Introduction to Intangible Assets

Valuation

Transaction

Consulting

Real Estate

Advisory

Fixed Asset

Management

Introduction to Intangible Assets

®

Introduction to Intangible Assets

Presented by Varun Gupta

Agenda

Introduction and Overview of Objectives

Section One: What Are Intangible Assets?

Section Two: Why & How We Value Section Two: Why & How We Value

Intangible Assets?

Section Three: Reconciling the Valuation of

Intangible Assets

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Instructor:

� Managing Director, American Appraisal India Pvt. Ltd.

� MBA from IIM Calcutta

� Over 14 years of Financial Advisory experience

� 11 years in PwC

Introductions

� 2 years in Deloitte

� 1 year at American Appraisal

� Key experience

� Business and intangible assets valuation

� Financial planning and business modeling

� Contact Details

� Email: [email protected]

� Mobile: +91 99 6766 4231

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The overall objective of this course is to provide you with a workingknowledge of intangible assets, why and how they are valued, and how theyrelate to the overall business enterprise

By the end of this course, you should be able to:

�Define intangible assets

Course Objectives

�Define intangible assets

�Describe the major categories of intangible assets

� Identify the commonly recognized intangible assets

�Define the three most common valuation approaches

�Assess which valuation approach(es) best applies to some of the individual intangible assets

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Section One:What Are Intangible Assets?

Agenda

Section One: What Are Intangible Assets?

Accounting Balance Sheet v/s Valuation Balance Sheet

Definition and Overview

Types of Intangible Assets

Types of Intangible Assets Defined

Q&A

5


CompanyBook Value

(INR Bn)

Market Value

(INR Bn)

Premium over Book

Value

Hindustan Unilever Ltd. 20.6 517.7 2,411%

Book Value and Market Value (as of March 31, 2009)

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Hindustan Unilever Ltd. 20.6 517.7 2,411%

Infosys Technologies Ltd. 182.5 758.4 315%

ITC Ltd. 137.4 697.7 408%

* As of March 31,2008


NET WORKING CAPITAL

Accounting Balance Sheet Valuation Balance Sheet

NET WORKING CAPITAL

FIXED ASSETS

INTANGIBLE ASSETS

FIXED ASSETS

LONG - TERM

DEBT

BOOK VALUE

OF

EQUITY

MARKET VALUE OF

LONG-TERM DEBT

MARKET VALUE

OF EQUITY

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FIXED ASSETS

Definition and Overview

AS 26(6) of ICAI defines an Intangible Asset as:

“an identifiable non-monetary asset, without physical substance, held for

use in the production or supply of goods or services, for rental to others, or

for administrative purposes.”

IAS 38.8 of International Accounting Standard defines an Intangible Asset as:

“An identifiable nonmonetary asset without physical substance”

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Try to name some of the potential intangible assets a business enterprise may possess

Potential Assets

�Customer Relationships

�Contracts

�Trademarks / Trade Names


�Trademarks / Trade Names

� Internally Developed Software

� In Process Research and Development

�Favorable Vendor Agreements

�Non-Compete / Non-Solicitation Agreements

�Trained and Assembled Workforce

�Applicable Licenses

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Intangible assets can be classified into the following categories.

�Marketing-related intangible assets

�Customer-related intangible assets

�Technology-based intangible assets

�Contract-based intangible assets


�Contract-based intangible assets

�Artistic-related intangible assets

�Other intangible assets

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Definition

�Primarily used in the marketing or promotion of products or services

Types of assets

�Trademarks, trade names

�Service marks, collective marks, certification marks

Marketing-Related Assets

�Service marks, collective marks, certification marks

�Trade dress (unique color, shape, or package design)

�Internet domain names

�Noncompetition agreements

Most commonly valued assets

�Trademarks and trade names

�Noncompetition agreements

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Trademarks

�Any word, name, symbol or device or other devices used in trade to indicate the source of a product and to distinguish it from the products of others

�Legal Protection via

– Patents

– Copyright


�Examples

– Reliance “R”

– Nike swoosh

– Coca-Cola script

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Trade names

�Name under which a particular business is carried on by a company

–Trade name is the name of the company, while the trademark is related to the products or

services sold by that company

�Examples

–Britannia, Kingfisher and Nokia names


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Internet domain name

�Unique alphanumeric name that is used to identify a particular Internet address, such as american-appraisal.com or icai.org

Noncompetition Agreements

�Agreement between buyer and seller of a business that restricts seller from competing in the same industry for a specific period of time, often within a defined geographic area


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Definition

�Relate to customer structure or customer relationships of the business

Types of assets

�Customer lists

�Order or production backlog

Customer-Related Assets

�Order or production backlog

�Customer relationships (contractual and non contractual)


�Customer relationships (contractual and non contractual)

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Customer Lists

� Information about customers such as name and contact information

–May also include other information such as order history and demographic information

�Although generally not derived from contractual or other legal rights, they are valuable and are frequently leased or exchanged.

–Doctor or attorney client lists, magazine subscriber lists

Customer-Related Assets

Order or Production Backlog

�Source of future earnings from sales that have already been closed but not yet fulfilled

�Strong backlog can represent a guarantee of future profits

Customer relationships

�A relationship exists between an entity and its customer if:

–the entity has information about the customer and has regular contact with the customer; and

–the customer has the ability to make direct contact with the entity.

�Can be contractual or non contractual

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Definition

�Relate to innovations or technological advances and are often protected through contractual or other legal rights.

Types of assets

�Patented and unpatented technology

Technology-Based Assets

�Computer software

�Trade secrets


�Computer software

�Patented and unpatented technology

�Databases

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Patented technology

�A patent gives the inventor “the right to exclude others from making, using, offering for sale,or selling” the invention.

�Legal protection

–A patent does not protect an idea but rather its embodiment in a product or process

–“Patent Applied For” or “Patent Pending” have no legal effect

–Patent protection ranges from 14 to 20 years


–Patent protection ranges from 14 to 20 years

–The standards of what is patentable and their duration differ from country to country

Trade secrets

� Information, including a formula, pattern, compilation, program, device, method, technique,or process, that

–derives actual or potential independent economic value from not being generally known, and

–is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

�Legal protection

–Patentable in many cases, but not often elected

–Potential relief in court if someone else improperly acquires or discloses the trade secret

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Computer software

�Two categories

–Product software for sale or license

–Operational software for internal use


�Under certain circumstances, computer software may be subject to copyright, patent, or trade secret protection.

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Definition

�Rights that arise from contractual arrangements


�Licensing and royalty agreements

Contract-Based Assets

�Licensing and royalty agreements

�Lease agreements

�Supply contracts

�Service contracts

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In process research & development (“IPR&D”)

�An asset is classified as IPR&D if it is a development project that has been initiated and has achieved material progress, but has not yet resulted in a technologically feasible, commercially viable product.

Other Intangible Assets

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Goodwill

�Value of an enterprise that cannot be associated with any other asset

–Going concern value

–Excess economic income

–Expectation of future events not related to current operations

Other Intangible Assets

Assembled workforce

�Value in avoiding the costs to locate, hire, and train employees

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Questions?

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Section Two:Why and How We Value Intangible Assets

Agenda

Section Two: Why and How We Value Intangible Assets

Introduction

Valuation Purposes

Valuation ApproachesValuation Approaches

Tax Benefit of Amortization

Expected Remaining Life

Q&A

25

Regulatory Compliance

Financial reporting requirements as per the different accounting standards:

�Financial Reporting Requirements as per IFRS

–IFRS 3 – Business Combinations

–Revised IAS 36 – Impairment of Assets

–Revised IAS 38 – Intangible Assets

Valuation Purposes

–Revised IAS 38 – Intangible Assets

�Financial Reporting Requirements as per Indian GAAP

–AS 26 – Intangible Assets

�Financial Reporting Requirements as per US GAAP

–SFAS 141 – Business Combinations

–SFAS 142 – Goodwill and Other Intangible Assets

–SFAS 157 – Fair Value Measurements

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Other uses for intangible asset valuation

�Transaction assessment

�General corporate planning and governance

�Financing (collateralization)

�Bankruptcy proceedings

–Liquidation value

Valuation Purposes

–Liquidation value

�Litigation support and dispute resolution

�Business formation and dissolution

–Contribution of intangible assets by parties

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Valuation Approaches

Income Approach

Based on the present value of expected future cash flows to be derived from ownership of the asset

Based on transactions involving

the sale or license of similar

intangible assets in the

marketplace

Cost Approach Based on the cost to reproduce

or replace the asset

Market Approach

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Relief From Royalty Method

�Based on the cost savings of not having to pay a royalty to a third-party for use of the asset

�Common applications

–Trademarks and trade names

–Patents

Valuation Approaches – Income

–Patents

–Developed technology


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Multi-Period Excess Earnings Method

�Based on present value of prospective net cash flow (or excess earnings) attributable to the asset


–Brands

–Customer Contracts/Relationships


–Backlog

–IPR&D

–Contracts/Licenses

–Developed technology


–Copyrights

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Other Incremental Income Methods

�Based on a comparison of the present value of the prospective revenues or expenses for the business with and without the asset in place


–Noncompetition agreements


–Noncompetition agreements

–Favorable or unfavorable agreements and contracts

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Principle of substitution

�A buyer would pay no more for an asset than the cost to develop or construct an investment of equal utility

Cost approach is appropriate when either:

Valuation Approaches – Cost

�A perfect substitute for the intangible asset can be developed more cost effectively in-house, or

�Stage of development is so early that reliable forecasts of future benefits or markets do not exist

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Methodologies

�Replacement cost

–Cost (at current prices) to recreate the utility of the asset, using modern materials, production

standards, design, layout and quality of workmanship

�Reproduction cost

–Cost (at current prices) to construct an exact replica of the asset, using the same materials,


–Cost (at current prices) to construct an exact replica of the asset, using the same materials,

production standards, design, layout, and quality of workmanship

Common applications

�Assembled workforce

� Internally developed/Internal use software

�Engineering drawings

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Required inputs

�Three components of cost that need to be considered:

–Materials - Costs related to tangible elements of development

–Labor - Costs related to the human-capital elements of development

–Overhead - Management and supervisory, support and administrative, and utility and operating

cost elements of development


�Two components of cost that may be considered:

–Intangible asset developer's profit

• Percentage return on developer's investment, or

• Fixed Rupee amount

–Entrepreneurial incentive

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Obsolescence - reflects that value is not necessarily equal to the sum of historical costs

�Physical deterioration

–Wear and tear resulting from continued use

�Functional obsolescence

–Diminished function or utility due to design and construction features


�Technological obsolescence

–Innovative changes that allow for lower cost, more efficient, or higher quality production, resulting in same or superior utility

�Economic obsolescence

–Results from external factors such as changes in interest rates, inflation, required rates of return, and levels of supply and demand

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Premise

�Based on guideline transactions involving similar intangible assets and similar market conditions

Common applications

�Least commonly used approach to value intangible assets due to lack of an integrated market for specific intangibles

Valuation Approaches - Market

market for specific intangibles

�Most commonly used to corroborate values from other approaches or establish a range of values

–Trademarks, trade names, and patents

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Amortization of acquired intangible assets reduces taxable income and creates an amortization tax benefit

As such, the value of an intangible asset is equal to the present value of:

�The asset’s after tax cash flows (excluding amortization of intangible assets); and

Amortization Tax Benefit

�The tax benefit resulting from the amortization of the intangible asset for income tax purposes

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The period over which an asset is expected to contribute to future cash flows

Expected Remaining Life depends upon following factors:

�The expected use of the asset by the acquirer and target

�The expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate

Expected Remaining Life

intangible asset may relate

�Legal, regulatory, or contractual provisions that may limit the useful life or enable renewal or extension of the asset’s legal or contractual life without substantial cost

�Effects of physical deterioration, functional obsolescence, technological obsolescence, and economic obsolescence

�Level of maintenance expenditures required to obtain the expected future cash flows from the asset

�Estimation of the future benefit derived from the trademark and trade name

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Questions?

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Section Three:Reconciling the Valuation of Intangible Assets

Agenda

Section Three: Reconciling the value of intangible assets

Introduction

Required Rates of ReturnRequired Rates of Return

Reconciling Value Indications

Q&A

41

Required rates of return attempt to estimate the return a typical investor would require

�Dependant on perceived risk, liquidity

The weighted average cost of capital or “WACC” is the required return on a business entity’s invested capital (i.e. equity and debt).

Required Rates of Return

business entity’s invested capital (i.e. equity and debt).

�WACC = (% Debt * Kd * (1-Tax Rate)) + (% Equity * Ke)

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The component assets of a business require different returns

�Disparate returns reflect differences in perceived risk and liquidity

� Intangible assets are often considered the highest risk assets of a business enterprise due to:

–Lack of versatility

–Illiquidity


–Susceptibility to competitive forces

�Goodwill generally has the highest required rate of return

–Usually appears last in the development of a business

–Disappears first in a business demise

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The valuation balance sheet revisited

UnderlyingAssets

Required Return=WARA=15.0%

Invested Capital Value

Required Return=WACC=15.0%

Normal Working Capital

Required Return 6% Market Value of Interest-

Bearing Debt

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Required Return 8%Tangible and Other Assets

Required Return 8%

Intangible Assets

Required Returns

Patented Technology: 18%

Customer Relationships: 22%

Goodwill: 23%

Market Value of Equity

Required Return 20%

Established business operations – intangible asset risk factors

�Degree of liquidity and versatility

�Ability to finance with debt versus equity

�Barriers to entry/Degree of competition

�Rate of technological innovation in the market

�Size of the market


�Size of the market

�Ability to maintain customer loyalty

�Personnel risk (retention of employees with key expertise)

�Other risks specific to the intangible asset or its industry

In these instances, the required return can be estimated as a premium to the WACC or the cost of equity of the company

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Development-stage companies – intangible asset risk factors

�Remaining time to market

�History of the company bringing products to commercial success

�Probability of market and customer acceptance

�Viability of technology


�Viability of technology

�Probability of regulatory approval

�Anticipated competitor response

�Risk of achieving price/performance expectations

In these instances the intangible assets are typically 100 percent equity financed

�Venture capital rates of return can be used to approximate return requirements

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Contact details

Varun Gupta

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Varun GuptaManaging Director

American Appraisal India

Mobile: +91 99 6766 4231Office: +91 22 4070 0123

[email protected]

Documents

Introduction to Intangible Assets