RoyaltyStat Blog

Hard-to-Value Intangibles sans mystere

Posted by Ednaldo Silva

Unlike the debutant affection of the OECD, we discourage using projected profits or cash flows to measure hard-to-value-intangibles (HTVI) for transfer pricing purposes because this method is speculative and based on several impeachable assumptions.

Forecasting Profit Margin Under CWI

Posted by Ednaldo Silva

We can consider a first-order autoregressive (AR(1)) model to determine an arm’s length profit margin of a “tested party” subject to transfer pricing audit compliance:

Valuation of Intangibles - Pfizer Example

Posted by Ednaldo Silva

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:

Valuation of Intangibles - Measuring Excess Returns

Posted by Ednaldo Silva

To measure excess returns attributed to intangibles, we divide the “return on assets” into two components, including a return to tangible assets that is “separate and distinct” from a return to intangible assets. We think of tangible assets consisting primarily of property, plant and equipment, net of accumulated depreciation, and intangible assets consisting of a weighted sum of past investments in R&D, software, and advertising. As such, we define total assets composed of these two components, tangibles (index = 1) and intangibles (index = 2):

Valuation of Intangibles – Based on Lagged Investments

Posted by Ednaldo Silva

The valuation of intangibles does not create any special problem as long as we keep track in a company’s general ledger the amounts of separate and distinct expenditures that for the purpose of valuation are treated as investments. Thus,

Valuation of Intangibles - Present Value

Posted by Ednaldo Silva

In transfer pricing intangibles are an enigma, regarded as hard-to-value assets. Let’s decipher: If we let Yt represent income (profits, royalties, dividends, interest), Greek gamma γ be the discount rate, and D = 1 + γ be the discount factor, then the present value (PV) of any asset, including intangibles, can be determined by a well-known formula:

Valuation of Intangibles - Initial Capital Stock

Posted by Ednaldo Silva

The initial stock of identifiable assets ("capital stock"), including tangible and intangible assets, is based on the project's initial investment, rate of depreciation or amortization, and estimated growth rate of revenue. This initial capital stock can be estimated by a straight-line equation:

Valuation of Intangibles - Perpetual Inventory Method

Posted by Ednaldo Silva

The NPV (net present value) of intangibles has serious break-points. To avoid them, we propose using the perpetual inventory method (PIM). A major advantage of PIM is that no forecasting of revenue attributed to the intangible is needed; instead, we use actual annual expenditures recorded on the company's general ledger (GL), say annual R&D and annual advertising expenses attributed to creating self-developed separate and distinct intangibles. Another major advantage of PIM is that intangible value is not sensitive to changes in discount rates, which in turn depend on an applicable interest rate and a controversial measure of risk attributed to projected royalties.

Valuation of Intangibles - Not Hard to Measure

Posted by Ednaldo Silva

The valuation of self-developed intangibles does not produce any special analytical problem compared to the valuation of tangible assets. The key issue is to separate and distinguish in the company's general ledger the stream of income and expenses attributed to the identifiable assets. E.g., it’s recognized that R&D expenses (XRD in Capital IQ Compustat’s mnemonics, or investment) produces technology intangibles, such as patents, know-how, and trade secrets. Likewise, it's recognized that advertising and promotion expenses (XAD) produces marketing intangibles, such as trademarks (branding) and customer list. In short, it’s recognized that:

Valuation of Intangibles - Future Benefits May Not Be Realized

Posted by Ednaldo Silva

The present value (“PV”) of intangibles based on projected (unrealized) royalties is speculative. As such, the PV of intangibles determined for tax purpose is mostly advocated by naïve analysts, policy-makers, and tax administrators. It's well-known that the PV of any income-earning asset, including intangibles, can be computed by using a weighted sum formula: