Transcript Celestial Biologicals Limited

Valuation of IPR
Presented by Deepika Maheshwari
Financial Advisory Services
Deloitte Haskins & Sells, Ahmedabad
Audit.Tax.Consulting.Financial Advisory
9th Feb 2008
This document is confidential. No part of it may be
be reproduced without express approval of Deloitte.
© Deloitte 2008.
1
Overview
•Basics of Intellectual property rights
•Importance of Intellectual property rights
•Management of IPR
•Valuation of IPR
Intellectual Property Rights- Basics
•Increasing investment in Intangibles.
• Shift in focus from Physical capital to
Intellectual capital
• “Value of firm= Value of physical
Assets+ Value of intangible assets”
Value of Intangible Assets
Value of future growth
opportunities that are
already in place
Value of future growth
opportunities from new
assets
Intellectual Property Rights- Importance
•Source Of unexpected revenue
•Increases Shareholders Value
•Establishes Proprietary Market
advantage
•Enhances Competitiveness
•Exploits new market opportunities
•Reduces risk
Intellectual Property Rights- Management
Identify
Valuation Approaches:
Design
Accounting
Process
Residual Value
Method
Cost
Software
Market value
Trade Secrets
Income
Know-how
Real option
Trademarks
Brand names
Formulations
IP Trading
Literary work
M&A
IPO/Fund raising
Financial Reporting
Patents
Licensing-In
Copyrights
Licensing-Out
Design
Contract/ Royalty rates
Trademarks
Source: Deloitte Research
Publishing rights
Transfer Pricing
Litigations
Technology transfer
To be able to reap benefits out of IP, a sound IP management
programme is required
Valuation
“The intangibility of a company’s most
important assets makes it extremely hard
to figure out what the company is really
worth.”
Valuation Parameters
What
Whom
What is the IP to be valued
For whom the valuation is
being done
Why
Why the firm has decided
to value IP rights
(Purpose)
How
How the valuation would be
done in given
circumstances
Patents, Copyrights, Designs, Trade
secrets, Know how, Trade marks,
Brand name
Shareholders, Management,
Licensor/Licensee, Investor, Court of
Law, Acquiror , Investment banker
Corporate valuation for shareholders,
M&A, Management buy-out or buyin, IPO/Fund raising, Financial
Reporting, Acquisition/Licensing of
IP, Litigations,, and reorganization
Different approaches to valuation may
be used
While valuing IP…
•Understand the value chain of business and understand
how profits are generated
Patent
Manufacturing
Distribution
Sales
Brand
•Understand Important features of IP and how it adds
value to business
•Obtain Adequate knowledge of trends in the industry and
technology
•Consider scope & Strength of IP asset
•Assess the availability of competing IP in the market
•Ascertain the unpredictability of future returns
Valuation- A Daunting task
•No active market for trading of intangible assets
•Difficult to identify the potential earnings and profits that
can be generated
•Uniqueness of each IPR – Non Comparability
•Difficult to Segregate profits generated from tangibles and
intangibles.
•Difficult to ascribe appropriate economic benefit to an
individual IP Asset if there are more than one IP.
•Inadequate disclosure of Intangibles in financial reports
•Most valuation methods ignore managerial flexibility
Valuation Methods
Valuation Methods
Static valuation
models
Dynamic valuation
models
Accounting Approach
Income
Approach/Discounted
cash flow
Cost Approach
Decision tree Analysis
Real Option Model
Market Approach
Monte carlo Simulation
Accounting Approach
•IPRs are subset of Intangible Assets
•As per AS-26 issued by ICAI, the recognition of an item as an intangible
asset requires an enterprise to demonstrate that the item meets the:
• “definition of an intangible asset and
• recognition criteria set out in the standard”
•As per definition Intangible asset should be
• Identifiable
• Controllable
• Able to generate economic benefits
•An intangible asset should be recognized if, and only if:
• it is probable that the future economic benefits that are attributable to the asset
will flow to the enterprise; and
• the cost of the asset can be measured reliably.
Accounting Approach- Acquisition
Valuation
Separate
Acquisition
• Cost of intangible would be the purchase
consideration paid either in form of cash or in Fair
value of shares or assets exchanged
• Cost =Purchase consideration+ Import Duty+ Taxes+
Any direct attributable exp.
Valuation
As a part of
Amalgamation
•
Allocation of purchase consideration to individual
identifiable assets (including IPs) and liabilities
based on their fair values at amalgamation date
•
Valuation method must:
•
Estimate Fair Value, and
•
Reflect current transactions and practices in
industry
Accounting Approach – Valuing Internally Generated IP
ECONOMIC BENEFITS
Research Phase
Development Phase
Commercial Phase
EXPENSES
Direct + Indirect
Expensed
Capitalized
1.
Technical feasibility
2.
Intention to complete and use/sell
3.
Ability to use/sell
4.
Probable future economic benefits
5.
Resource availability
6.
Ability to measure
Expensed
Available for use
• Internally generated goodwill can not be recognized as an intangible asset
Cost Approach
Historical
cost trending
Method
Value
(Rs)
Recreation
Cost Method
Assumptions :
 Cost to purchase or
develop new property is
commensurate with the
economic value of service
An investor would pay
no more to purchase an
asset than would be
required to reproduce
the asset
Replacement
cost method
This method seeks to measure the future benefits of IP assets by calculating the
amount of money that would be required to replace the future service capability
of the subject intellectual property
Cost Approach- Examples
Historical Cost
•Example : Cost incurred
on R&D to develop a new
technology know-how:
INR 100 for Y1 and INR
200 for Y2
•Inflation index: Y1 = 100,
Y2=105, Current = 110
•Estimated Value of IP
100 x 110/100 + 200 x
110/105 = INR 320
Replacement Cost
•Example : Cost incurred
on R&D to develop a new
technology know-how:
INR 100 for Y1 and INR
200 for Y2
•Inflation index: Y1 = 100,
Y2=105, Current = 110
•Chances of Success : 60%
•Estimated value of IP
would be (100 x 110/100
+ 200 x 110/105)/0.6 = Rs
533
Cost Approach- Pros & Cons
Pros
•Good for internally
developed intangibles or
in liquidation scenario
•When comparable
market data is not
available
•When intangible is not
income producing
Cons
•Requires numerous
adjustment to financial
data
•Difficult to apply if
historical records are
not there
•No direct correlation
between price and value
•Risk is not factored
Market value Approach – Comparable Market value
•Value of an IP = prices paid for
comparable IP as part of arm’s length
transactions
•The transaction price, as a ratio of an
asset attribute such as sales, is used to
derive a market multiple
•This market multiple is then applied to
the attribute of the asset being valued
Requirements
•Active market involving comparable property
•Past transactions of comparable property
•Access to price information at which comparable property exchanged
•Arm’s length transactions between independent parties
Market value Approach – Comparable Market value
•Factors to be considered while comparing
– Industry
– Market Share
– Profits
– Impact of New Technologies
– Barriers to Entry
– Growth Prospects
– Strength of Legal Protection
– Remaining Economic Life
Market value Approach – Comparable Market value
Objective: To value a trademark ‘XYZ’ of a pharma co. ‘Pharma Co.’.
•Annual sale of products with ‘XYZ’ trademark = INR 100
•Comparable transaction: Purchase of 32 medical remedy trademarks by
M&J Labs for INR 5000. Annual sale of all 32 trademarked products
just prior to purchase was INR 4000
Solution
•Value-to-sales multiple of comparable trademark = 5000/4000 = 1.25
•Value of ‘XYZ’ trademark = Annual sale from ‘XYZ’ trademarked
products x Value-to-Sales multiple of comparable trademarked products
= INR 100 x 1.25
= INR 125
Market value Approach- Pros & Cons
Pros
Cons
•Most of the information is not
publicly available
•Relatively easy to apply
•Conceptually attractive
•Provides evidence of value
•Low Frequency of comparable
transactions
•Each intangible transaction is
unique.
Residual Value Approach
Assumption : Markets are efficient. i.e, all future economic benefits from assets
(tangible and intangible) and IP of the firm are factored into the market price of
firm’s equity and debt
•Starts with the company’s value of equity (as measured by its stock
price) plus the value of its liabilities.
•From such amount, value of the company’s tangible assets, plus the
value of any intangibles not transferred (Unidentifiable Intangible
Assets) is reduced. The result is the lump-sum value of the intangibles
being valued.
•Value of IP = MC-(N+U)
– Where MC= Market Capitalization
N= Net Tangible Assets as shown in book (Total assets- total liabilities)
U= Unidentifiable Intangible Assets
Drawback: Valuation would fluctuate with market. IP assets would not be valued
individually. Is the market really efficient to factor in all the benefits
Income Approach
Variations
Method
Premium Pricing method
Premium over generic product/services
Excess Profit method
Excess earnings over the company that
does not possess intangible
Royalty saving method
License fee/ Royalty saved by owning the
intangible
Cost savings method
Cost saved by owning the asset
Value of IP = Present Value of expected future economic benefits from ownership of IP
Approaches
Direct Capitalization
• Estimate an appropriate measure of economic benefit for one period future to the
valuation date and multiply it by an appropriate capitalization rate (r)
r = 1/discount Rate
•Where, r is a measure of economic benefit
• Does not consider future economic benefits
Discounted Future Economic Benefits
Value of IP =
Economic Benefit Period 1
(1 + k)1
Economic Benefit Period 2
(1 + k)2
Plus
The terminal value of the business at the terminal year
TV = Economic Benefit n
(K - growth)*(1+k)^n
..
Economic Benefit Period n
(1 + k)n
Illustration
• The book is expected to generate
$150,000 in after-tax cash flows for the
first three years and $100,000 a year
for the following two years. These are
the cash flows after author royalties,
promotional expenses and production
costs.
Year
Stable
Cash
flows
Present
value @
7%
Volatile
Cashflows
Present
value @
10%
1
60,000
56,075
90,000
81,818
About 40% of these cash flows are from
large organizations that make bulk
orders and are considered predictable
and stable. The cost of capital applied
to these cash flows is 7%. The
remaining 60% of the cash flows are to
the general public and this segment of
the cash flows is considered much
more volatile. The cost of capital
applied to these cashflows is 10%.
2
60,000
52,406
90,000
74,380
3
60,000
48,978
90,000
67,618
4
40,000
30,516
60,000
40,981
5
40,000
28,519
60,000
37,255
Total
Source: Damodaran online
216494
302053
DCF Approach- Pros & Cons
Pros
•Captures economic benefit
flowing due to Intangibles
•Considers appropriate risk
based rate of return at which
to discount cash flows and
estimates economic life
Cons
•Reliable financial projections
•Estimating income
attributable to intangibles,
its economic life, appropriate
discount rate/ cost of capital
•Use of same discount rate in
R&D as well as Market
phase
•Managerial flexibility is
completely ignored
•No accommodation to option
like nature of investments
Matrix- Accounting for Risk & flexibility
Source:Crystal ball confrence
Real option model
•Investment in intangibles does not generate immediate payoff
•Each intangible may have a bundle of options
Source:Crystal ball confrence
Decision Tree Analysis
Patent failed
P = 0.70
NPV5= (0.20 x NPV1 + 0.80 x NPV2)
Lapse
P = 0.20
Product fails
P = 0.20
Patent
Application
Cost
NPV10 = NPV9 x0.3 - Cost
Low
Revenue
P = 0.40
Patent
granted
P = 0.30
NPV8= NPV7 x0.8
Renew
P = 0.80
NPV2
Status Quo
P = 0.60
NPV3
File patent
in UK
P = 0.40
NPV4
Product
Success
P = 0.80
NPV7= NPV5 x0.4 + NPV6 x 0.6
High
Revenue
P = 0.=60
NPV6= (0.60 x NPV3 + 0.40 x NPV4)
Application to Grant
NPV1
Grant to
Commercialization
PHASES
End of first year of
commercialization
Real Option Technique
• Valuation under uncertainty
• Use Black-Scholes (1973) Option Pricing Model
• Option parameters
– Value of Underlying = Present Value of Economic Benefits
– Exercise Price = PV of investment in IP
– Time to Expiry = Remaining economic life of IP
– Standard Deviation = Standard Deviation of Economic Benefits
– Risk free Rate = Riskless interest rate that corresponds to the
economic life of IP
– Dividend (Value Leakage) = 1/Economic Life of IP
Patent Payoff Diagram
Net payoff from Patent
PV of Cost of developing
and commercializing the
Patent
Present Value of Economic
Benefits from Patent
Problems
•Estimation of future economic benefits
•Economic benefits may not follow a continuous process
•Variance may be unknown and may change over the
economic life of IP
•Exercise may not be instantaneous
•Compound options
Categorizing Valuation
Independent and Cash flow
generating intangibles
Not independent and cash flow
generating to the firm
No cash flows now but potential
for cashflows in future
Examples
Copyrights, trademarks,
licenses, franchises,
professional practices
(medical, dental)
Brand names, Quality and
Morale of work force,
Technological expertise,
Corporate reputation
Undeveloped patents, operating or
financial flexibility (to
expand into new
products/markets or abandon
existing ones)
Valuation
approach
Estimate expected cash flows
from the product or
service and discount
back at appropriate
discount rate.
Compare DCF value of firm
with intangible with firm
without (if you can find one)
Assume that all excess returns
of firm are due to intangible.
Compare multiples at which
firm trades to sector averages.
Option valuation
Value the undeveloped patent as
an option to develop the
underlying product.
Value expansion options as call
options
Value abandonment options as
put options.
With multiple intangibles (brand
name and reputation for
service), it becomes
difficult to break down
individual components.
Need exclusivity.
Difficult to replicate and arbitrage
(making option pricing models
dicey)
Challenges
Life is usually finite and
terminal value may be small.
Cashflows and value may be
person dependent (for
professional practices)
Source: Damodaran website
Concluding Remarks
•IP valuation calls for co-ordinated efforts from a CA, IP attorney, and a
technology person
•Adopt as many appropriate valuation techniques as possible,
understand the pros and cons of each valuation method, and make a
best estimate
Thank You
Deloitte Haskins & Sells
‘Heritage’, 6th Floor
Near Gujarat Vidhyapith
Off Ashram Road
Ahmedabad-380 014
Gujarat
Deepika Maheshwari
Assistant Manager
Email: [email protected]