MISSION INTANGIBLE

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MISSION:INTANGIBLE, the blog of the Intangible Asset Finance Society, offers critical comments on intangible asset, corporate reputation, and finance; supplemented by quantitative reputation metrics. Intangible assets include business processes, patents, trademarks; reputations for ethics and integrity; quality, safety, sustainability, security, and resilience; and comprise 70% of the average company's value. MISSION:INTANGIBLE is a registered trademark of the Intangible Asset Finance Society.

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Tsk tsk, Liska

Nir Kossovsky - Monday, April 20, 2009
You may have heard about the spat between Motorola Inc. (NYSE:MOT) and its former CFO, Paul Liska. Briefly, Liska believes he was dismissed for blowing the whistle on inaccurate financial forecasts; Motorola's version is that he was dismissed for "serious misconduct and incompetence."

Our interest was piqued by a recent JP Morgan analysis that reported "this entire soap opera likely ends with little or no impact to Motorola." We are less sanguine for we see evidence of significant , albeit restorable, reputation impairment.

Liska was dismissed 29 January. He was officially fired 19 February according to an SEC filing. As shown below, between 2 and 9 February, Motorola's reputation as measured by the Steel City Re Intangible Asset Finance (corporate reputation) Index dropped precipitously from the 82nd percentile to the 23rd percentile among 93 companies in the Communications Equipment sector.


The data indicate a decreasing IA index, an increasing EWMA IA index volatility with an average log magnitude of 4, and a not unexpected economic underperformance of 3% below peers. In contrast, Qualcomm Inc. (NASDAQ:QCOM) the #1 ranked firm in this sector, shows a decreasing EWMA IA index volatility with an average log magnitude of 3, and an economic return that exceeds its peers by 41%

We believe Motorola's reputation issues are significant and now center about the core issue of ethics. This additional concern exacerbates pre-existing concerns about innovation which have dogged the company for some time. To stakeholders facing ambiguous facts as they now stand, ethical concerns place all executive pronouncements under a cloud. The discounting effect on share price, in our opinion, is similar to the discounting we saw years ago when Research in Motion was laboring under the uncertainty of intellectual property litigation.

It doesn't have to be this way. Operational transparency and some fine footwork by corporate communications should be able to undo the damage if indeed, as JP Morgan suggests, Motorola's case is the stronger of the two. The reward for success by our estimation, if you want to put a number to it, is up to $11B in restored market capitalization (F-test 10E-30, adj. R2 0.79). But as most companies are learning in these challenging times, in reality, reputation is priceless.

Serving reputation for dinner

Nir Kossovsky - Tuesday, April 14, 2009
Tweens and adolescents often playfully disparage their meals with monikers such as "mystery meat" or "tuna surprise." While this is good fun, it is something quite different when the CEO of a major food products company similarly characterizes his company's products. David McKay of Kellogg Company (NYSE: K) raised a few eyebrows when he testified last month before the House Committeee on Energy and Commerce that Kellogg relied on third parties to assure food safety. We wonder what thoughts ran through the minds of financial analysts who knew at that time that competitors, such as Nestle, conducted their own supplier inspections thereby signalling to their stakeholders that food safety is a core business process and critical intangible/reputation asset.

And while it has been a rough time as of late with Salmonella in peanuts and pistachios, the industry as a whole is settling down to a steady state of intangible asset volatilty. So it piques our interest when H. J. Heinz Company (NYSE: HNZ), a company that has made reputation enhancement a key business strategy, experiences a sudden drop in the Steel City Re Intangible Asset Finance (Corporate Reputation) Index.

The chart below shows Heinz. As seen in the upper chart, among the 56 companies comprising the Food Products Group, Heinz has ranked in the top 95th percentile earlier this year but has been declining and is now at the 83rd percentile. In terms of return on equity, this past year it has outperformed the median of its peers by 2.6% - the peer group having lost a median of about 27% over the past 12 months. As seen in the lower chart, Heinz's exponentially weighted moving average IA index volatility began this last six month period at under two orders of magnitude and is now approaching three orders.


Yet while Heinz is showing a reputation decline and increasing volatilty, the industry as a whole is showing increasing stability. In the upper half of the chart below, the variance amond different companies in the peer group is leveling off at about 0.25. Furthermore, among all 5000 companies tracked by the IA index, the median IA index value of the peer group is rising to about the 72nd percentile. Last, the lower half of the chart below shows that the % of value at the Heinz Company ascribable to intangible assets has been increasing and now stands at about 120% while the median fraction in the peer group has been decling slightly to about 60%.



How is all this to be interpreted: decreasing IA index, increasing EMWA IA index volatilty, increasing IA fraction?

We believe its all about reputation. We believe that the extraordinarily high level of intangible asset value comprising some 120% of the company's market value (implying a negative book value) means stakeholders are relying greatly on extra-financial information to set a fair market price. Stakeholders are going with their gut, and gut is driven by reputation -- the impression stakeholders form on management's stewardship of a firm's intangible assets. The increasing volatilty associated with a decline in the IA index suggests to us that the impression stakeholders are receiving from these extra-fiancial channels is increasingly less uniform. Higher stock price volatility and increasing cost of both equity and debt will be among the earliest pains Heinz may experience.

Not convinced? Google search the stock ticker for Heinz, Kellogg, General Mills (NYSE:GIS), and Ralcorp (NYSE:RAH) - food product companies whose IA index values as of 6 April were .83, .90, .94 and .96 respectively - and the term "reputation." The hit counts are 504, 484, 543, and 1950. Did we mention that Ralcorp also had a peanut recall issue, yet their EWMA IA index volatility is decreasing and their ROE for the year is 23% above the peer-group median?

Eclipse of the sun

Nir Kossovsky - Monday, April 13, 2009
Last Monday, 6 April, the world learned that IBM (NYSE:IBM) was no longer interested in acquiring Sun Microsystems (NASDAQ:JAVA). Speculation as to the reasons for the collapsed deal include price, intellectual property and hubris. Let's look at the intangibles of this deal from the perspective of the Steel City Re  Intangible Asset Finance (corporate reputation) (IA) index.

The charts below shows IBM. As seen in the upper chart, among the 48 companies comprising the Computers and Peripherals sector, IBM has ranked in the top 99th or 100th percentile this past year. In terms of return on equity, it outperforms the median of its peers by 33%. As seen in the lower chart, the volatility of its index score is only two orders of magnitude and is decreasing. This is a company with an exceedingly strong reputation that stakeholders believe they understand, and clearly like.



The charts below shows Sun Microsystems. As seen in the upper chart, among the same 48 companies comprising the Computers and Peripherals Group, Sun (JAVA) has ranked no higher than the 50th percentile a year ago and is now ranking below the 20th percentile. In terms of return on equity, notwithstanding the surge in anticipation of a potential deal, it has underperformed its peers by nearly 20%. As seen in the lower chart, the volatility of its index score is three orders of magnitude and is now increasing. This is a company with a rapidly deteriorating reputation that stakeholders are liking less, and are concerned they no longer know.



The data indicate that since Sun Microsystem's reputation is not going to help IBM, the latter can afford to wait until hubris is humbled and the price stabilizes.


Imposing behavior

Nir Kossovsky - Tuesday, April 07, 2009
Cadbury plc (NYSE:CBY), Kellogg (NYSE:K), Mattel (NYSE:MAT) are iconic firms whose products, cash flows, and reputations have been sullied by their business partners through ethical breaches including melamine in milk, salmonella in peanut butter, and lead paint. These three are but a sample of firms afflicted by an epidemic of trading partner (third party) risk who have placed their corporate reputation at financial peril.

Risk & Insurance magazine's senior editor, Dan Reynolds, reviews the Society's conference call from 3 April with the leading question, "Imposing best practices on trading partners today is considered vital, but how does one secure an increasingly global trading community?"  He then brilliantly summarizes Robert Rittereiser's hour-long presentation in a short, entertaining and accessible article.

Rittereiser knows risk. As Reynolds summarizes, "In Rittereiser's deep past, he was a chief financial officer and chief administrative officer of Merrill Lynch & Co. and a president and CEO of E.F. Hutton. On Wall Street, according to press coverage from his glory days, he had a reputation as a guy people hired to solve problems. These days, he is on the board or serving as an officer with several risk management companies, including the Pittsburgh, Pa.-based companies
Zhi Verden and Steel City Re."
 
To link to the the Risk & Insurance article,
click here. To acess the original slides from the Intangible Asset Finance Society call or inquire about purchasing a recording, click here.

Introducing MISSION:INTANGIBLE

Nir Kossovsky - Monday, April 06, 2009
Dear Reader,

Beginning this week and with surprising regularity, the Society will post a quantitative and qualitative analysis of the intangible asset management implications of a current news story involving a publicly traded company. These analyses will draw on IA index data published by Steel City Re. Periodically, the Society will also post announcements to supplement the monthly news alerts, the quarterly newsletter, and the bimonthly publication in IAM magazine.

As always, the Society welcomes your comments and feedback.

Nir Kossovsky
Executive Secretary

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