into great detail about how to implement these policies. However, the discussion of them in the venue of the World Bank/OECD Innovation Policy Platform is very welcome. Let us hope that it spurs more interest and activity in further developing policies and programs to utilize intangible assets in financing activities. As I have stated before, there is a huge potential for innovation financing that remains untapped.
As you probably know, Thomas Piketty’s “Capital in the Twenty-First Century” has taken the intelligentsia by storm. The massive study of wealth and inequality is already a sold-out Amazon best seller with used copies selling for over 2X the original price (though I suspect it will be one of those books that only gets read by a fraction of those who have it on their bookshelves and nightstands – which is a shame). It is already the subject of demagoguery, a sign of its true importance.
In the spirit of full disclosure, I have not yet read the book — although I did attend one of Piketty’s many recent presentations (and listened via the web to others) and read a number of reviews. I won’t try to fully summarize the book, other than to say its major argument is that wealth inequality is baked into capitalism, but not because inequality is required for economic growth. Here are three reviews I think are especially useful.
Justin Fox’s “Piketty’s ‘Capital,’ in a Lot Less Than 696 Pages” in the HBR Blog. A good summary of the book.
Robert Solow’s review in the New Republic “Thomas Piketty Is Right” Everything you need to know about ‘Capital in the Twenty-First Century’.” A comprehensive review by the Noble-Laureate.
Tyler Cowen’s review in Foreign Affairs “Capital Punishment: Why a Global Tax on Wealth Won’t End Inequality.” Don’t let the title mislead you – this contains more than an argument against the wealth tax. Cowen carefully points out some of the possible flaws in the argument.
Note that all three reviews agree that this is an important contribution to economic thought. And as Cowen’s article points out, one that will be debated on theoretical and empirical grounds for many years.
A rather lackluster employment report this morning. The unemployment rate stayed at 6.7% and payrolls grew by 192,000. This was somewhat below economists’ expectations of 200,000 new jobs. The number of involuntary underemployed (part time for economic reasons) increased slightly in March. Both the number of workers part time because of slack work and the number of those who could only find part time work rose. Involuntary underemployment remains well above pre-Great Recession levels.
The trade deficit unexpectedly jumped up by $3 billion to $42.3 billion in February from $39.3 billion in January, according to BEA’s data release this morning. February imports were up by $1 billion and export down by $2 billion. Economists had expected the deficit to fall to $38.5 billion. The slowdown in exports is an especially unwelcome event, but not necessarily one that is seen as continuing.
Our trade surplus in pure intangibles also moved the wrong way, declining by $688 million to $15.5 billion. The decline was solely due to a surge royalty payments (imports) that swamped the increase in royalty receipts (exports). The trade surplus in business services grew as exports rose faster than imports. At least part of the increase in royalty payments was the result of payments for the television rights to the Winter Olympics.
The good news is that the deficit in Advanced Technology continued to improve, declining by almost $1.5 billion to $3.2 billion. And once again the improvement was due in large part to a drop information and communications technology imports. A more worrisome fact was the decline in the trade surplus in aerospace technology as imports rose and exports fell slightly.
Advanced Technology goods also represent trade in intangibles. These goods are competitive because their value is based on knowledge and other intangibles. While not a perfect measure, Advanced Technology goods serve as an approximation of our trade in embedded intangibles. Adding the pure and embedded intangibles shows an overall surplus of approximately $12.3 billion, up from $11.5 billion in January.
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.