Intangible asset mis-pricing creates a value opportunity for investors

By Dr Chris Donegan

AAEAAQAAAAAAAAcLAAAAJGRlMjNkMDZhLTU4MmQtNDM5Yy1hZjkxLWE2NGJhNGZmNTU2MQThe Wall Street Journal (from which this graph is borrowed) and other notable journals have pointed out repeatedly that the absence of intangible assets in corporate balance sheets undervalues the enterprise value of the market substantially.  The WSJ estimates this as much as $8 trillion.

The Financial Accounting Standards Board (FASB) it appears is now heeding the call to bring accounting into the 21st Century and oblige companies to recognise some value for their data, brands, trademarks and patents.

The test case for a methodology is the valuation rule for leases – which comes into effect in 2018 and is expected to enhance corporate values by unto $2 trillion – in effect catching up with the balance sheet structuring of the last decade that saw ROA numbers manipulated by outsourcing fixed assets to leasing companies.

The challenging issue for valuing intangibles is context.  The fact is that some intangible assets are closely tied to products (such as pharmaceutical patents) and these have transferable value tied to revenue streams – although its not clear that Valeant’s portfolio for example would be correctly valued from a straightforward DCF calculation.  Others are less straightforward like brands or customer data, whose value is very much in the eye of the buyer and the competitive context that they are in at any moment in time.

Such contextual valuation lies outside the comfort zone of many traditional valuers (such as accounting firms) and moreover needs to be updated annually (at least) to reflect a dynamic and competitive marketplace.

This creates a huge opportunity for sharp eyed investors – as the contextual bid/offer for intangible assets creates significant pricing inefficiencies, allowing deep discounted value opportunities to be identified by those who know how and for overvalued assets to be skewered by similar analysis.  Remembering that this is not simply a numbers game such analysis must be overlaid with discount factors for the quality of management in monetising intangibles, which is a significant part of the contextual picture.  This is a qualitative and quantitative discipline requiring expertise not commonly found on Wall Street research desks.

What is quite clear to those of us who work in this space is that by understanding the value of the intangibles and the factors that drive intangible value, meaningful insights can be drawn about credit quality, earnings quality and competitive position/outperformance potential.

The FASB would like to create a level playing field for everyone.  Until they do the misplacing inherent in the market is an opportunity for the few investors who understand this space.

[This post originally appeared on LinkedIn Pulse.]

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