Valulation

1. Valuation of Intellectual
Property Assets
Professor Derek Bosworth
Intellectual Property Research Institute
of Australia
Melbourne University

2. Coverage of the presentation
• IP as a component of IC
• Nature of the management problem
• The Diageo problem
• Nature of the accounting problem
• Accounting issues surrounding intangibles
• Accounting methods for intangible assets
• Options pricing and optimal stopping
• [Other strategic issues]

3. Not covered in the presentation
• Economic approaches to valuation
Production function and market valuation –
dealt with in a previous presentation
Patent valuation analysis – using renewal
data
• Methods of valuing product characteristics
Conjoint analysis (marketing)
Hedonic analysis (economics)

4. IP as a component of IC

5. Intellectual
Capital
Human
Capital
Relational
Capital
Organisational
Capital
Intellectual
Property
“Sociological”
Skills and
Capital
“Technological”
Skills and
Competencies
Infrastructure
Capital

6. Organisational (structural) capital:
examples of IP/IPRs
• patents
• copyrights
• design rights
• trade secrets
• trade marks
• service marks
• trade dress
• utility models
• plant & seed varieties

7. Nature of the management problem

8. Why Value Intellectual Capital
• Measurement of IC - enables a more efficient
management of the company - i.e. to:
understand where value lies in the company
have a metric for assessing success and growth
provide a basis for raising finance or loans
• If borrowing can only be secured against
tangible assets, then knowledge-based
companies will be disadvantaged in
investment and growth.

9. The Diageo problem

10. Diageo: the company
• Grand Metropolitan - formed as a hotel
company in 1962
• by mid-1980s strengths in variety of
branded products
• became known as Diageo in 1997, on
merger with Guiness

11. Previous accounting practice
• GrandMet – often bought and sold brands
• Acquired Heublein from Nabisco in 1987
• Paid £800 million, of which over £500 million
was for the Heublein brands (i.e. intangibles)
• Given the accounting procedures at the time,
GrandMet published its next set of accounts in
January 1988
the Heublin brands were not valued
£565 million of the £800 million paid for the company
was written off as goodwill against reserves
as a result, the balance sheet net assets fell, giving
the impression than £565 million had been wasted

12. Changed accounting practices
• Subsequently GrandMet introduced brand
capitalisation
• after acquiring Pilsbury in 1989, the balance
sheet showed the importance of brands
brands £2.7 billion
other assets £6.9 billion
liabilities (mainly debt) (£6.7 billion)
net assets £2.9 billion
• Without brand capitalisation the balance sheet
would have shown net assets of only £0.2 billion
• Corbett (1997) argues that this would have been
an absurd situation

13. Further example of brand aquisition
• GrandMet acquired Pet in 1995 at a cost
of £1.8 billion
• Again, the acquisition affected GrandMet's
balance sheet
brands £3.8 billion
other assets £7.3 billion
liabilities ( 7.7 billion)
net assets £3.4 billion

14. Accounting issues surrounding
intangibles

15. Accounting concerns
• Is the intangible asset clearly identifiable
• Does the company hold an unambiguous
title to the asset
• Could the intangible asset be sold
separately from the business
• Does the intangible give rise to a “premium”
not earned by other companies?

16. Replicated
plant and
equipment
Product
modification
Innovation
New
factory
Staff
training
Research and
development
Most certain Most uncertain
Source: Webster
Tangibility and uncertainty

17. Separable Not separable
Wholly tangible (i.e.
machine tool)
Highly intangible
(i.e. goodwill)
Source: Wild and Secluna
Tangibility and Separability:
the Spectrum of Assets

18. Accounting methods for intangible
assets

19. Accounting approaches to valuation
• Cost based valuation
historical creation cost - how much did it cost to create?
current recreation cost - how much would it cost to
recreate an identical intangible?
• Market based valuation - evidence from sale or
purchase of similar assets (i.e. individual brands,
branded divisions or whole companies)
• Income based valuation looks at the stream of
income attributable to the intangible asset, based
on:
historical earnings (i.e. multiple of earnings)
expected future earnings (i.e. discounted cash flow)

20. External influences on IC
measurement and disclosure
• Writing off expenditures on intangibles
against profits or reserves seems wrong
• Thus, there is considerable pressure on
accounting bodies devise new accounting
codes of practice (SSAPs/GAAPs)
• Examples:
SSAP 13, 1989 - covers the treatment of R&D
expenditure
Draft SSAP 22, “Accounting for Goodwill”

21. IC audits

22. Towards an IC audit
• Various authors suggest an IP audit – see
e.g. Brooking 1997
• Each company produces a taxonomy and
set of checklists similar to Slide 3 above
• Weights are applied to each item on the
checklist – reflecting importance in
achieving company goals
• Large “dots” reflect very important and
small less important
• Position within the target reflects the
perceived strengths (close to “bull”) and
weaknesses (far from “bull”) of each asset.

23. Brooking’s “target”

24. Conclusions on IC audits
• Majority of the 8 large dots (more) and 22 small
dots (less important), in IP quadrant
• Brooking argues
target is consistent with an IP dominant company
(40% of listed assets are IP assets)
if the company is not intended to be IP dominant, then
“severe changes are required”
66% of the IP assets are below average in value,
including the significant ones
• Tracking likely changes over time, she argues
“The IC of this company looks like its in pretty bad
shape and likely to get worse.”

25. Options valuation and optimal
stopping techniques

26. Options values
• Options pricing methods are potentially the
way forward
• Only method that really deals with risk
• Applicable to every stage of creative process:
investment in R&D
decision to patent, etc.
decision to commercialise the invention
• But:
Need information about wide range variables
Inventive process is a multi-stage decision – which
makes the calculation very complex

27. Underlying principle
• Black-Scholes→Merton→Dixit & Pindyck
• equations that allow for changes in the
degree of risk over time
• in the D&P model
the benefits of waiting one more period
minus costs of waiting
= value of the option
• often called optimal waiting models

28. Value of a real option
The value of real option is determined by:
• present value of project cash flows (+)
• investment cost of project (-)
• time remaining to invest in the project (+)
• standard deviation of the project value (+)
• risk free interest rate (+)
Pitkethly (2002)

29. Optimal stopping rules
• Use the distribution of possible returns to
decide:
how much to do
how long to go on doing it
• Uses the distribution to calculate a
“reservation return” R* which indicates:
whether to do any R&D
whether to accept a given result, R, and
exploit, R>R*
or carry on doing research