Business valuers can expect further changes in the UK landscape for IP creation and commercialisation. Intellectual Property Exchange argues that UK investment in IP is now over £150 billion—50% more than investments in tangible assets.

Intangibles now represent almost 90% of the market value of the largest listed companies (according to analyses from Ocean Tomo, the leading management and advisory firm in the area), so these changes may be the most significant factor in many current business valuations.

Changing valuation expectations: Projected synergies and/or profits derived from IP assets have trended downward after the bubble the huge Nortel and Motorola transactions created in 2011. Nortel’s insolvency led to its IP assets being sold for £3.4 billion (for some 6,000 patents and patent applications in fields including wireless, wireless 4G, data networking, optical, voice, internet, service provider, and semiconductors). The buyers were Apple, Microsoft, and Research in Motion (Blackberry). In the same year, Google attributed £4.3 billion to patents and developed technology when it acquired Motorola.

Many patent sales have occurred since then, though none have equaled the size or expected ROI.

Growth in the market for IP rights: The market for IP rights, particularly patents, has grown in recent years, with a number of entities active in funding, syndicating, acquiring, and licensing or asserting patents and other IP rights. Both investor groups, which typically purchase patents and seek to generate revenue by negotiating licences, and ‘patent trolls,’ which typically sue potential licensees, continue to operate in the market.

The EU Commission last published a report on the patent enforcement situation in Europe in 2016, and it agreed that the legal environment could force down the value of these intangible assets. The report expressed concern that additional litigation, the threat of litigation, and arbitration efforts may impose additional cost on the innovation ecosystem and obstruct innovative initiatives.

Other trends affecting the business value and marketability of IP and other intangible assets:

• New IP exchanges, which create local or regional marketplaces for buying and selling IP rights (the London IP Exchange is one example).

• Patent ‘networks,’ which acquire patent rights and license them to their members.

• Government-sponsored patent pools (GSPP): an example is the Innovation Network Corporation of Japan (INCJ)—founded partly in order to increase the patent royalties Japanese universities receive.

• Programs an increasing number of governments established to encourage enterprises to exploit their IP rights and help companies raise funds based on such assets.

• Cross-licenses of large patent pools to avoid litigation between the parties to the cross-license, provided these are within the scope of applicable antitrust laws.

• Technological innovation continues to move away from large, in-house R&D labs and toward fully open innovation ecosystems consisting of startups, academia, special interest groups, incubators, accelerators, etc.

• The adoption of open source platforms and open access repositories (e.g., arxiv.org) as inventors prefer to leverage their skills or publish their work, thereby immediately creating prior art rather than monetizing their inventions through patents.

• Standard-essential patents (SEPs) and FRAND licensing principles. When a patent is considered to be essential to a technological standard—a standard-essential patent (SEP)—this fact has to be reflected in the valuation process. The parameters considered for the valuation of SEPs have to be aligned with fair, reasonable, and nondiscriminatory (FRAND) principles, which underlie licensing terms for SEPs. In Setting Out the EU Approach to Standard Essential Patents, The European Commission placed a high emphasis on SEP and FRAND, highlighting the need for increased transparency and searchability of SEP databases as well as more scrutiny on claims of essentiality.

• Some digital companies publish user statistics in their financial statements (e.g., daily average users, monthly average users, and average revenue per user). Financial analysts should consider any ‘user base’ information when estimating future market valuations for these companies.

A new helpful resource: The International Chamber of Commerce released the ‘Handbook on Valuation of Intellectual Property Assets’ late last year. It examines many of these trends and provides additional resources for UK business valuers.

The Finance Act 2016 set corporation tax for 2020-21 at 17%, but the Conservative party intends to increase the rate to 19% (and maintain that rate for the rest of the new Parliament).

Business valuers should adjust their models accordingly, which will decrease the concluded values in most valuation reports, all else being equal.

Other tax changes that influence value, or future benefit streams, are less certain prior to the new budget proposal in March. For instance:

• The Chancellor has continued plans to restrict research and development tax credits this year, while the Conservatives want to increase the expenditure credit for big companies from 12% to 13%;

• A tax ‘triple lock’ on income tax, VAT, and NIC appears likely, which at minimum reduces policy risk going forward;

• Five-year incremental increases in national minimum wage to £10.50 appear likely, which should be considered in future cost calculations for businesses with affected employees, beginning in 2020; and

• Changes in digital services tax, if any, should be confirmed by the second quarter. Less likely is a change in off-payroll employee taxation policy.
  

The ‘Global Mergers & Acquisitions Review: Full Year 2019/Financial Advisors’ from Refinitiv (now a subsidiary of the LSEG) was released last week. It contains M&A statistics—and also rankings for worldwide providers of fairness opinions.

M&A activity is so integral to the global economy that analysts shouldn’t worry if they’re unimpressed by the sheer volume of transactions. Eight investment banks completed more than 200 transactions each last year: Goldman Sachs, Morgan Stanley, JP Morgan, Citi, Bank of America/Merrill Lynch, Lazard, Rothschild, and Houlihan Lokey.

Despite all the dark clouds, Brexit did little to dim deal volume in the UK, so this sector remains an important market for business valuation services.

Fairness opinions generate a lot of revenues (and some risks) for the larger valuation firms. The top fairness opinion providers in the EMEA region last year were:

1. KPMG (18 opinions);

1. JP Morgan (18);

3. Duff & Phelps (12);

4. Houlihan Lokey (10);

5. Rothschild (9);

5. Evercore (9);

5. BDO (9);

5. Lazard (9);

5. Morgan Stanley (9);

10.Centerview (7); and

10.Credit Suisse (7).

Here are the top five providers (based on the number of transactions) of announced fairness opinions globally:

1. Duff & Phelps (2018 rank: 1);

2. J.P. Morgan (2018 rank: tied for 3);

3. (tie) Houlihan Lokey (2018 rank: 5);

3. (tie) Stout (2018 rank: 6); and

5. CITIC Group (2018 rank: 2).

Option price models help analysts project values, particularly when assets have little history or highly volatile future outcomes. BVWire—UK has spoken to an increasing number of business valuers who employ Black-Scholes or other models, particularly for financial reporting purposes (one reader commented that, ‘if I included an OPM analysis in a fiscal valuation, Treasury would just send it back,’ so clearly the practice is not universal).

Valuers who are interested in these approaches will enjoy the article on calibration of valuations, written by Alvarez & Marsal’s Neil Beaton, and Andreas Dal Santo and Antonella Puca, both of the BlueVal Group. The article originally appeared in the March 2019 issue of Business Valuation Update.

Beaton, Dal Santo, and Puca focus primarily on five inputs business valuers could use to assess the value of prerevenue or early-stage assets, and they build a number of examples in their study so that analysts can see the impact of typical estimates:

1. Volatility of the enterprise value. This can be estimated based on the volatility of guideline companies, with adjustments to account for the risk profile of the enterprise based on an industry/sector analysis.
   
   
2. Exercise price. Multiple exercise prices are determined based on the waterfall embedded in the company’s capital structure, which in turn depends on the contractual rights of the various classes of securities. The authors point out that two classes or more are common.
   
   
3. Time to exit. This input represents the expected timing of an exit event (one case study, for instance, estimates the time to exit at three years from the measurement date).
   
   
4. Risk-free rate. This input is often based on the yield of U.S. Treasury securities with a matching term.
   
   
5. Dividend yield. Equity securities of early-stage enterprises do not typically generate cash dividends, but, when they occur, value can be significantly increased.

The UK’s FRC is not alone in its expectations for improved reporting on intangible assets, though their discussion paper from February 2019 (‘Business Reporting of Intangibles: Realistic Proposals‘) remains front and center as valuation organisations (and IASB/FASB) review current methods. ACCA, ICAEW, RICS, and many member organisations including the Big Four in the UK have responded to this discussion paper, so the debate continues.

Last summer’s meeting of the European Financial Reporting Advisory Group (EFRAG) summarized current UK and global efforts to improve business reporting for intangible assets. FRC and the International Valuation Standards (IVS) update effective this week are not alone in demanding better analyses of these often-complex assets.

RICS has reminded members—including those with specialities in business valuation—of their obligation to record their CPD activities each year. Members can record their CPD by logging into their RICS online account.

Another option for MRICS, FRICS, and AssocRICS professionals is the updated version of the RICS CPD recording app (the previous version had been removed to fix compatibility issues). The new app is available for both Apple and Android users.

In view of the budget on 11 March, the Shares and Assets Valuation Fiscal Forum 2020 has been rearranged to Thursday 26 March. The meeting will start at 1.00 p.m. Those who haven’t registered previously may do so by responding to Helen Malone at SAV prior to 14 February.

Two years out, Carillion remains the largest trading liquidation under UK insolvency law. The knock on effects are still generating criminal claims, FRC investigations, auditor (KPMG) partner separations, lender (RBS, HSBC, Santander, Lloyds, and Barclays) surprises, new redundant staff pension liabilities, and major project completion (NHS hospitals; Sunderland and Manchester redevelopment; and Alberta, Canada, highways) and quality problems.

While not compensating for the disaster, it’s also a case study on how the warning signs (as early as 2013 for the most significant concerns) financial reporting and business valuation provided were either ignored or brushed aside.

For instance, the failure to write down acquisition goodwill despite huge and increasing losses, particularly in the case of the Carillion acquisition Eaga, has been cited as one basis for changing the IFRS goodwill reporting standards. BVWire—UK has covered this topic in previous issues.

Several financial reporting and business valuation experts have also addressed the use of supplier financing and other methods to ‘hide’ problems. While perhaps too late, a 2017 report to Carillion’s banks from BVWire—UK subscriber FTI Consulting highlighted ‘aggressive accounting and working capital management.’ And a thoughtful new study on supply chain financing by The Footnotes Analyst shows the leverage, cash-flow, and nondisclosure problems that analysts may miss, even when these financing techniques are valid. While borrowing remains an essential business tool, business valuation experts must understand all the risks and rewards before reaching conclusions of value. As The Footnotes Analyst reports:

We believe that supply chain finance can be a legitimate approach to managing working capital and raising short-term and flexible finance.… The concern regarding supply chain finance is that it is great when a company is successful and growing, but that it can contribute to instability when times are more challenging. It is for this reason that the existence and presentation effects of supply chain finance must be disclosed by companies and why investors need to take note, even where the direct impact is on the reporting company’s customers or suppliers.

Advanced Valuation Techniques, 17 February, 11 June, 16 September, London

ICAEW Practical Business Valuation, 16-17 March, London; 14 and 26 May, London; 9 and 29 July, London; 9 and 19 November, London

HMRC Shares and Assets Valuation Fiscal Forum, 26 March (rescheduled), London

ICAEW Business Acquisition & Due Diligence, 22 April, 24 September, 25 November, London

73rd CFA Institute Annual Conference, 17-20 May, Atlanta

ASA-Europe Business Valuation Conference, 24 September, Prague (details available soon)

EACVA 14th Annual Business Valuation Conference, 29-30 October, Munich

Our thanks to Marianne Tissier, Andrew Strickland, and Nick Talbot for their valuable contributions to BVWire—UK.

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David Foster at ukeditor@bvresources.com or +011-917-741-3853.