What is Your IP Worth An Assessment of the Methods for Determining Value David Moss 678 4191358

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What is Your IP Worth? An Assessment of the
Methods for Determining ValueDavid Moss(678)
419-1358
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Dispute Analysis and Investigations - the
Licence Enforcement process

• Intellectual Property licensing disputes
• Expert witness in IP licensing litigation
  concerning damages reasonable royalties
• Global license enforcement team
• Concerned with the pro-active management of IP
  to enhance value to the organisation
• Intellectual property exploitation validating
  new or existing business models based on IP

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Importance of Intellectual Property

• John Coombe - GlaxoSmithKline
• For quoted companies, bridging the gap between
  balance sheet net assets and stock market
  value would be an extremely useful expansion of
  shareholder information. Simply identifying
  unrecorded intangible assets and indicating
  their value would be a major step in the right
  direction .

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MV as a Multiple of Net Book value FTSE 350
Utilities
Transport
Tech
Services
Retail
Pharma
Media
FS
Food Drink
Engineering
Energy
Construction
Chemicals
0
1
2
3
4
5
5
IP by industry
Average of total purchase price accounted for
by type of intangible asset - 2003
Source PwC analysis
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IP by sector
Technology, Media and Telecoms
Pharma / Biotechnology
39
66
13
14
22
47
Net Assets
Intangible Assets
Goodwill
Net Assets
Intangible Assets
Goodwill
Other consumer / industrial products
Financial Services
57
38
26
50
17
13
Net Assets
Intangible Assets
Goodwill
Net Assets
Intangible Assets
Goodwill
Source PwC analysis
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Why is valuation of IP important?

• The ability to identify and leverage the value of
  IP has become a priority and a critical
  differentiator for an increasing number of
  forward looking companies
• Recognition by investors that some firms can
  generate additional returns by effective
  management of intangible assets
• Management need to maximise value and minimise
  risks associated with IP
• If you can visualise it you can measure it, and
  if you can measure it then you can manage it for
  continuous improvement
• Other valuation drivers
• Purchase price allocation
• Transactions
• Tax / transfer pricing
• Making protection and litigation decisions

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IP Valuation and Commercialisation Why is it so
hard to get right?

• Missing skills repackaging, bundling, new
  technology, different distribution channels,
• Poor planning - IP rights are often not
  considered pre-production
• Strategic content - content owners believe
  exploitation cheapens primary use
• Useful life - Complex to understand the longevity
  of IP (current versus archive)
• Content intensive companies struggle with IP
  exploitation as it is often classed as non-core
  or secondary
• Specialists exploit these outsourced
  opportunities from the majors

DIFFICULT TO PRICE WHAT IS ITS VALUE?
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IP Valuation and Commercialisation Why is it so
hard to get right?

• THE CHALLENGES
• Intangible nature obvious, but true difficult
  to identify exactly what it is you are trying to
  value
• Legally Defined - Needs protection and ownership
  identification
• Uncertainty to realise cash flows many business
  models,
• Unique assets difficult to make comparisons
• Difficult to separate must legally extract from
  fixed assets and the going concern to exploit
• Liquidity lack of an existing market mechanism
• Useful life driven by fads, trends

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What drives the value of the IP?

• Exclusiveness
• Exploitation methods what delivery platform
  (type of media) is used?
• Asset life
• Unique nature and liquidity how is it packaged?
• Ability to define (legally) and segment out of
  legal structure
• Ability to enforce
• protection against IP leakage
• how easy is it to audit?

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Valuation approaches
Valuation approaches
Income Approach
Market Approach
Cost Approach
Direct methods
Indirect (Residual Methods)
Return on Assets (Residual Earnings Method)
Premium Profit Method
Real Options Valuation R O VTM
Premium PricingMethod
Relief-from-Royalty or Royalty Savings Method
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Market approach
Valuation approaches
Cost Approach
Income Approach
Market Approach

• Based on comparisons with market, e.g.
  transactions, comparable businesses, licence
  agreementsIncreasing evidence of an active
  market as industry restructures on a global basis
  
• Used with care some useful multiples from company
  acquisitions can be calculated
• Need to separate the business element from the
  intangible asset

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Cost approach
Valuation approaches
Market Approach
Income Approach
Cost Approach

• Looks at the cost of replacing an asset
• How much would it cost someone else to get to the
  same stage of development
• Does not consider any future economic benefit
• Cost of successes and failures may be similar but
  value is widely different

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Income approachDirect methods
Income Approach
Indirect or residual methods
Direct methods
Premium Profit Method

• excess over guideline company earnings of
  companies that do not possess the brand being
  valued
• premium over generic product prices of products
  or services that do not possess the brand being
  valued
• after-tax royalties or licence fees saved by
  owning the brand requires market based royalty/
  licensing data
• applied in patent, franchise or brand valuations

Premium Pricing Method
Relief-from-Royalty or Royalty Savings Method
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Income approach Premium Profit method

• Obtain from management the operating profit
  projection of IP over its economic life.

Step 1

• Estimate normal operating profit margin from
  comparable companies that engage in similar
  business activities but do not posses the IP
  being valued.

Step 2

• Subtract the normal operating profit based on
  your comparables from subject company profit to
  arrive at the excess operating profit.

Step 3

• Apply an appropriate cash tax charge in each
  period to determine the after tax excess profit
  streams.

Step 4

• Discount to present value the after tax excess
  profit stream.

Step 5
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Income approach Premium Pricing Method

• Obtain from management the price projection of
  the single product/service that employs the
  intangible (e.g. a licence) over its economic
  life.

Step 1

• Subtract projection of incremental costs
  necessary to maintain the value of the intangible.

Step 2

• Estimate normal price level from comparable
  generic products that do not employ the
  intangible being valued.

Step 3

• Subtract the normal price based on the comparable
  generic products from subject product price, net
  of incremental expenses, to arrive at the price
  premium.

Step 4

• Apply an appropriate cash tax charge in each
  period to determine the after tax excess profit
  streams.

Step 5

• Discount to present value the after tax excess
  profit stream.

Step 6
Difficult to apply due to price vs volume trade
off
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Income approach Relief-from-Royalty Method

• Estimate revenues attributable to the IP over its
  economic life.

Step 1

• Estimate of an arm's length royalty rate be paid
  for the use of comparable IP.

Step 2

• Apply concluded royalty rate to the projected
  sales of the brand over its economic life.

Step 3

• Apply an appropriate cash tax charge in each
  period to estimate the after tax royalty savings.

Step 4

• Discount to present value the after tax royalty
  savings stream.

Step 5
Easy and common, but can be misleading if not
applied carefully
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Royalty rate determinants

• Excess operating profit attributable to the brand
• Market comparable royalty rates
• The nature of the licence
• The strength and importance of this intangible
  asset
• The geographical scope of the licence
• The need for both parties to secure a
  satisfactory return
• The probable level of continuing sales
• The commercial obligations undertaken
• The relative negotiating strengths of each party

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Income approach Indirect or residual methods
Valuation approaches
Cost Approach
Market Approach
Income Approach
Indirect or Residual Methods
Direct methods
Return on Assets or Residual Earnings Method

• Residual earnings left after deducting from
  after-tax operating earnings the fair returns on
  all other assets employed

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Income approach Return on assets method

• Estimate revenues attributable to the IP over its
  economic life.

Step 1

• Estimate revenues attributable to the IP.

Step 2

• Apply normalised cost structure to adjusted
  revenues and derive operating earnings.

Step 3

• Allocate level of other assets used to generate
  adjusted revenues.

Step 4

• Calculate fair return on average balances of
  other assets and subtract from operating earnings
  after taxes to compute residual earnings

Step 5
Step 6

• Discount to present value the residual earnings
  stream.

Used mainly as a cross-check
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Pros and cons of each approach
ADVANTAGES
DISADVANTAGES
Income

• Considers the life of the asset and appropriate
  risk-based rate of return at which to discount
  cash flows

• Relies on the ability to accurately forecast
  future performance

Approach

• Estimating remaining useful life of asset is
  difficult

• Captures the unique economic features of the
  subject intangible

• Provides compelling empirical evidence of value

Market

• Lack of transactions

Approach

• Transactions are often unique to the particular
  asset (liquidity)

• Relatively easy to apply

• Conceptually pleasing

• Information necessary to make meaningful
  comparisons is not public

• When comparable market data is not available

Cost Approach

• IP development costs generally have little to do
  with the value inherent in the right to exploit
  that property

• When intangible is of unusual type

• Difficult to apply because data not readily
  available

• Works well with internally developed intangibles
  or in liquidation scenarios

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Real Options Valuations (ROV)

• ROV is a process for maximising value by
  understanding and exploiting the link between
  asset management and asset value
• Provides a set of analytical techniques for asset
  valuation which incorporates all the options for
  the asset which add to value
• Originally associated with financial instruments,
  now commonly used in Oil and Gas, Pharma,
  Chemical industries - now moving into intangible
  asset valuation
• Examples
• patents on emerging pharma or technology
  products
• brand extension options in a trademark valuation
• Estimating 2nd market value when commissioning
  content creation
• ROV can be used either as a direct or indirect
  approach to valuation
• Can use direct expected cash flows of the subject
  intangible asset or
• Look at the difference in the expected cash flows
  of the business, with and without the subject
  intangible asset

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Real Options Valuations (ROV)

• Typically we use a 3-step process
• Open framing - Formulate the valuation as an
  asset management problem including uncertainty
  and complexity and corresponding managerial and
  corporate synergy
• Analysis - Incorporate market and corporate risk
  perspective as appropriate
• Interpretation - Identify the best dynamic asset
  management strategy and determine resulting value

Open Frame
Analyse
Interpret
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Real Options Valuations (ROV)
Step 1
Step 2
Step 3
Identify main uncertainties (development phases,
commercial environment at launch)
Build a valuation model that captures relevant
decisions and uncertainties over time
Use benchmark probabilities to capture chances of
success for each development phase
Success in Phase II
Competitive environment
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Real Options Valuations (ROV)
Step 4
Step 5
For the base case scenario calculate potential
value of asset by discounting at the WACC to
capture time value of money and undiversifiable
risk
Calculate expected value of asset integrating
development and commercial risk using WACC
Intangible asset values obtained using this
methodology incorporates uncertainties to reflect
both market risks and corporate risks
Potential value of asset
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The value of the IP is therefore a function of
uncertainties, rewards, and costs
Expected Value NPV weighted for risk and
different commercial scenarios
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Calculating the Cost of Equity and WACC - the
CAPM formula

• Ascertain suitable beta and optimal gearing
  through comparable company analysis
• Beta is a measure of the variability of the
  stock price compared to the market as a whole
• Calculate cost of equity using risk-free rate,
  equity risk premium and beta
• The risk-free rate is the cost of borrowing
  10-year government bonds
• Equity risk premium is the premium above the
  risk-free rate required by an investor to invest
  in equities
• Calculate cost of debt using risk-free rate,
  company debt premium and corporate tax rate
• Company debt premium is the premium above the
  risk-free rate which the company is charged on
  long-term debt
• Calculate WACC from cost of equity, cost of debt
  and optimal gearing level

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Select appropriate Valuation Approach
Does the asset generate earnings?
Are market transaction data available for
comparable assets?
Apply the Cost Approach (if replacement
cost would be capitalised) or the Cost Savings
Method (if replacement costs would be expensed)
NO
NO
YES
YES
Can the earnings attributable to the asset be
directly and separately estimated?
Apply the Market Approach
NO
YES
Apply the Income Approach Return on Assets
or Residual Profit Method
Apply the Income Approach Premium Profit Method,
Cost Savings Method, Royalty Savings Method, or
ROV approach (to model uncertainties)
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Case Study PwC developed a comprehensive
intellectual asset management system for Microsoft

• Microsoft is the worlds number one software
  company, developing, manufacturing, licensing and
  supporting a wide range of software products for
  a multitude of computing devices.

• Microsofts patent portfolio is also one of the
  largest in the world and growing. Chairman, Bill
  Gates, recognised that the existing management
  systems were failing to keep pace and limiting
  Microsofts ability to generate value from the
  portfolio. He assigned a progressive team with a
  broad authority to solve the problem.

• PwCs assignment was to design a system to
  support Microsofts full intellectual property
  development lifecycle from idea generation to
  patent creation and application, to maintenance
  and the exploitation of value. PwC were hired due
  to their strong track record of success and an
  IAM competency that exceeded that of the
  competition.

• Sited as one of the most important strategic
  initiatives of the company, the project covered
  strategic analysis, value proposition, design,
  development and implementation phases. The system
  went live, successfully, in January 2002.

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Biography
David Moss

• Position Director
• Intellectual Property and Strategy Specialist
• Qualifications BSc in Finance Marketing,
  University of Virginia - McIntire School of
  Commerce
• Relevant Experience
• David has 13 years of experience both as a
  consultant and within industry and advises his
  clients to exploit their intellectual property
  (media rights, patents, brands)
• He assists his clients to identify evaluate
  strategic options within their industrys value
  chain to maximise shareholder value while
  considering the risks to the business. This
  includes the provision of business plans,
  investment decision advice, strategy validation,
  and risk analysis focusing on intellectual
  property business opportunities.
• David has particular speciality concerning new
  business models and intangible asset exploitation
  businesses as well as the Entertainment Media
  industry
• Clients include Nomura, Hg Capital, DB Capital
  Partners, BBC, BBC World, Sainsbury's, Odd Bins,
  British American Tobacco, UK Government
  (Codeworks) Carlton, Granada, Channel 4, Channel
  5, Independent Television Commission, mmO2, Pace,
  British Telecom, The Financial Times, News
  Corporation, The Telegraph