Communicating the value of intangible assets
If an asset is weightless, colorless, and odorless, and leaves no trace on the balance sheet, does it exist? You would not expect IROs and accountants to engage in such philosophical speculation, but these days many are sounding positively metaphysical as they discuss the growing intangibility of the business world, and the importance of corporate assets that can't adequately be measured in dollars and cents.
'Everything's becoming more intangible,' says Charlotte Borger, a public relations consultant at Borger & Killeen in London. Factories that produce tangible goods are losing ground to service providers and Internet-based businesses with difficult-to-explain functions.
Not only has the essence of business become less tangible, but a company's assets are more likely to be conceptual rather than concrete. Intangible assets like goodwill, R&D, patents, copyrights, brands, culture, training, customer relationships, and employee know-how may be critical in determining which companies win in the marketplace. But these are awkward things to discuss with shareholders.
Mind Wrap
For IROs, communicating about intangibles can be a tricky business because intangibles are, by definition, hard to wrap your mind around. Baruch Lev, professor of accounting and finance at New York University's Stern School of Business, says IROs searching for a way to discuss intangible assets shouldn't turn to the accounting system for help: 'Right now, we don't have a good way of measuring intangibles.'
Lev also contends that companies grossly underestimate the role intangible assets play in investment decisions. Arguably, he says, intangible assets are three to six times as influential in determining the price of a stock as a company's balance sheet assets.
As evidence, he points to the three-to-one ratios between the market and book values of the average company and the six-to-one market-to-book ratios for high-tech concerns. In other words, investors are willing to pay as much as six times the dollar value of a company's tangible assets for that certain je ne sais quoi that makes the whole worth more than the sum of its parts.
Since many biotech start-ups have no profits to recommend them, IROs in this industry live or die by their ability to inspire faith in an intangible future. Oxford-based British Biotech, for instance, was launched as an IPO in 1992 and is currently capitalized at around ú1.7 bn, yet its first product isn't on the market and it has only recently entered the final stage of clinical trials.
Katie Arber, British Biotech's head of corporate communications, says that when talking to investors, she highlights the company's strategy and the track record of its executives. Next, she attempts to educate people about the quality of British Biotech's pipeline, which features a class of drugs called matrix metalloproteinase inhibitors. 'What we can't talk about,' she acknowledges, 'is sales and profits.'
Lacking traditional benchmarks of success, Arber has had to teach fund managers, analysts, and individual investors about the biotechnology industry, mapping out the specific milestones that lie before a company like hers. Once British Biotech rolls out its first product, Arber says that her educational mission will shift from explaining the R&D process to prepping investors about commercialization and product launches.
IROs outside the biotech sphere may not experience quite the same pressure to communicate about intangibles, but most successful companies find ways to make intangibles more, well, tangible, says Charlotte Borger. To accomplish this, she recommends that IROs make internal processes as clear and detailed as possible, creating compelling investment stories whenever possible.
Kris Chellam, CFO of Atmel Corporation in California, says that the chips his company manufactures aren't 'sexy,' and to set his company apart from the pack, he must place his company's story within the larger context of the electronics industry. Atmel, explains Chellam, is concentrating on non-volatile memory chips that retain information without a power supply and are therefore ideally suited for the rapidly growing segment of cellular phones, laptops, and other portable applications.
'It's very hard for a portfolio manager to accurately assess the competitive landscape and the viability of one technology,' says Chellam, noting that this is exactly why context is so critical. Chellam tells the story of how Atmel is harnessing the growth potential for non-volatile memory chips every chance he gets - in the materials the company publishes, in its annual report, presentations, and in one-on-one meetings with analysts and portfolio managers.
A supplier of automotive interior systems, Michigan-based Lear Corporation takes the concept of making the intangible concrete one step further. Jonathan Peisner, Lear's IR director, invites portfolio managers and analysts to view Lear's intellectual capital firsthand by taking them on a tour of the company's technology center. 'When you see the center for yourself - most people are visual - the light bulb comes on,' explains Peisner. 'You see the acoustic technology center and what it does for the company.'
Quantifiable Assets?
In the 1980s, companies began to attach values to intangible assets, primarily for tax purposes, recalls Howard Scribner, senior manager in the valuations services group of Arthur Andersen, New York. When a company merged or acquired assets, managers discovered they could take the same tax deductions for realistically-valued intangible assets as they could for tangible ones. A handful of far-sighted leaders also recognized that estimating the worth of intangible assets could be central to making strategic decisions for the future.
One problem with quantifying intangible assets is that 'intangibles' is a catch-all phrase, referring to everything from financially-oriented categories like R&D and patents to far fuzzier concepts like corporate identity. Devising a formula to determine the worth of a patent is relatively straightforward, says Scribner, while quantifying the contribution of a particular employee involves a debatable judgement call.
Here's how Scribner values patents. Given that patents are only awarded for unique technology, he endorses the 'relief from royalty approach,' or calculating how much a company actually saves by holding a patent rather than paying royalties for leasing the technology from an outsider. Valuing patents does, of course, involve some educated guesswork. For instance, to calculate the value of a technology, the company has to estimate the increase in operating profits that the patent will bring over its economic lifetime.
However, not all accounting experts believe that placing numerical values on intangible assets is a productive exercise. Ron Paterson, head of the technical department at Ernst & Young, London, says that there's been a long-running debate in Europe over the extent to which intangibles belong on the balance sheet. He personally believes that intangibles aren't balance sheet material because any attempt to value an intangible asset simply represents one individual's opinion.
Paterson also takes exception to the claim that intangibles lack all representation on the balance sheet. If intangibles allow a company to post strong results, they are then reflected within those results. In other words, Paterson contends that intangibles should not be explicitly listed on the balance sheet because they're part and parcel of the revenues a company posts.
Valuing Without Numbers
If a scale of intangibility existed, brand equity, people, and culture would rank among the least tangible of all assets. Brands, in particular, seem as ineffable as they are influential. The investment community clearly recognizes the importance of brand loyalty, but the majority of analysts and portfolio managers don't attach numerical values to brand names, says Jon Greer, director of investor relations for 3M in Minnesota. Nor does Greer think IROs should attempt to place financial values on their brands: 'It's probably not something that the auditors would sign off on.'
Ulla James, Nokia's European investor relations manager, takes communicating about brands very seriously. Internally, the company conducts surveys gauging customers' awareness of Nokia brand mobile phones, but she does not relate the results of these surveys directly to analysts, portfolio managers, and individual investors. 'We communicate more about the parameters of what's important than about the absolute values,' says James.
For other companies, the key intangible asset is the assembled workforce. At investment banks, advertising firms, and mutual fund companies, managements often joke that the assets go home every night at five or six o'clock and return the next morning. Confronted with an asset as intangible as the capability of individual employees, IROs have little choice but to demonstrate aspects of the corporate culture through visits, the corporate Web site, and meetings with top performers and management.
The most obvious way to offer a glimpse into intangible assets like people and corporate character is the annual report, says Jane Gundell, executive vice president of Straightline International, a design and communications firm based in New York. Gundell singles out Disney for having distilled the essence of its corporate culture in its annual report. 'Michael Eisner writes a letter to the shareholders from his home in New England,' says Gundell, noting that this friendly touch personalizes the company's financial performance. Profiles of senior management and photo essays are other ways of capturing the atmosphere of a company, she says.
Naturally, not every company wants a touchy-feely image. Gundell notes that the Bank of New York's communiquÄs to investors are strictly business, reflecting the company's dedication to delivering shareholder returns. 'Whatever expense can be spared in creating the [Bank of New York] annual report is a good thing,' she observes.
More Awareness Ahead
If intangible assets are arguably three to six times as instrumental in determining share price as tangible assets, why do so many IROs overlook those assets not found on the balance sheet?
For some companies, communicating too fully about products in the pipeline is problematic. 'You want to create an image of innovation without giving away the store,' says Straightline's Gundell. 'Microsoft isn't about to tell you what they're working on because they don't want everyone following their tails.'
Scribner suggests that some companies have created an impression of innovation without tipping their hands. As an example, he cites Lucent Technologies. Lucent's print ads openly boast that the company invented the transistor 50 years ago without divulging anything about what its scientists are working on today.
Being too forthcoming about a company's R&D budget can also cause problems. Ulla James publishes R&D expenditures for Nokia, but she's found that R&D numbers are controversial. According to James, analysts want a company to invest in the future, but are easily dismayed by the toll R&D expenditures take on the bottom line.
Portfolio managers and analysts with an eye on short-term profits might be one reason why IROs are not more forthcoming about intangible assets. However, Arthur Siegel, a partner at Price Waterhouse in Connecticut, maintains that this is but one of several forces at play. He suspects that IROs are hesitant to talk about intangibles because the conversations are difficult to frame. 'Today's companies are attempting to communicate about [intangibles] in fits and starts,' says Siegel.
NYU's Lev maintains that pressure for companies to pay more attention to intangible assets is building within academia and some government agencies: 'There is huge awareness and concern about these issues, but it won't change overnight.'
No matter how slow in coming, he believes that greater recognition for intangible assets is inevitable. 'The future,' concludes Lev, 'is in intangibles.'
Walking the R&D Talk: 3M
Communicating about R&D is an increasingly important issue for all companies, even those far afield from Silicon Valley and the high-tech sphere. Minnesota-based 3M - which makes household and industrial products - has earned a formidable reputation for innovation precisely because it has made its R&D goals concrete, attaching numerical targets to them. At 3M, employees working on R&D can spend up to 15 percent of their time on projects of their own devising. 'Innovation is really the lifeblood of 3M. It's the engine of growth,' says Jon Greer, director of investor relations. 'To quote numbers like this helps.'
3M has set the aggressive goal of generating 30 percent of sales from products developed within the past four years. Greer points out that such a goal underscores the outcome of R&D, rather than calling attention to the research dollars spent. In 1996, for instance, Greer says that 3M generated $4.2 bn - or 29.2 percent of the company's total sales - from products developed within the past four years.
3M prides itself on the new markets it's pioneered for products like Scotch tape, water-proof sandpaper, and Post-It notes. 'Nobody ever said they needed a Post-It note,' says Greer. 'This is something we invented and then had to find a use for.' Greer believes that only when intangible assets are deeply rooted in the reality of the company will investors recognize their value. The truth, says Greer, is that 3M has a demonstrable history of innovation and the pace at which it's creating new products is accelerating.
When placing a value on R&D, Howard Scribner at Arthur Andersen advocates comparing the money spent developing a product against its potential for future profits. To do this effectively, a company needs to understand the industry as a whole and gauge the demand for a given item.
For instance, Scribner points out that within the pharmaceutical industry, the first drug of its kind could earn $100 mn, while the third runner-up might only do one-tenth as well. Because it's so easy to let passion for a particular pet project to cloud one's reason, Scribner advises companies to take a team approach when assessing the value of intellectual property.