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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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Leftovers - M:I MB of 10-Jan-8 (Part II)

Nir Kossovsky - Thursday, January 14, 2010
Among the educational resources offered by the Society are the Mission:Intangible® Monthly Briefings. These one hour events, moderated by Mary Adams who chairs our Member News Committee, comprise about 45 minutes of prepared remarks backed up by presentation materials, and about 15 minutes of responses to questions submitted by listeners. Often, because of time constraints, there are questions leftover.

The 8 January 2010 Mission: Intangible Monthly Briefing comprising a robust panel of Society committee chairs evoked many questions. As promised, here are some more of the leftovers.

QUESTION TO JON LOW: You talked about how we shouldn't look to the accounting profession for support on intangibles yet you also call for comparability. If we don't get this from financial data, where will we find it? What will it look like?

ANSWER: Useful, comparable data supporting the growing economic importance of intangibles will most likely come from practitioners who perceive a financial benefit to themselves. Historically, this is where such innovations have come from as opposed to regulators or stolid, conservative and internally conflicted practitioner groups like the accountants. In the case of comparable data for intangibles we are already seeing growing interest in certain segments like reputation, brand and R&D as a proxy for innovation. Sustainability in its various manifestations is also gaining as a topic of interest.

From these basic roots, successive branches will grow as more factors become important to more industry segments. For instance, once M&A activity revives, data on post-merger integration success or failure – already a subject of considerable research – will probably also blossom.

It would be nice to think that some supra-national organization like the UN or OECD will take the lead, but they see no financial incentive or moral imperative to do so. Self-organized groups like WICI might have been able to lead had they adopted a more open-source approach, but they appear to be pursuing the secretive ‘let’s corner the market and see how much we can charge for our insights’ approach that has failed repeatedly in the past. Any group wedded to a particular technology or set of what they hope will be patented-able processes are similarly doomed because the market is simply too dynamic and unmanageable at this stage. Again, this is not a philosophical, political or doctrinal point of view, it is simply a reflection of natural phenomenon based on historical experience.

When comparable data emerge I believe they will look like the sort of ratios and benchmarks that managers use as a practical means of evaluating their performance. This is in contrast to the increasingly ambiguous or obfuscated metrics served up by GAAP or international accounting standards. The basis of intangibles importance to managers is their usefulness in evaluating and predicting performance, not in enabling arcane acts of financial sleight of hand. It is this usefulness that has prevented their oft-predicted demise and will support their ultimate adaptation.

Jon Low.

QUESTION TO NIGEL PAGE: You predicted a convergence of IP and IA/IC. I agree with you although in my experience, many folks in the IP space have a very strong prejudice that leads them to think (and often say) that intangibles outside of traditional IP (patents, trademarks, copyrights and trade secrets) have limited value. How do we cross this chasm?

ANSWER: I suspect that the events of the coming few years will see this prejudice start to disappear. Most organisations are likely to refocus their priorities as they emerge from recession and, as they do so, they will begin to pay far greater attention to the whole range of intangible assets they own, as well as the potential for monetising these assets. At the same time, CIPOs (or equivalent) will increasingly realise that the best way to secure C-suite attention for their efforts will be to make sure that they incorporate IP into a broader reputation-based 'package'. CEOs will sit up and pay attention to IP if and when they can be made to understand that it is a cornerstone of their corporate reputation, and not a techy side-avenue that's best left to in-house counsel.

Nigel Page
Intellectual Asset Management Magazine

Leftovers - M:I MB of 10-Jan-8 (Part I)

Nir Kossovsky - Tuesday, January 12, 2010
Among the educational resources offered by the Society are the Mission:Intangible® Monthly Briefings. These one hour events comprise about 45 minutes of prepared remarks backed up by presentation materials, and about 15 minutes of responses to questions submitted by listeners. Often, because of time constraints, there are questions leftover.

The 8 January 2010 Mission: Intangible Monthly Briefing comprising a robust panel of Society committee chairs evoked many questions. As promised, here are some of the leftovers.

QUESTION TO CATHY REESE: Your comments about the concept of director's duty of oversight driving greater attention to intangibles management are intriguing. Must a new area like this be built case by case or can there be a catalyst that speeds up the process (such a new set of laws and/or regulations). Is this reasonable to expect in the space of the next ten years?

ANSWER: Directors and officers currently have an affirmative duty under Delaware fiduciary law to oversee and monitor corporate assets and liabilities. Delaware's highest court has said that directors and officers can be held personally liable for losses suffered by the corporation as a result of their inattention. That court has also said that directors violate this duty by failing to (i) implement "reporting and information systems and controls" designed to ferret out such risks and report them on a timely basis to the board, or (ii) failing to monitor and update such systems and controls and thus ignore red flags that can lead to corporate liability. The losses engendered by one patent infringement suit can be enormous, particularly in a wilful infringement suit where damages may be trebled because the company "wilfully" continued to infringe when it knew or should have known of the infringement. I believe that the catalyst that will speed up the process and lead to nationwide awareness that this body of law applies to IP or IA risks and losses, would be one shareholder suit against corporate directors seeking to recover from them personally these infringement damages. Another route might be a shareholder suit to recover market losses for director and officer failure to monitor or address reputational risks before they damaged the value of the company. Shareholder actions for breaches of fiduciary duties by director and officers that are filed in the Delaware Chancery Court receive nationwide attention from corporate lawyers and the boards that they advise and can lead to instant changes in board focus.

Cathy L. Reese, Esq.
Fish & Richardson P.C.

QUESTION TO MARK LUCIER: In your presentation, you made reference to “IA-based financial products and investment vehicles.” How do we position these products so as to avoid being tainted by the recent financial derivatives debacle?

ANSWER: When I was talking about financial products and investment vehicles, what I was referring to was inventing new ways to "ring fence" intangible assets and the risks associated with them, thereby enabling investors to own or finance those assets or bear those risks. The creativity and complexity, then, is more about how we isolate the assets and risk than in how we slice, dice and allocate cash flows among various classes of investors.....think of it more as creating an intangible asset tracking stock or risk-linked security than as engineering a multi-tranche royalty-based CDO or securitization. Alternatively, to the extent we're able to quantify value & risk associated with intangibles, and further, if we can somehow link that to more traditional measures of financial or equity value and risk, then that could serve as the basis for a financial product that enables a company or its outside investors to share in the value being created by the company's intangibles or to hedge against the risk associated with those intangibles.

Of course, your point is well taken that regulators and the general public are skeptical of (read: hostile toward) anything that requires more than one or two boxes and arrows to describe its structure. A financial product's purpose should be plainly evident to those on Main Street and not just to those of us on Wall Street. If we are to be successful in creating these instruments and having them be broadly accepted, our driving motivation needs to be a focus on creating something that funnels capital to intangible assets to support and encourage innovation, rather than on cleverly shuffling the capital structure deck and obfuscating the instrument's true purpose. If we approach the creation of new financial products from that perspective, then "positioning" what we've created will simply be about highlighting the substantive economic benefits, rather than hiding something from the regulators or the Wall Street Journal.

Marc Lucier
Deutsche Bank

Sovereign intangibles

Nir Kossovsky - Saturday, January 09, 2010
For the few remaining skeptics who read the phrase 'intangible asset finance' as a joke without a punch line, consider this. In the Friday 8 January issue of the Financial Times, Gillian Tett noted that in recent months,

“some of the brightest minds at Moody’s rating agency have been mulling a fascinating question: should they introduce a formal rating of ‘social cohesion’ in sovereign debt indices, when they judge whether a government is likely to default on its debt—or not?”

In other words, if pressed for cash, does a country have enough political and social ‘cohesion’ to make truly tough choices—cutting services or raising taxes—without fomenting revolution? And how do you characterize that risk in a spreadsheet? Hardly a laughing matter, these intangibles, no? 

Dearest Reader:  If the above is winning you over, consider joining the Society and helping us create a rational framework around these critical intangible asset issues. Learn more about us at www.iafinance.org.

Heartland: IT tales

Nir Kossovsky - Thursday, January 07, 2010
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.

Costco: Food for thought

Nir Kossovsky - Tuesday, January 05, 2010
While the CEO contributes materially to a company's reputation, the products and services also speak for themselves. This is true even when the CEO is a founder and a lightning rod for controversy. Consider John Mackey, CEO, Whole Foods Markets (NASDAQ:WFMI).

In late summer, we shared that he had courted controversy with the left-leaning segment of his customer base through a strongly worded op ed in the Wall Street Journal. We speculated about the reputation effects. On October 3, he reappeared in the Wall Street Journal in an interview that markedly softened the tone of the August writings. Last, at the end of last month, he finally agreed to relinquish the role of Chairman under pressure from a pension fund-based investment group.

Let's look at the numbers courtesy of Steel City Re , Big Charts.com and the FT's Newssift.com. Over the past twelve months, Whole Foods has had a volatile ride on the Corporate Reputation (IA) Index. It entered the year below the 40 percentile, and exited at about the same level having touched the 90th percentile in late October and diving below the 20th percentile in February. Meanwhile, its equity has returned to stakeholders about 140% for the year while the mean of the 24-member peer group matched the S&P500 returns of around 20%. Note the August 2009 dip on both the reputation index and the market cap.

Compare and contrast this extraordinary return for a company with a controversial CEO and a volatile corporate reputation with the returns of one of the highest reputation-ranked Food and Staples Retailing firms this past year, Costco Wholesale Corp (NASDAQ:COST). Its CEO, James D. Sinegal, is a quiet man, relatively speaking. The Steel City Re Corporate Reputation (IA) Index shows values in the 90th percentile or greater, excluding an early September 2009 dip. Yet the 12-month returns, while positive, are underperforming the S&P 500 by 13%.

With respect to sentiment, over the past 12 months, Newssift reports that of the 238 articles on Whole Foods and its high profile CEO, 32% were positive and 21% were negative for a ratio of 1.5. Of the 99 articles on Costco and its lower profile CEO, 35% were positive and 16% were negative for a ratio of 2. Yet Whole Foods outperformed Costco by a factor of 20. What gives?

There is a simple explanation -- reputation resilience. The financial benefits of Costco's high reputational standing are best seen over a two year window in the stock price chart below. While the markets suffered greatly in 2008 through March 2009, Whole Foods suffered massively with a 75% loss in market cap at its low point. Costco, however, outperformed the market over this two year window with a 24 month loss of about 7% compared to the S&Ps loss of about 22% and Whole Foods' loss of around 25%.

The dark lining to the silver cloud of reputation resilience is that there is less ground lost, and therefore less ground that can be made up. The polish on the silver cloud, however, is in cost of credit. Firms with superior reputations exhibit resilience and lower volatility. Firms with superior reputations have lower betas, lower costs of credit, and credit protection (credit default swaps). Whole Foods' beta is 1.19; Costco's is 0.79.

You're invited

Nir Kossovsky - Tuesday, December 29, 2009
To kick off the new decade, on Friday, January 8, we are hosting a live panel discussion among Society committee chairs about the critical intangible asset issues we will face in the '10s. Each of our chairs working in a different segment of the intangibles market will share their ideas on the most important issues. Our panel includes Scott Childers, Walt Disney Company; Marc Lucier, Deutsche Bank; David Hetzel, Motorola; Jon Low, Predictiv; Cathy Reese, Fish & Richardson; David Gould, Buchanan Ingersoll; Andy Gibbs, Andy Gibbs; Nigel Page, IAM magazine; and Judy Giordan, Steel City Re.

You too can participate in this special Mission:Intangible Monthly Briefing. You can register for free, and slides will posted on the website in advance of the event. Questions submitted by the audience in advance or during the broadcast will be fielded and addressed.

But we thought we would also reach out to a broader audience in the blogosphere and Twitterdom. We're talking to you. You may not be able to tune in to the Briefing, but you are interested in intangible asset finance. What do you think are the critical intangible asset issues for the coming decade? Please share your thoughts through comments on this post and help us spread the word about the discussion. If communicating by Twitter, please include #IAFS in your tweet. We will share highlights from the comments in the call as well as in follow-up posts on this blog. Or send us your questions directly at questions@iafinance.org.

We look forward to hearing from you and working with you in the coming decade to help spread the word about excellence in intangible asset management and corporate reputation.

And to all, best wishes for a happy, prosperous and new year.

Mary Adams, Moderator, M:I Monthly Briefings
Nir Kossovsky, Executive Secretary, IAFS

Faking trades

Nir Kossovsky - Monday, December 21, 2009
As financial intermediaries, brokers play a crucial role of matching buyers and sellers. Central among those role is facilitating price discovery. This is especially true in markets for bespoke, less liquid products. Having a reputation for ethical behavior is valuable—as are the underlying business processes that foster ethical behavior.

Faking trades to distort pricing could threaten the commercial viability of a broker were the practice found to be widespread. At the very least, it is fraud. On Friday 18 December, ICAP Securities USA LLC reached a settlement with the United States Securities and Exchange Commission (SEC). The company, a US subsidiary of ICAP plc (LON:IAP) and winner of a Queen’s Award for Enterprise, is alleged to have posted fictitious trades in 2004 and 2005 on some Treasury brokers’ screens to encourage trading by attracting those brokers’ attention.

ICAP is active in the wholesale markets in interest rates, credit, commodities, FX, emerging markets, equities and equity derivatives. ICAP has an average daily transaction volume in excess of $2.3 trillion. In June 2009, ICAP purchased the intellectual property markets division of Ocean Tomo thus becoming one of the largest market makers in a class of bespoke intangible assets. Intellectual property markets have suffered chronically from price discovery challenges.

ICAP Securities has agreed to pay the SEC disgorgement of $1 million and a penalty of $24 million as settlement to end the investigation. The settlement includes the concept of non-intentional fraud. ICAP Securities has also agreed with the SEC that ICAP Securities will appoint an independent consultant to review the improved control environment that is now in place. Shares of ICAP ADRs fell 46 cents or 3.37% in Friday’s session in New York to close at $13.19 a share. The S&P 500 index was up 0.58% and the financial services sector average was up 0.68%

Blankfein's feign

Nir Kossovsky - Wednesday, December 16, 2009
Let's turn briefly to reputation restoration efforts at Goldman Sachs (NYSE:GS). Lloyd Blankfein’s decision to withhold cash bonuses from himself and Goldman Sachs’ 30-person management committee reflects a child rearing philosophy that we share not. This is why. Allowing a child to send himself to bed without supper does not rectify the wrong; nor does it foster desired behavior. To paraphrase, “it is a tale told by Blankfein, full of sound and fury, signifying nothing.

As we have argued repeatedly, and now provide the business case in the Society's new book, Mission: Intangible. Managing risk and reputation to create enterprise value, the path to reputation restoration begins with changes in business processes. Excessive risk taking requiring parental bailout was the transgression. A commitment never to repeat the offense affirmed by evidence of substantive business process changes is the only acceptable penitence. The desired behaviors Mr. Blankfein should demonstrate are (1) institution of policies and procedures to better govern the actors that individually contributed to the collective risk and (2) deployment of methods to foster conformance with them.

Genzyme fixates on process

Nir Kossovsky - Friday, December 11, 2009
Earlier this week, Robert Bertolini, former Schering-Plough Corp. executive vice president and CFO, was elected to the board of directors at Genzyme Corp (Nasdaq: GENZ). Bertolini worked for the last six years at Schering-Plough, where he was responsible for overseeing tax, accounting and financial asset management before the company’s merger with Merck & Co. Prior to his time at Schering-Plough, he worked at PriceWaterhouseCoopers.

Why elect an accountant to the board of a leading biotechnology company? We think it is for his process expertise. This is why. Three weeks prior, the U.S. Food and Drug Administration notified Genzyme of new deficiencies at its primary manufacturing plant in Massachusetts. A five-week inspection of the facility made the timely approval of the new drug, Lumizyme, unlikely and comes after the location failed an inspection in May.

Today, Genzyme CEO Henri A. Termeer said Genzyme also hired Pamela Williamson from Serono Inc. to be Genzyme’s senior vice president and head of regulatory affairs and corporate quality compliance; Ulrich Goldmann from Novartis Pharmaceuticals to be Genzyme’s senior vice president of global medical affairs; Andrew Lee from Pfizer Inc. to be senior vice president of clinical research; and Michael Panzara from Biogen Idec Inc. to be Genzyme’s therapeutic area head and group vice president for multiple sclerosis and immune diseases. Genzyme has to focus on process improvements.

There is not much else to tweak. Its stakeholders are giving it the benefit of all doubts. Its reputation ranking (see IA index below) is near the peak of the Biotechnology sector according to the Steel City Re Corporate Reputation Index. Nevertheless, its stock price is back to 2004 levels, and trading activity level is rising--a harbinger of reputation changes.

This is what we read in the messaging. Reputation protection is the mission, and business process improvement is the strategy. Loss of reputation at this stage would lead to a precipitous drop in enterprise value and an empowerment of activist investors such as the hedge fund, Relational Investors LLC, of San Diego. Failure is not an option.

United: Reputation breeds indifference

Nir Kossovsky - Wednesday, December 09, 2009
Followers of Mission:Intangible know the mantra—reputations result from perceptions that stakeholders have about a company’s intangible assets. Superior reputations pay off with (i) stronger pricing power, (ii) lower operating costs, (iii) greater earnings multiples, (iv) lower beta, and (v) lower credit costs. And conversely.

From time to time we chronicle on these pages case studies where executives enhance a company’s lowly reputation through substantive operational changes, and where executives tarnish a company’s lofty reputation through process failure(s). In each issue of IAM magazine, detailed case studies now appear routinely. And a compendium will appear end of 2010 first quarter when the Society publishes its first book, Mission: Intangible. Managing risk and reputation to create enterprise value.

Today for the first time we looked at a company where executives tarnish a company’s already low reputation. The company, UAL Corporation (Nasdaq:UAUA), the parent company of United Airlines, is in the Airlines sector where competition for the bottom rank is keen. We’ve looked at this sector before in the context of flight safety. Safety is something stakeholders clearly consider material. Quality, on the other hand, is something stakeholders embrace with resignation. By quality, we use one of three Mission:Intangible standard definitions for this reputation-linked asset. This is it. Reputation is the extent to which a service meets or exceeds the expectations of customers or clients.

For United Airlines, expectations are low. The Steel City Re Corporate Reputation Index shows a low ranking among the 19 companies tracked. By our measure that ranking was not affected by Dave Carroll’s 6 July YouTube release, United Breaks Guitars (embedded below), a song written in protest because the airline would not compensate him for damaging his Taylor guitar. Nor was it affected by the 4 million view of that video before the end of the month. And we can not support claims by Chris Ayres of The Times Online in the U.K. that the Carroll mishap actually cost United $180 million, or 10 percent of its market cap. None of that.


In fact, we are dedicating time and effort to report that nothing happened. The dog didn't bark. The chart below plotting United, the Airlines sector median return, and the S&P 500 shows broad economic slides in July (red V) for all three while the reputation index for United which is volatile for the entire preceding year is remarkably flat. In August, the reputation slides briefly again but there is a broad economic bump upwards. 

Looking at this another way, this chart below shows that the overall reputation standing of the Airlines group (red diamond) rose over the coarse of the year while the variance narrowed. This suggests that the relative flat features of United's reputation are consistent with an industry wide reduction in volatility, if ever so briefly.

What can we learn from this case? First a low ranking reputation may deprive its owner of i) stronger pricing power, (ii) lower operating costs, (iii) greater earnings multiples, (iv) lower beta, and (v) lower credit costs, but there is a silver lining. As the data show, and we write this with all sincerity, a low reputation ranking makes it is easy to meet expectations and deliver quality service.

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