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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Capturing Latent Reputation Value

C. HUYGENS - Monday, January 19, 2015

RepuSPX and its bigger-tent cousin, RepuStars Variety, were designed to capture latent reputation value not evidenced by stock price. According to Technology Option Capital, the portfolio manager, there were two objectives. The first was to demonstrate that the indicators of value, the Reputational Value Metrics calculated by Steel City Re, provide useful information on enterprise value. The second was to obtain an indication of the magnitude of latent reputational value that could be realized when it becomes sufficiently transparent for investors to appreciate.

Weekly trailing 12-month returns of a simple reputation-based composite equity portfolio reconstituted algorithmically once a year from constituent members of the S&P500 composite equity index outperformed the S&P500 index 86.1% of the time. In 629 serial samples of trailing twelve month returns, RepuSPX generally outperformed SPX returning an excess of 9.5% on average (median 4.7%). In 91% of the cases of outperformance, the excess trailing 12-month returns were greater than 2%.

A time series plot shown below further demonstrates that there is useful information on latent (reputation-sourced) enterprise value in the Steel City Re Reputational Value Metrics. The cumulative price returns through 15 January 2015 are 362.5% for RepuSPX and 69.9% for the S&P500.

Reputation's ROE Was An Added 3.7% in 2014

C. HUYGENS - Sunday, January 04, 2015
Managing reputation adds value that can be quantified. In 2014, RepuSPX, an equity portfolio comprising 35 companies distilled from among the constituents of the S&P500 that showed promise of favorably surprising their equity investors on the basis of their reputation metrics, outperformed the S&P500's 12% return by an additional 3.7% for an annual return of 15.7%.

Over the twelve years Technology Option Capital has been designing reputation-linked equity portfolios from Steel City Re's  indications of reputational value, the annual equity portfolios distilled from the S&P500 have returned an annual excess of 9.5% on average (4.3% median). That's why RepuSPX, with a 367.12% return since inception, is handily beating the S&P500's 12-year return of 79.27%

See RepuSPX chart here.

Below, annual returns of select equity indices showing the returns of RepuSPX (arrow) at 15.7% and the other reputation-linked composite equity index, RepuStars (REPUVAR) that provides global exposure through US market listings of non US-based companies and ADRs.

Pepco: Reputational value, realized

C. HUYGENS - Wednesday, April 30, 2014
Pepco Holdings, Inc. (POM) is a holding company, that, through regulated public utility subsidiaries, is engaged primarily in the transmission, distribution and default supply of electricity and the distribution and supply of natural gas. Earlier this year, Steel City Re’s reputational value metrics suggested there was significant value implied by the expectations of stakeholders that was not being appreciated by equity investors. On that basis, POM became one of the 35 constituent members of the 2014 RepuSPX portfolio, a composite equity index comprising only constituent members of the S&P500 selected for reputation-implied arbitrage opportunities.

After the close of markets Tuesday, Exelon announced that it is buying Pepco Holdings Inc. for $6.83 billion to create a large electric and gas utility in the Mid-Atlantic region. Exelon will pay $27.25 per Pepco share, an 18 percent premium to the company's $23.10 closing price on Tuesday.

Carnival Corp: Hidden value or fool's gold?

C. HUYGENS - Wednesday, March 26, 2014
Huygens has reflected in the past on the travails of Carnival Corp (CCL), the vacation experience company that at times has provided passengers with more than they bargained for. This week, the Consensiv blog picks up a discussion at Motley Fool in which is is observed that the stock price for CCL, while apparently a bargain, may also reflect outsized operating expenses, future liabilities, and ongoing adverse publicity.

Carnival does offer a dividend yield of 2.50%, which is more generous than Royal Caribbean at 1.90%, but considering the other factors — PR challenges and lack of efficiency — that shouldn’t be enough to lead investors in Carnival’s direction.


The key message from Motley Fool's discussion, notes Jonathan Salem Baskin, a reputation controls expert, is that different stakeholders will potentially view the reputational value of CCL differently. Equity investors speak through stock price, which is the most transparent to all outsiders; other stakeholders speak through more opaque channels that create or reduce revenue, increase or reduce expenses and operational efficiencies, etc.

The myriad "valuations" diverge most during and after shocks; over time, they converge. In between the two, there are arbitrage opportunities. Such opportunities are exploited in the RepuStars Variety and RepuStars SPX equity strategies whose weekly returns are posted on this blog.

Read more.

Buffett Buys Businesses At Bargains and Deputies at Discount

C. HUYGENS - Monday, March 03, 2014
If you have not yet caught on that reputation is much bigger than brand marketing, and if the fear of personal reputational damage doesn't motivate reputation-linked changes in your company's governance, controls and risk management strategy, try this incentive: cost savings.

Warren Buffett's reputation creates cost benefits. Business Insider reports: "Berkshire Hathaway's annual shareholder letter explains that 'If you treat people well, they'll often sell their companies to you and work for you for less than they would the competition.'

These cost savings can be applied to investments in reputation protection, as when Berkshire purchased for BNSF rolling stock that exceeds safety requirements and reduces the risk of deadly railroad fireballs. The reputation burnishment Berkshire gained from taking a position opposite the one the auto manufacturer took when confronted with the risk of deadly Ford Pinto fireballs reinforces stakeholder expectations of responsible behavior. This creates further goodwill (lay definition, not accounting definition.) "This strategy of creating goodwill to get lower prices is an explicit part of Berkshire's strategy."

A superior reputation creates value in many tangible and intangible ways. While most of the value eventually becomes apparent on the profit and loss statement, there are good reasons to signal the benefits of better reputation management to those who can appreciate and value it.

Warren Buffett's annual investment letter may be the most followed corporate communication in the world. If you don't have Warren Buffett's cachet, consider Reputational Value Insurance. Like a warranty, this index-linked insurance tells stakeholders that the company has the requisite risk controls to protect its reputational value, a message that by themselves neither Public Relations nor Investor Relations can credibly deliver.

Read More.

Reputation: Who's asking?

C. HUYGENS - Wednesday, June 19, 2013
Reputation is a reflection of the implicit social contract between a company and its myriad stakeholders. One size does not fit all.

Ron Orol reports this week in Capital Report that supply-chain management, interest-rate risk and sustainability issues are three topics that are high on the list of concerns raised by investors in U.S. corporations. He writes:

Lynn Turner, a former chief accountant at the Securities and Exchange Commission, said shareholders’ focus will vary by industry. Big banks, for example, need to explain to investors how they will manage their risk as interest rates rise, he said. “If you are retail corporation, supply-chain stuff has got to be at the top of the list,” Turner said. “If you are a financial institution today, what is going on with interest rates and, as interest rates rise, being able to manage your debt, being able to explain to investors how you are positioned to deal with the risk as interest rates rise and spreads change is going to be very important.” He added that oil and gas companies invested in natural resources will need to respond to investors with environmental concerns.

Steel City Re calculates measures of reputational value that report company performance against that which stakeholders expect -- the implicit social contract. Those metrics "aren’t value judgments, they’re tangible proof of the quality of stakeholder relationships."

Consensiv, a consultancy focusing on returns in investments in reputation and which incorporates the licensed metrics into robust management solutions, explains the inherent value in what are agnostic measures. "We don’t decide what causes matter, or how to best substantiate our beliefs that they should have effects. We measure effects as a platform from which to better explore and reveal causes."

Companies seeking to maximize stakeholder value, the value of the implicit social contracts, aka, reputational value, will be sure to know what is of greatest concern to their stakeholders. They will find creative ways to enable stakeholders to appreciate and value that which they are doing, and monitoring tools to ensure that they are meeting stakeholders' expectations.

Reputational Value Symmetry

C. HUYGENS - Saturday, February 04, 2012
From the time of the pioneering work by Fombrun and others in the 1990's, market observers generally agreed that reputation was a source of equity value. When good, it drove customers to buy more at higher prices, employees to work harder for less, vendor and creditors to offer superior terms, equity investors to bid up multiples, and regulators to cast a more benign eye. Since then, punters have sought methods for linking to concepts into an equity strategy.

The dominant challenge has been the inherent nature of reputation. It is an epiphenomenon of the interplay between culture and operational matters on one hand, oversight and governance practices on the second, and allowing for a third hand -- how the package is presented and delivered to stakeholders. The latter is recognized as being generally in the domain of marketers, and since it represents the "last mile" to the stakeholder, it has received the lion's share of attention.

Reputation value can be teased out of equity value through major adverse reputational events. Many have been documented in this blog over the years. Informal estimates suggest that the cost of an adverse reputational event is around 5% of market cap. Steel City Re, the reputation risk insurance specialist, calculate a value closer to 7% but their model arguably ignores "lesser" reputational events. Since 2005 when the Economist Intelligence Unit published its seminal article on reputation risk, reputation management gained a new internal stakeholder - the enterprise risk manager.

These data affirmed management's need to avoid reputational risk, but they provided little in the way of guidance of how to avoid it. Also, while they suggested how much to invest in the avoidance effort, the lumpy nature of reputational events ensured that any classical actuarial model would leave a firm statistically comfortable with its risk management strategy and yet woefully underprepared.

In November 2011, Steel City Re announced that its data on reputational value indicators had been incorporated into an equity strategy and was available through Dow Jones Indexes. The ten-year history, several years of which have been published weekly on this site, indicated a significant outperformance relative to the benchmark S&P500 index. Critics suggested that the outperformance could be attributed to higher beta securities rather than an inherent value proposition associated with exploiting latent reputation value.

We now report an additional analysis of the RepuStars algorithm in which the stock selection was limited to the S&P500 constituent members only. Details on the 3-year old RepuStars Variety algorithm and the underpinning reputational statistics are provided elsewhere. In this study, stocks were selected by the algorithm at the beginning of each of ten years beginning December 2001. In general, the portfolios comprising stocks selected using the RepuStars Variety algorithm outperformed the universe of S&P500 firms (the Index) each of the ten years. The single exception was 2008 (image below). The ten year average was 6.5%, a value surprisingly similar to the 7% losses realized with adverse reputational events.


From an investment perspective, the portfolio based on the above would have produced an annual 9% cumulative return which is within 10% of the RepuStars Variety price index returns that are reported each Monday (image below).


The upshot is the reputation management is not only good risk management. It is a source of value creation. Firms that do it right can expect, on average, an additional 6.5% in equity value growth, and protection against 7% in equity value loss, all other things being equal. Arguably, there are very few managerial strategies a firm can pursue today short of inventing the next i-device or replacement for facebook that can deliver such value.

Warehousing goodwill

C. HUYGENS - Saturday, December 17, 2011
“Reputation resilience is the benefit arising from having a company pre-position stores of goodwill on which it can draw when the headline crisis strikes,” the Mission Intangible blog of the Intangible Asset Society asserted in June of last year. “It means stakeholders will tend to feel a company’s pain and empathize rather than holding a company culpable.”

The S&P500 index  lost nearly 10% of its value in November. There is fear in the markets as evidenced by the rise in the CBOE VIX. The result is a broad-based run on corporate goodwill. Therefore, today, those stores of goodwill are needed more than ever to conserve enterprise value. To build and protect stores of goodwill, corporate boards need to understand what intangible assets underpin their company’s reputation. They need to oversee the management of the reputation of their firms.

But before boards can oversee reputation management, and before executives can manage reputation, they need to measure it. This is how. The benefits of reputation are embedded in the value and costs associated with operating a business. These values can be extracted, inexactly but usefully using the same tools financial analysts estimate value – essentially, the unexplained excess or deficit in an appropriately structured multivariate regression holding all other comparable elements constant.

If DIY is not on the table, there are an increasing number of consultancies providing access to third party data and offering integrated solutions that fall under the general heading of quantitative reputation management. The data shared weekly in the blog branded as the Steel City Re® Corporate Reputation Index metrics, are exemplary of the  range of reputation management tools now emerging.

With so much value tied today to corporate reputation, few other managerial investments can create, protect or restore an equivalent amount of value.

Massey Energy: Reputation fire sale

C. HUYGENS - Thursday, February 03, 2011
The Wall Street proverb, “buy low...sell high” applies to many metrics. On 31 January, Alpha Natural Resources Inc. (NYSE:ANR) said it had reached a deal to buy rival coal company Massey Energy (NYSE:MEE) for $7.1 billion in cash and stock. The sale price was driven by expectations that 2011 will bring both high prices and high demand for the metallurgical coal produced by many Massey mines. That there was a sale at all was driven by mounting losses precipitated by last year's deadly explosion at Massey Energy's Upper Big Branch coal mine in West Virginia. And by Massey’s rock-bottom reputation.

In its final financial report for 2010, Massey said it suffered a net loss of $166.6 million last year. That's down from a $104.4 million profit in 2009, despite higher revenues in 2010. Close to 70 percent of last year's loss, or $115 million, were the result of costs associated with the Upper Big Branch disaster that killed 29 coal miners. The April explosion focused attention on the company's record of safety violations and drew intense scrutiny from federal mine safety regulators. Massey has cited the increased oversight, an ongoing mine disaster investigation and resulting production declines as reasons for its losses. The company also blamed its lower productivity on difficulty in finding enough mine workers.

In short, the reputational consequences of the catastrophic safety event have been costly -- in the last quarter of 2010 alone, the company's losses totaled $70.1 million. This is why. While firms with superior reputations outperform their peers, firms with damaged or poor reputations command lower prices and market share, have higher operating costs, pay more for credit, and have inferior vendor terms. And in heavily regulated industries, they have higher regulatory burdens.

The Steel City Re Corporate Reputation Index shows the precipitous fall in reputation ranking in April, a moderate rebound, and then a final collapse by the fall of 2010. The exponentially weighted moving average (EWMA) of reputation volatility peaked at 80% in October. And the equity value, reflecting the effects of the costs of the safety event, is giving investors an return on equity over the trailing twelve months that is underperforming the median of its peers by 14%.




The story continues. On 2 February, Massey Energy held a conference call with industry analysts. Among the key reputational message points were the comments by COO Chris Adkins that "voluntary quits" were up 12% in the 4th quarter over the same period last year; and from an operational perspective, Massey's labor shortage and increased federal regulation in response to the Upper Big Branch explosion account for a quarterly production shortfall of 300,000 tons.

And then there's the litigation related to reputation and its drivers: ethics, innovation, quality, safety, security and sustainability. In June 2010, a securities class action complaint charged the company with issuing false and misleading financial information to investors. The complaint alleges that Massey Energy claimed to be one of the safest coal mine operators in the industry, but in fact, safety at Massey Energy’s coal mines was allegedly sacrificed so that production goals could be met, and Massey had received undisclosed citations arising from uncorrected safety and other regulatory violations.

There's more. Shortly after the agreement was announced, a prominent plaintiff's law firm announced an investigation as to whether the 21% premium offered over the prior day's close, and accepted by the board, was consistent with the Board of Directors' duty to maximize value for Massey Energy investors.

Valuation of intangibles: New international standards

C. HUYGENS - Thursday, October 14, 2010
Justice Potter Stewart’s concurring opinion in Jacobellis v. Ohio 378 U.S. 184 (1964) enshrined the qualitative standard “I know it when I see it” into business culture. Now there is a quantitative standard too. For features other than the content of films, that is, as well as other intangibles.

The International Organization for Standards (ISO) has adopted a standard for the valuation of brands - a common term for many of the assets comprising some fraction of the typical ~70% gap between market value and book value. As abstracted from the report in the IAM blog,

ISO 10668 applies to brand valuations commissioned for all purposes, including: accounting and financial reporting; insolvency and liquidation; tax planning and compliance; litigation support and dispute resolution; corporate finance and fund raising; licensing and joint venture negotiation; internal management information and reporting; strategic planning; and brand management. The last of these applications includes brand and marketing budget determination, brand portfolio review, brand architecture analysis and brand extension planning.

ISO 10668 is a meta standard which succinctly specifies the principles to be followed and the types of work to be conducted in any brand valuation. It specifies that when conducting a brand valuation the brand valuer must conduct three types of analysis before passing an opinion on the brand’s value. These are legal, behavioural and financial analysis.

1. Definitions: The first requirement is to define what is meant by brand and which intangible assets should be included in the brand valuation opinion. The brand valuer is required to assess the legal protection afforded to the brand by identifying each of the legal rights that protect it, the legal owner of each relevant legal right and the legal parameters influencing negatively or positively the value of the brand.

2. Behavior: The brand valuer must understand and form an opinion on value drivers; ie,  likely stakeholder behaviour in each of the geographical, product and customer segments in which the subject brand operates.

3. Financial:  [The standard] specifies three alternative brand valuation approaches - the market, cost and income approaches.


The above, which seem to enshrine common practice, may move valuation experts to apply these principles to patents and other intangible assets, and the fact that these practices now have the imprimatur of the ISO may enable the capital markets to accept more readily these indications of value.

To find out if this is the case and to get the latest news from the valuation front, the Society will be hosting three consecutive Mission Intangible Monthly Briefings programs on the subject of intangible asset valuation: markets, value management, and valuation, on Nov 5, Dec 3 and Jan 7. Registration is free. You won't want to miss these!

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