Reporting again from Tokyo…

In the last two days I have had the opportunity to meet with representatives of two leading Japanese professional associations. The Japanese Institute of Certified Public Accountants (JICPA) and the Japan Association of Real Estate Appraisers (JAREA).  I met with these representatives at the request of Mark Penney, National President of the American Society of Appraisers.  Mark was assisted by Kazuo Wakayama, Chief Executive of the Japanese Society of Independent Appraisers, an organization affiliated with the American Society of Appraisers. It has been a packed two days.

RICS Asia Valuation Conference

I spoke at the 2013 RICS Asia Valuation Conference in Tokyo this morning (November 6, 2013).  The theme of the conference was “Asset Valuation: The Lifeblood of Global Financial Markets.”  It was a very interesting conference, attended by about 170 persons, mostly Japanese real estate appraisers, but with a smattering of business valuation and machinery & equipment appraisers.  The conference was simultaneously translated from English to Japanese and from Japanese to English.

The full-day conference was packed with information, beginning with a Japanese economic outlook (not so dissimilar to many US conferences).  Broad topics included:

• Impact of Valuation Standards in the Financial Markets
• True Worth of Your Company’s Assets
• Keynote: London Olympics Legacy
• Asset Performance Around the World
• Implication of Valuation on Lending and Auditing
• Comparison of Japan Valuation Standards with IVSC (International Valuation Standards)

Two Former Brands

My general session talk was titled “The Value of Brands Is In or At The Margin.”  A brand is an “identifiable intangible asset,” in accounting terms.  We can describe it and attempt to measure its impact on cash flows. You can touch and feel a tangible asset.  You can, perhaps, “feel” but you cannot touch an intangible asset.

I suggested that the value of a brand lies in the expected cash flow it can protect and in the pricing power it provides.  Further, the value of a brand is in the incremental tranche of cash flow it can generate for a business. However, brands are not forever.

Brands rise and fall.  There is nothing permanent about a brand, no matter how well it may have once been established.  Two brands were mentioned in particular, the “former brand” companies of including Xerox, and Kodak.  Xerox was a company whose massive brand in color copiers could not save it from technological and market changes.  While the company exists today, it is an entirely different company than it was as I began my working career more than 30 years ago.  It had to reinvent itself and is now a multi-billion market capitalization company.  But that is a different story.  Xerox is not the “copier king” it once was.

Kodak was king of photography.  They made their money selling film which many recall had to be developed.  Who has bought a roll of film in the last many years?  Kodak never survived the emergence of digital photographic technology.  The world changed and Kodak did not.  So Kodak went into bankruptcy, only recently emerging.

Four Current Brands

Monday’s Asia Edition of the Wall Street Journal carried announcements of earnings disappointments for Sony and Nissan.  Then Tuesday’s edition had lead articles about BlackBerry and Twitter.  I augmented my presentation to discuss these current brands.

Blackberry was king of corporate communication.  BlackBerry phones were called “CrackBerries” because so many people were addicted to them.  But BlackBerry failed to recognize that the world of handheld devices was changing.  By refusing to change and to adapt, BlackBerry lost out on its franchise.  It is currently losing money and has been for sale.  The article in the WSJ Asia Edition is reported elsewhere as well.

Blackberry currently has a market capitalization of $3.4 billion and a reported book value of $8.4 billion.  The market is questioning its survival and its is trading at about 40% of book value. There’s no market value added or brand value there.

The expected Twitter IPO was mentioned on the same front page as the Blackberry sale disruption. Twitter is a brand in the making. The proxy for its IPO indicates that in the most recent twelve months, Twitter had revenue of $575 million and a net loss of more than $100 million. And yet, the expected market capitalization at the IPO is perhaps $12 or $13 billion. This is a brand in the making. With this kind of pricing, the markets are clearly expecting that the Twitter brand (and Twitter management, of course), will be able to generate sufficient advertising and other revenues and margin to warrant this heady market capitalization.

Recent announcements by Sony and Nissan were also noted. Nissan cut its full year profit outlook by 15% in a surprise announcement, citing weakness in emerging markets and big recall costs – and a management recall (or overhaul). Sony cut its annual earnings forecast by 40%, citing box-office flops and weak sales of televisions. The “brands” of these two companies have not absolved them from the pressures of market forces.

The Value of a Brand

Think of the value of a business enterprise in terms of its expected future cash flows, the expected growth in those cash flows, and the risks associated with achieving the expected cash flows. In those terms, the value of a brand lies in its ability to facilitate either the current level of cash flow or the expected future growth of cash flow, or in its ability to reduce the risks associated with achieving future cash flows. This is fairly simple conceptually, but this is the way the value world works.

A couple of simple examples illustrate how brands (or good management) can create value. Simplistically, the greater the market price of a stock in excess of its book value, the greater its market value added (i.e., the difference).  Return on equity is a function of earning power and is influenced by such things as brand power. Margin and multiple combine to create value as a multiple of sales.  Consider the following table:

At a given multiple of earnings, increasing the return on equity (e.g., through brand power) increases the price/book value (value) ratio.  In the example, increasing the return on equity from 8% to 20% increased the price/book ratio from 80% to 200%.  If you think of the difference between the market price of a stock and its book value (as represented by the price/book ratio) as a measure of market value added, then brand power helps create market value added.

Similarly, increasing the EBITDA margin from 10% to 20% at a given multiple of EBITDA raises value in terms of a percentage of sales from 80% to 200%.

Both of these illustrations indicate that the value of a business lies in or at the margin. That’s why I said that the value of brands is in or at the margins of businesses.

Current Highly Successful Brands

To illustrate the concept of margin and brand power, I then briefly discussed three current examples, Coca-Cola, Google, and Apple.

Coca-Cola has a market capitalization of some $590 billion on a balance sheet of $1.4 billion which is mostly financed by equity. Coca-Cola does this by owning and managing its Coca-Cola brand.

Google and Apple are high margin, highly successful companies with market capitalizations of  $340 billion and $470 billion, respectively.  Each maintains substantial amounts of cash and equivalents on its balance sheet, and many have wondered why? Perhaps management enjoys sitting on mountains of cash while generating prodigious cash flow each quarter and year. Apple did institute a dividend in its fiscal 2013 year, and now shows s dividend yield of 2.3%.  Something similar must inevitably come from Google.

But the point is that both companies have enormous brand power and they use their brand power to extract substantial margins and to generate substantial market value added.

After all, the value of your brand, or of any brand, lies in or at the margins of your business.

Wrap-Up Thoughts

It was a pleasure to speak at the 2013 RICS Asia Valuation Conference.  It was the first time I have been translated simultaneously with speaking.  I’m afraid I gave the translators a run for their money, but the talk nevertheless seemed to be well-received.

The week in Tokyo continues.  The Professional Board of the International Valuation Standards Council, of which I am a member, has its public meeting today.  We have a packed agenda.  I hope to write one or two additional posts while here in Tokyo.

Until next time,

Chris