On 14 November, Warren Buffett said his Berkshire Hathaway Inc had accumulated a 5.5 percent stake in IBM since March, the billionaire investor's biggest bet in the technology field he has historically shunned.

The Christian Science Monitor (November 14, Berkowitz) noted that "the move puts Buffett's money squarely in the heart of the technology industry, a sector he has steadfastly avoided on the grounds he simply did not understand it." The Wall Street Journal's Marketwatch (November 14, Hinton) observed that "In building up his $10.7 billion stake in International Business Machines Corp., billionaire Warren Buffett apparently turned a blind eye to one of the most basic rules of investing: Buy low. "

Leave it to the Hollywood Reporter (November 14, O'Connell ) to get to the heart of the matter: Buffet is buying reputation. "'I don't think there's any company that I can think of... that's done a better job of laying out where they're going to go and then having gone there,' Buffet told the Reporter. 'They have laid out a road map and I should have paid more attention to it five years ago where they were going to go in five years ending in 2010. Now they've laid out another road map for 2015.'"

IBM's reputation is at the top of the charts. The Steel City Re Corporate Reputation Index places IBM at the 100th percentile among the 145 companies in the Information Technology Services sector as of 17 November 2011 - exactly where it was 12 months ago. It's exponentially weighted reputational volatility is 0.1%, its trailing twelve week velocity is 1%, and its vector is .1%. Those are the metrics of a highly stable reputation. Meanwhile return on equity has outpaced the median of this sector by 42%.

In the current environment when fear dominates equity markets, there is much to be said for a stellar reputation. Even it it means buying dearly a company whose intangible asset fraction is much greater than the median of the peer group - but then again, what does reputation rest on if not the intangibles?

Here is an intangible asset paradox: How is it that Google, whose core business is connecting people to information, has to buy the manufacturer of physical products (telephone handset) to obtain intellectual property? Monday morning, Google (NASD:GOOG) announced that it was acquiring Motorola Mobility Holdings for $40 a share in cash or $12.5 billion.

The Financial Times (16 Aug, Taylor, Waters) reports that “the deal also gives Google direct access to Motorola Mobility’s portfolio of more than 17,000 patents and 7,500 pending patents, ammunition Google believes it needs to repel a patent assault by Apple, Microsoft, Oracle and others on its Android mobile phone operating system.
 
According to the Los Angeles Times (Aug. 16, Sarno, Li), experts say the Google purchase is aimed squarely at defending itself and its partner firms that use its Android technology -- including HTC Corp. and Samsung Electronics Co. -- against patent infringement lawsuits filed by such competitors as Apple Inc. and Microsoft Corp. Ken Dulaney, vice president of mobility at the Gartner information technology research and advisory company, remarks, "They are getting hammered by everyone suing them, and they didn't have much of a defense." Among the most recent patent actions are Apple's suits against Android makers HTC and Samsung, Oracle Corp.'s suit against Google itself, and Microsoft's suit against Barnes & Noble Inc. over its Android-powered Nook reader.

But acquiring a handset manufacturer will put Google into direct competition with many of the companies that rely on Android to power their own smartphones, including Samsung and HTC. National Public Radio (Aug 15, Peralta) notes that this business risk compounds existing regulatory risk. “The Federal Trade Commission is already scrutinizing Google. As the Wall Street Journal reported earlier this month, one thing the FTC is looking at is whether Google prevents smartphone manufacturers that use Google's operating system from using competitors' services.”

Shares in Motorola Mobility, advised by Qatalyst and Centerview, closed up 56 per cent. Google, advised by Lazard, saw its stock fall 1.2 per cent. Google's reputation index rankings, as reported by Steel City Re, were at the 99th percentile among 105 peers in the IT services sector days before the deal was announced. The reputational volatility metrics have been rising for the past three months, but at 2%, they would not appear to be material. Yet, with Google, any volatility translates into a slip from the #1 rank, and that is almost always associated with a slight decrease in value. Over the trailing twelve months to 11 Aug, Google has underperformed the median of its peers by 2% reflecting the premium associated with being stably situated as the top ranked firm.

About one year ago, Heartland Payments Systems (NYSE:HPY) reported a record-breaking security breach. We reported previously on this event and its economic consequences. In today's note, we look quantitatively at the reputation effects of this breach and contrast them with two of Heartland's customers, Mastercard (NYSE:MA) and Visa (NYSE:V), who sued Heartland for damages. The intangible asset financial management point we wish to make is that there are useful financial metrics to help executives manage risk and reputation to create value from their intangible assets.

Let's begin with the Steel City Re Corporate Reputation Index. The fall in Heartland's reputation in January 2009 exhibits the typical cliff effect associated with events that speak to the heart of a company's intangible asset value -- in Heartland's case, data security. Contrast Heartland's reputation with Mastercard, a firm whose Steel City Re Reputation Index standing is pegged at the 100th percentile for most of the past year. Not surprising, Mastercard rewarded its stakeholders during this period with an above average 76% return on equity relative to both the S&P 500 index (20%) and the median return of the 72 companies in the IT Services sector (60%). Visa, with a public offering less than 2 years old, shows a climbing reputation index with values in the high 90's percentile, but its return is slightly less that the median of its peers. We'll call this less than above average performance the results of the hangover from Visa's IPO.



Let's look quickly at the book values. Heartland booked its loss in intangible asset value at the end of March, about 10 weeks after the equity markets panicked. Its intangible asset value dropped from around 100% of enterprise value to 70%, but has been climbing since. In contrast, Mastercard's intangible asset value has been climbing steadily to the 100% mark, while Visa showed some volatility over the year and ended up in the mid 90's.

Today’s MISSION:INTANGIBLE note was prompted by my colleague Robert Liscouski, COO with Steel City Re and a former Assistant Secretary in the Department of Homeland Security. Bob is yielding his IAFS position to the incoming Chair of the Security Committee, Scott Childers from The Walt Disney Company.

To my query of what is hot in security business processes and reputation that will interest our IAFS members, Bob said this: data security. This is why. The new poster child for data security is Heartland Payment Systems, (NYSE:HPY). Heartland, the sixth-largest payments processor of credit and debit card transactions in the U.S., announced in January that its records were hacked. A recently apprehended cyber-gang, according to the Justice Department, compromised 130 million Heartland accounts.

What are the lessons of interest for IAFS members? There are two lessons covering, respectively, the costs of reputation loss and the potential for reputation restoration.

The first lesson is that this was an expensive breach with growing costs. Heartland reported in May that the breach had cost it $12. 6 million so far, which included legal costs and fines from Visa and MasterCard, who said the company was not compliant with payment-card–industry rules. Then, In filings for the Securities and Exchange Commission, Heartland said the 2008 data security breach cost it $32 million as of June 30. Most recently, as of 30 Sept in the 10-Q filing, the Company recorded pre-tax expenses of $105.3 million or about $1.74 per share, associated with the security breach, aka, the Processing System Intrusion.

The majority of these charges, or approximately $90.8 million, related to: (i) assessments imposed in April 2009 by MasterCard and VISA against us and our sponsor banks, (ii) settlement offers we made to certain card brands in an attempt to resolve certain of the claims asserted against our sponsor banks (who have asserted rights to indemnification from us pursuant to our agreements with them), and (iii) expected costs of settling with certain claimants with whom settlement discussions are underway.

There is more. The Heartland breach – which has so far resulted in 28 class-action lawsuits filed against the company precipitated a near-immediate 50 percent drop in Heartland's share price (shown in red). Total equity value lost, rebased against the S&P500 Index (shown in blue) as of today, is about $300 million. Data source: Big Charts.com.



The second lesson is that following its near-death experience, Heartland is now committed to building reputation resilience by establishing the new standard for data security processes. Heartland is raising the bar in retail payments security by bringing end-to-end encryption to its network. It will be expensive and a big logistical challenge to execute. However, as long as it's accompanied by good policy and process, Heartland's encryption initiative will plug a definite security gap in the payments system.

In turning to processes to cure the defects that led to the reputation loss, and by creating a new standard for best practices, Heartland is following the model established by Johnson and Johnson with their product security issue, and El-Al Israel Airlines with their hijacking-related security issues. It is a best practice that examplifies the values of the IAFS and its members. Won't you consider joining us?

Heads up: IAM magazine, the official publication partner of the Society, will feature a reputation-focused case study on Johnnson & Johnson (NYSE:JNJ) in the January 2010 issue, #40.