RoyaltyStat Blog

Valuation of Intangibles - Pfizer Example

Posted by Ednaldo Silva on Apr 23, 2016 3:12:14 PM

Estimates of unidentifiable intangibles based on Tobin’s Q tend to be exaggerated because (in addition to dividend yield) they include a speculative element represented by stock price appreciation. In many cases, capital appreciation can swarm dividend yield. Let’s consider Pfizer Inc. (NYSE: PFE), as an example. Pfizer is a global biopharmaceutical company engaged in discovering, developing and manufacturing healthcare products. Pfizer’s technology and marketing intangible-based products include Prevnar, Lyrica, Enbrel, Lipitor, Viagra, Sutent, BeneFIX, Genotropin, ReFacto, and Xyntha. Several products in Pfizer’s current portfolio were acquired from Wyeth Pharmaceuticals, including Prevnar and Enbrel. Here are some of Pfizer’s selected annual financials for the 12-month ending 2015-12-31 in Million USD. To keep matters in perspective, we provide more information than is needed to value Pfizer's self-created intangibles:

  • Revenue                                     48,851
  • R&D (XRD)                                    7,690
  • Advertising (XAD)                        3,100
  • Depreciation                                5,157
  • Operating Profit                        13,859
  • Capital Expenditures                  1,397
  • PPENT (Net)                               13,766                         
  • Goodwill (Net)                           48,242
  • Intangibles                                 88,598
  • Common Equity                        64,694
  • Market Cap                              206,310

An estimate of Pfizer’s unidentifiable intangibles based on Tobin’s Q is Intangibles = (Market Cap − Common Equity) = (206,310 – 64,694) = 141,616, that is, $141.6 billion. However, we get a smaller (and we consider more reliable) estimate of intangible value if instead we use a simple formula based on the perpetual inventory method (PIM):

     (1)     Kt = It / (g + δ),

where It denotes an identifiable or specific annual investment item recorded in the company's general ledger (GL) such as Capex, R&D (XRD), or Advertising (XAD) expenditure,  g = ∆Kt / Kt – 1 = {(Kt / Kt – 1) – 1}, such that (Kt / Kt – 1) = (1 + g) and LN(1 + g) ≈ g. The Greek minuscule delta is the depreciation (applicable for Capex) or amortization rate (applicable for intangible producing investments such as XAD, XRD, or software development costs).

We consider two separate and distinct annual investments to compute technology and marketing intangibles. First, we can estimate the value of technology intangibles based on R&D investment (XRD) to be:

     (2)     Kt (XRD, 2015) = 7,690/0.092 = 83,587,

when we assume g = 0.025 (or 2.5%) and δXRD = (1/15 years) = 0.067.

Second, we can estimate the value of marketing intangibles based on Advertising investment (XAD) to be:

     (3)     Kt (XAD, 2015) = 3,100/0.358 = 8,659,

when we assume g = 0.025 and δXAD = (1/3 years) = 0.333.

Based on our g and δ assumptions, which we hold to be reasonable, the combined sum of Pfizer's technology and marketing intangibles is:

     (4)     (Kt (XRD, 2015) + Kt (XAD, 2015)) = (83,587 + 8,659) = 92,246,

that is, $92.2 billion compared with Tobin’s Q figure of $141.6 billion. Please note that in this Pfizer example, R&D (XRD) is greater than Advertising (XAD), which is greater than Capex; therefore, technology and marketing intangibles, individually, exceed the PIM capital stock value of structures and equipment for any reasonable assumption about the parameters g and δ.

This PIM-based estimate of Pfizer's intangibles produces a more reasonable ratio of total self-created intangibles to common equity (92,246/64,694 = 1.426) than certain hyperbolic figures derived from using Tobin’s Q = (206,310/64,694 = 3.189). In addition, using the PIM equation (1), we can identify the separate and distinct technology and marketing intangibles that according to IFRS are not disclosed on a company's balance sheet. Also, we can get more detailed estimates when we divide the XRD and XAD annual base amounts into separate and distinct components, including discrete components that we find on the tested company's GL and that we can attribute to separate and distinct product franchises (e.g., Prevnar, Lipitor, etc.) within a specified portfolio of intangible-based products.

These estimates of the self-developed technology and marketing intangibles are different from the acquired intangibles recorded on Pfizer’s balance sheet, which are included on lines 8 and 9 on the table above. The figures estimated using the PIM equation (1) represent the values of separate and distinct self-created intangibles. We can easily provide a sensitive analysis in which Kt (XRD, 2015) and Kt (XAD, 2015) can vary subject to small and reasonable variations in the parameters g and δ. In Pfizer's example, g = 2.5% is reasonable because since 2010 the annual growth rate of Pfizer’s revenue has been negative.

The PIM equation (1) can provide a reliable estimate of the value of separate and distinct intangibles, such as specific technology and marketing intangibles, which we can enrich by adding a sensitivity analysis based on small variations of its two relevant parameters (g and δ). Again, we suggest that the valuation of intangibles is not “hard-to-value” when we exclude the metaphysical veil that permeates recent discussions prompted by BEPS about the valuation of intangibles in transfer pricing. As illustrated above, we can reduce tax controversy because instead of speculation we can use actual investment data (Capex, XRD, XAD, software develpment expenses) to determine the value of intangibles, without having to ascertain the expected life of the tested intangibles, forecast their revenue or profits into an uncertain future, and without having to determine a very sensitive risk-adjusted discount rate.

Ednaldo Silva (Ph.D.) is founder and managing director at RoyaltyStat. He helped draft the US transfer pricing regulations and developed the comparable profits method called TNNM by the OECD. He can be contacted at: [email protected]

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Topics: Valuation of Intangibles