As a follow-up to our recent post on profiting from intangible assets in a business sale, this post introduces intangible asset valuation. As our last post outlined, “intangible assets are identifiable, non-physical in nature. They are something you can describe, document … and, most importantly, transfer.” Once identified, there are several ways to value intangible assets. I’ll discuss a common approach called the “with and without” method, using a simple and recognizable case study.
Let’s say you have a headache and you’re walking down the pain relief aisle of your local Walgreens pharmacy. You see Bayer Aspirin, “The Wonder Drug” to the left and a Walgreens generic bottle on the right. Same ingredients, strength and pill count. However, the Bayer Aspirin is $7.99 and the generic brand is $5.29.
What is the value of the Bayer brand name?
The shopper comparison suggests that Bayer believes that a buyer will pay $2.70 more for a bottle of its aspirin than a generic equivalent. What does this $2.70 represent? In this simple example it represents the premium attached to the Bayer name. Bayer is able to capture a 34% premium WITH the use of this brand and no premium WITHOUT it. But why?
The Bayer brand has a history that dates back to 1863. They developed the drug in 1897 and sold it under the Aspirin brand name. Only after Bayer’s rights to that brand name either expired, were lost or sold in other countries, did the Aspirin name become a generic descriptor for the drug. This history creates brand recognition and helps the company command a higher selling price than generics to this day.
Why does this all matter? Because the value of the Bayer brand can be determined to be the value of the premium that company is able to generate by owning this brand.
Quantifying brand value is based on the “relief from royalty” concept. This concept suggests that brand value is the value the owner gets by being “relieved” of the royalty payments they would otherwise have to make if they did not own the brand; a more detailed With and Without scenario.
How the numbers work in the Bayer example:
- Sales: Assume Bayer sold $500 million in aspirin and other related products over the last year. (This is an estimate; Bayer doesn’t disclose sales by product.)
- Royalty Payment: Assume the Bayer brand, including artwork, colors and logo, can be licensed for 10% of sales. (Bayer has royalty agreements for its various brands but doesn’t disclose specifics.)
- Royalty Stream of Payments: If you multiply $500 million by 10%, the owner of the brand would generate a royalty stream of $50 million.
- Long-Term Growth (g): Let’s assume that the growth of this revenue is 3%.
- Discount Rate (i): Assume, with a stable company and a low interest rate environment that the discount rate (or required rate of return for an investment is this company and therefore its brand) is 10%.
- Capitalization Multiple: The theory of capitalizing a payment is to multiply next year’s payment by the inverse of its cap rate or as noted above, (i – g) or (10% – 3%) or 7%. The inverse is 1 / 7% or a capitalization multiple of 14.28x.
- Value of Brand: Assuming the $50 million grows by 3%, the next year’s royalty stream is equal to $51.5 million or $50 million times (1 + 3% growth rate). Value is therefore equal to this next year’s royalty stream times capitalization multiple times 14.28 or $735.4 million.
It may seem strange that the value of a brand that generates only $500 million a year is equal to almost 1.5 times that revenue but if you look at from the point of Bayer, it makes sense. Because Bayer has a “relief from the royalty” payment it would need to make if it did not own the brand, it is able to generate an additional $50 million in value by owning it. The value of that rising income stream over time is worth a great deal to a stable company like Bayer.
However, if the holding company was smaller and less stable, we would increase the discount rate to reflect that additional risk. Using the above math with a 15% discount rate (an extra 5% of required return to compensate an investor for accepting this additional risk) produces a value of $429.2 million (equal to (i – g) or (15% – 3%) or 12%. The inverse is 1 / 12% or a capitalization multiple of 8.33x times $51.5 million). All other inputs are the same except for this risk which has a direct and significant impact on the value.
Think of other intangible assets in the same way.
What would my business be worth if I didn’t have:
- My customers
- My supplier relationships?
- The non-competes with my senior management team?
- My workforce?
While the approach to valuing these other assets is a bit more complicated, the concepts are fundamentally the same — what is value with and without the asset?
My goal for this blog post was only to introduce this concept. Hopefully reading this didn’t give you a headache. But if it did, reach for your favorite brand of pain reliever! Or for a deeper dive into intangible asset valuation methodologies, read this blog post from the CFA Institute.
* * *
Exit Strategies values intangible assets for a variety of purposes including divestitures, mergers and acquisitions, purchase price allocations, financial reporting, corporate restructuring and planning. If you’d like help in this regard or have any related questions, you can reach Joe Orlando at 503-925-5510 or firstname.lastname@example.org.