4/10/2014

www.pwc.com

Intangible Asset
Valuation
Tony Hadjiloucas

April 2014

Content

• Overview of valuation methodologies

• Worked examples
• Key considerations
• Discussion

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Overview of valuation methodologies

Valuation approaches - Overview

Valuation
approaches

Market Approach Cost Approach Income Approach

Value
a ue estimate
est ate Value estimate Value estimate
based on multiples = =
or prices from reproduction/replace present value of
market -ment cost-adjusted earnings attributable
transactions for depreciation and to the asset or costs
involving the sale obsolescence avoided as a result of
of comparable owning the asset
assets

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Valuation approaches

Valuation approaches

Market Approach Cost Approach Income Approach

Indirect or
Direct methods
Residual Methods

Premium Profit Various custom methods Return of Assets or

Method (e.g. Real options, Residual Earnings Method
Conjoint etc.)
etc )
Premium Pricing
Method

Relief-from-Royalty or
Royalty Savings Method

Cost Savings Method or

Avoided Cost Method

Market approach
Valuation approaches

Cost Approach Income Approach

Market Approach

Difficult to apply to intangibles: sufficient number of transactions of

truly comparable assets is rarely available

Market data is also used in income approach valuations:

• comparable profit benchmarks to compute excess earnings; and

• market royalty & licensing rates to compute royalty savings

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Cost approach

Valuation approaches

M k Approach
Market A h I
Income Approach
A h

Cost Approach

Inappropriate for most intangibles: fails to capture expected returns to the asset

Appropriate for intangibles that do not directly generate cash flows: e.g. software for internal use and
workforce

Sometimes appropriate as a second approach to check whether income approach results are
reasonable: make or buy decision, assets with a short history, assets that can be reproduced

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Income approach

Valuation approaches

Market Approach Cost Approach

Income Approach

Most common approach for intangibles:

- captures expected future returns to the owner; and

- q assets when market transaction data is not available

is able to estimate values for unique

Several variations of the Income Approach:

- based on cash flows or earnings generated by the intangible asset or

- based on the costs saved by the intangible asset.

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Income approach

Valuation approaches

Market Approach Cost Approach

Income Approach

Indirect or
Direct Methods
Residual Methods

• CF or earnings generated by
the intangible or expenses Residual Earnings Method
saved by the intangible are
estimated directly by • Residual earnings left after
reference to market deducting from after-tax
benchmarks operating earnings the fair
returns on all other assets
employed (Multi-period Excess
Intangible Asset Valuation
PwC
Earnings Method – MEEM) April 2014
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Income approach - Direct methods

Income Approach

Indirect or
Direct methods residual methods

Premium Profit Method excess over guideline company earnings of companies that
do not possess the intangible being valued

Premium Pricing Method premium over generic product prices of products or services
that do not possess the intangible being valued *

Relief-from-Royalty or after-tax royalties or licence fees saved by owning the

Royalty Savings Method intangible; requires market based royalty/ licensing data;
applied in patent, franchise or brand valuations
Cost Savings Method or after-tax costs saved by owning the asset; applied to
Avoided Cost Method
favourable contracts and workforce
*PwC Valuation & Strategy has developed an Advanced Brand Valuation
method, which allows the measurement of brand equity in consumers’ minds
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using market research data

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Typical methodologies for example intangible

assets
Example intangible assets Typical valuation
method
Brand / trademark
Market benchmarks and
income based method (e.g.
premium profit)
Customer relationships
Income based method
Product IP/ technology
Income based method
Software
Replacement cost
Which cash flows?
What discount rate?
Overall cross checks (Return on assets, residual goodwill etc)
Always preferable to apply two or more methodologies to cross check results

Relief from royalty /

royalties foregone method
• Key to valuing many types of IPR
• Important to recognize difference between real world licensing deals
and a theoretical license used to estimate the fair market value of an
outright sale of the asset
• Based upon market data for benchmarks
• Used extensively on an international basis and across industries
• Based upon the likely future royalty stream that could be earned from
licensing out
• Generally
G ll expressed d as a percentage off revenue
• Value = after tax present value of the stream of future royalty
savings/potential future royalty payments
• Can provide misleading results unless the “right” royalty rate is chosen

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Relief-from-Royalty Method
Concept

Ownership of the
from paying
asset relieves owner
royalty rate
e.g. trademark

The royalty savings are the expected cash flows

for the subject intangible asset

Relief-from-Royalty Method
Valuation steps

1. Determine appropriate royalty rate

2. Multiply with matching valuation base

3. Subtract tax expenses

4. Calculate the present value of royalty savings

5. Compute the tax amortisation benefit (TAB)  if necessary (discussed later)

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Worked example of Relief from Royalty method

Relief from royalty method – valuation of trade mark

License to distribute product granted to 2022 Variables

Royalty: 2% •Royalty rates
Discount rate: 10%
Tax: 30% •Discount rate
•Useful economic life

Business forecasts for exploitation by hypothetical licensee

2014 2015 2016 2017 2018 2019 2020 2021 2022

Sales 500 500 500 500 500 500 500 500 500
Royalty rate 2%
Royalty earned 10 10 10 10 10 10 10 10 10
Tax payable 30% 3 3 3 3 3 3 3 3 3
After-tax cash flow 7 7 7 7 7 7 7 7 7
Discount rate 10%
Discount factor 0.95 0.87 0.79 0.72 0.65 0.59 0.54 0.49 0.44
Discounted Cash flow 6.7 6.1 5.5 5.0 4.6 4.1 3.8 3.4 3.1
NPV 42.3

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Royalty rate determinants

The need for both parties to secure a satisfactory return
The nature and geographical scope of the licence
The strength and importance of this intangible asset
The probable level of continuing sales
The commercial obligations undertaken
The relative negotiating strengths of each party
Georgia Pacific case – 15 factors
Some methods for determining an appropriate royalty rate:
Market Comparables – analysis of licensing agreements in the marketplace
p
Excess Operating g Profit – comparison
p of margins
g enjoyed
j y byy the company
p y
exploiting the subject IP to those of companies that do not own similar IP (e.g.
contract manufactures)
Return on Assets – Subtract market returns on tangible assets from forecast
operating profits; the remainder is attributable to all intangible assets and must
be apportioned between the different intangibles
“25% rule of thumb” (?)
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Relief-from-Royalty Method
Common pitfalls
Find appropriate licensing agreements!
(e.g. licensing agreements of the company, PwC-Database,
www royaltysource com)
www.royaltysource.com)
Do not apply the royalty rate without considering facts and
circumstances – particularly profitability and need for both
licensor and licensee to generate adequate returns! Consider
IRRs!
Have a close look at the licensing agreements!
Are there other additional agreed
g terms ((e.g.
g upfront
p p
payment)
y ) or
restrictions (e.g. exclusive v non-exclusive license)!

Consider deal-specific circumstances! Many publicly available

licensing agreements involve new products in new markets,
rather than developed products in mature markets – ask the
question: Would I license out the product/ brand for x% ?

Valuation of workforce
Cost Approach
• What do you think might be components of the cost to replace an
assembled workforce?

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Multi-Period Excess-Earnings Method (“MEEM”)

Identify hierarchical relationship between assets

Which intangible asset drives the

How are all identified Intangible Assets business?
linked? Which assets contribute?
Use MEEM to value the key asset

Tangibles
Contracts

Customer
Workforce Leading
Relation
Trade- Trade-
intangible asset
name eg. Customer Business
names contract or
Technology Patents Product IP

Backlog Workforce

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Multi-Period Excess-Earnings Method (“MEEM”)

Valuation steps

1. Derive future cash flows for subject intangible asset

2. Subtract tax

3. Apply contributory asset charges (CAC)

4. Calculate present value of future cash flows

5. Compute the tax amortisation benefit (TAB)  if necessary

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MEEM
Valuation steps
Derive future cash flows for subject intangible asset
1. (e.g. customer contracts or product IP) – also see relevant case study on
dealingg with uncertainty
y
Revenues

Time

MEEM
Valuation steps

3. Apply contributory asset charges (CAC)

Question:
Would the subject intangible asset generate the same revenues on a
stand-alone basis?

The owner has to Concept of

NO lease assets to generate contributory asset
those revenues charges

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MEEM
Valuation steps

Possible contributory asset charges (CAC):

Working Machinery &

Capital Equipment

Other Intangible
Assets

Assembled Land &

Workforce Buildings

MEEM Approach
Example
(in thousand €) 2014 2015 2016 2017
Revenues 1.000,00 800,00 500,00 300,00
Costs 750,00 600,00 375,00 225,00

Profit before tax 250,00 200,00 125,00 75,00

Taxes @ 40% 100,00 80,00 50,00 30,00

Net income 150,00 120,00 75,00 45,00

Contributory Asset charges

Land & Building 10,00 8,00 5,00 3,00

Machinery & Equipment 25,00 20,00 12,50 7,50
Working capital 15,00 12,00 7,50 4,50
Workforce 9,50 7,60 4,75 2,85
Trademarks 20,00 16,00 10,00 6,00

Total Asset Charges 79,50 63,60 39,75 23,85

Cash Flow after tax 70,50 56,40 35,25 21,15

Present value factor 0,9174 0,8417 0,7722 0,7084

Present value of cash flows 64,68 47,47 27,22 14,98

Value of key intangible 154,35

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Required Rate of Return on the Subject Assets*

Working capital Short-term lending rates for market participants

Fixed assets Financing rate for similar assets for market

(for example PP&E) participants (e.g.terms offered by vendor
financing),or rates implied by leases

Workforce, customer lists, Weighted average cost of capital (WACC) for

trademarks, and trade names young, single-product companies

Patents In cases where risk of realising economic value

of patent is close to the risk of realising a project,
rates would be equivalent to that of the project

Other intangibles, including base (or Rates appropriate to the risk of the subject
core) technology intangible

•* from the perspective of a hypothetical buyer

Cost of Capital
Return on Assets Reconciliation (WACC Table)

Rates should be consistent with the relative risk of other

assets in the analysis and should be higher for riskier assets.

Weighted Return of Assets

Goodwill
16% x 200/1000
200
Enterprise WACC
12% x 150/1000 Brand 150
Value = 10%
1000
8% x 500/1000 PP&E
500 (Equity +
Financial
Fi i l Debt)
D bt)

5% x 150/1000 NWC 150

∑ 1000 ∑ 1000

Weighted Return of Assets ≈ WACC

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WACC Table Review & WACC table analysis

Asset After Tax Premium After Tax Fair Market FMV x

Discount ROR1 Value Discount
Discount
Factor
rate
Working Capital 12.1% -6.1% 6.0% 15,000 900

Fixed Assets 12.1% -4.1% 8.0% 30,000 2,400

Non-Compete Agreements 12.1% -0.1% 12.0% 5,000 600

Customer Relationships 12.1% -0.1% 12.0% 14,000 1,680

Patented Technology 12.1% 4.9% 17.0% 10,000 1,700

IPR&D 12.1% 5.9% 18.0% 0 0

Implied Goodwill 12 1%
12.1% 6 2%
6.2% 18 3%
18.3% 26 000
26,000 4 770
4,770

Total 12.1% 100,000 12.050

This is Enterprise Value

12,050 / 100,000 = 12.1%

1) ROR = Rate of Return

Key considerations

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Key considerations

Ensure correct definition of assets and who owns them

In valuing the IP, identify/carve

identify/carve-out
out the cash flows that it generates

Select an appropriate valuation methodology and cross-check against

other approaches

Depending on the purpose of the valuation, it may be important to seek

expert legal advice, particularly if it relates to a transaction or dispute

Valuation of IP is a subjective area involving a high degree of technical

complexity
l i

Where there is a lot at stake, it is advisable to seek expert assistance

In most cases, IP valuations will be challenged and consequently the

experience and credibility of the valuer is of paramount importance
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Discussion

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