Why equity research must account for intangibles
23rd March 2015
We are now operating in a business environment in which intangible assets have taken over the balance sheet. Once dominated by tangible assets like real estate, plant, machinery and stock, enterprise value is these days defined more by intangibles – of which intellectual property represents an important element.
This is not mere conjecture; the facts speak for themselves. It is estimated that upwards of 70% of enterprise value is attributable to intellectual property (including patents) and intangible assets more generally. Indeed, recent analyses suggest that intangibles make up 53% of the total assets of the FTSE100.
All this represents something of a challenge for equity research. Investors want meaningful insight around intangible assets like IP, but few equity analysts are yet able to deliver it, for a couple of broad reasons.
First, information is hard to come by. Despite their importance, intangible assets barely get a mention in most financial disclosures and annual reports – still less in the management conference calls and industry information databases that remain the chief sources of data for equity analysts. Patents, when mentioned, are simply being presented as a number of filings or grants. However, counting doesn’t count anymore. Not all patents are equal so a more detailed insight is needed to understand the rapidly changing technological landscape.
Second, the information that is available is often misunderstood. Examples of this lack of understanding are not hard to find. Only a few weeks ago, the grant of a single Apple patent generated an astonishing market over-reaction – GoPro shares tumbled by 12%, wiping millions of dollars off the company’s market cap. The point is, this was a single patent in a universe of thousands, and its true significance was negligibly small.
But equity research must overcome these issues if it is to keep pace with an increasing requirement to take meaningful account of intangibles. That means understanding the mechanisms via which intellectual property affects equity risk and value, and using insight around patents to shine a light on wider corporate indicators. For instance:
- Patent litigation is a significant risk factor – it is extremely costly, the outcome is uncertain and the impact of a negative outcome can be significant.
- IP licensing can drive incredible value but a lack of reporting makes it hard to pinpoint and quantify – for instance, Philips holds a significant portfolio of legacy patents that seem disconnected from corporate strategy and current revenue streams. But far from being the ‘worthless’ assets they might appear at first glance, those legacy patents generate income of €477 million in high margin licensing income every year.
- Patent portfolios and patenting activity can offer a useful proxy for innovation – insight here, provided it is in context with the wider market, can offer a useful view of strategy, the focus on innovation and the level of return an organisation realises on its R&D investment.
In a world where intangible assets dominate enterprise value it is not hard to imagine measures like these taking on increasingly prominent roles in equity analysis, in fact it is inevitable. The only question is how analysts will gather the information they need to deliver.