what is a company really worth? - rutgers...
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Name
Director, Associate Service
The Conference Board
Trusted Insights for Business Worldwide
What is a Company Really Worth?The Role of Internally-Produced Intangibles
Charles HultenUniversity of Maryland and The Conference Board
Janet HaoThe Conference Board
*Presentation to the Comprehensive Firm Valuation Symposium
Rutgers Business School
September 14, 2010
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Economic Research on Intangible Assets Has Found
That They Are Important Drivers of Economic Growth
and Corporate Wealth
Macro intangibles Nakamura (1999, 2000)—intangible investment was $1 trillion a year.
Corrado, Hulten, Sichel (2009)—intangible assets contributed to one quarter of growth from 1995 to 2003.
International comparison of sources of growth (Marrano, Haskel and Wallis, 2009, Fukao et. al. 2009, van Ark et al. 2009).
Firm-level analysis Lev (2001)-called attention to intangible assets as a solution of price-book
gap.
Hulten and Hao (2008)-reported results of intangibles on price-book gap.
Hulten (2010)- study of Microsoft show company is virtually all intangibles, both as inputs and outputs.
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One indication of how important intangibles are for US non-
farm business sector: More has been invested in intangible
assets than tangible assets in recent years (as % of output)
Source: Corrado and Hulten (2010).
0%
2%
4%
6%
8%
10%
12%
14%
16%1
94
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19
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53
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56
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59
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62
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65
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68
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71
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74
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77
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80
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83
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86
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92
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95
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98
20
01
20
04
20
07
fixed capital investment
intangible investment
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Intangibles When we use the term ―intangibles‖, we mean the within-company
expenditures on product research and development, marketing and brand equity, and organization development.
Unlike intangibles reported on the company’s books, these internal outlays are treated as costs on financial statements and not as investments.
CHS classification of intangibles:
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Computerized
Information
Innovative
Property
Economic
Competencies
•Software
•Databases
•R&D
•Mineral Exploration & Evaluation
•Copyright & licenses
•New products in financial industry
•Architectural & engineering designs
•Brand equity
•Firm-specific human capital
•Organizational structure
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Another Dimension of Intangible Assets: They can fill the
price-to-book gap. Here is the case of Johnson & Johnson
0
50
100
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2501
99
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19
98
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20
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07
20
08
Unexplained MV
Equity
Source: Johnson & Johnson annual reports, various years.
$ billion
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Our Method
Hulten and Hao (2008), What is a Company Really Worth? Intangible
Capital and the ―Market to Book Value‖ Puzzle. NBER wp14518.
Use Johnson & Johnson as an example.
Data source: Compustat (10-Ks from 1989 to 2008).
Estimate R&D Capital.
use R&D costs.
R&D capital in t =R&D capital in (t-1) + R&D investment in t –
R&D amortization in t.
Depreciate over 10 years.
Estimate organizational capital.
use about 30% of SG&A costs and varies across years. Estimate the
fraction using data from CHS (2005).
Org Capital in t =Org Capital in (t-1) + Org investment in t
– Org Capital amortization in t
Depreciate over 5 years.
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When Internally-developed Intangibles are Capitalized:
Intangible assets account for 61% of total assets of Johnson &
Johnson in 2008.
- Internally developed intangible assets amount to 7 times
purchased intangible assets.
After we capitalize intangible spending,
- earnings per share increase from $4.62 to $7.37.
- debt-to-equity ratio decreases from 1.00 to 0.31.
- return on equity ratio decreases from 0.30 to 0.15.
Intangible assets contribute to the value of a firm substantially.
- the percentage of market value explained by equity increased
from 23% to 76%.
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Modified
Income
Statement
Johnson &
Johnson
2008
$billions 10-K +R&D K +ORG K
Conventional Revenues 63.7 63.7 63.7
Own production of R&D 0 11.1* 11.1*
Own prod. of Org. Capital 0 0 8.9*
Adjusted Value of Product 63.7 74.8 83.7
Conventional cost of sales 15.7 15.7 15.7
Current R&D costs 7.8 7.8 7.8
Current SG&A costs 21.3 21.3 21.3
Total current costs 44.7 44.7 44.7
Operating Surplus 19.0 30.1 39.0
Conventional depreciation 2.8 2.8 2.8
Amort. of own-account R&D 0 5.4* 5.4*
Amort. of own-account org K 0 0 6.9*
Adjusted operating surplus 16.2 21.8 23.9
Net interest and other adjust. 0.8 0.8 0.8
Before-tax income 16.9 22.6 24.6
Income tax paid 4.0 4.0 4.0
After-tax income 12.9 18.6 20.6
Earning per share 4.62 6.63 7.37*Our estimates of
intangibles are in red.
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Modified
Balance
Sheet
Johnson &
Johnson
2008
$billions 10-K +R&D K +ORG K
Current assets 34.4 34.4 34.4
Plant and equipment 14.4 14.4 14.4
Purchased intangibles 14.0 14.0 14.0
Goodwill 13.7 13.7 13.7
Other long-term assets 8.5 8.5 8.5
Total assets 84.9 84.9 84.9
Total liabilities 42.4 42.4 42.4
Equity 42.5 42.5 42.5
R&D capital 0 64.4* 64.4*
Organizational capital 0 0 31.8*
Assets adj. for own intang. 84.9 149.3 181.2
Equity adj. for own intang. 42.5 106.9 138.8
Market value of equities 181.9 181.9 181.9
% Market value explained 23% 59% 76%
Debt-to-equity ratio 1.00 0.40 0.31
*Our estimates of intangibles are in red.
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Adding Intangibles to J&J Books Fills Price-to-Book Gap
Source: Johnson & Johnson annual reports, various years.
0
50
100
150
200
250
Unexplained MV
equity
0
50
100
150
200
250
Unexplained MV
Org. capital
R&D capital
Equity
0
50
100
150
200
250
Unexplained MV
historic. cost adj.
Org. capital
R&D capital
Equity
$ billion
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Decomposition of Market Value
of 633 R&D Intensive Firms
Source: unpublished updates to Hulten & Hao (2008).
0
1
2
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5
6
7
8
9
Unexplained MV
equity
0
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Unexplained MV
Org. capital
R&D capital
equity
0
1
2
3
4
5
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8
9
Unexplained MV
Historic. cost adj.
Org. capital
R&D capital
equity
$ trillion
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Conclusion
Internally-produced intangible assets are an important
source of company value.
They are hard to measure precisely, and are not
capitalized on financial statements.
Keynes: ―It is better to be imprecisely right than
precisely wrong.‖
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