Getty Images

March 03, 2007

The Value of Clouds

Capital markets are a wonderful thing … if you like transparency. I have a friend who hates transparency. He prefers to deal in thin/opaque markets. Those where he can leverage uncertainty. It's a very risky way to invest. For us mere mortals the transparency provided by (more or less) efficient stock markets is a good thing. Because these markets are jam-packed with information.

"Financial price data provide a viewing window into the firm through the market's evaluation of the securities issued by the firm and the changes in these values over time. Accounting data, on the other hand, provide information on the resources used by the firms. Thus, comparing accounting data and financial valuation data offers the opportunity to examine performance, the difference between inputs, on the one hand, and output, on the other (Eric B. Lindenberg and Stephen A. Ross, "Tobin's "q" Ratio and Industrial Organization," The Journal of Business, Vol. 54, No. 1, (Jan 1981, pp 1-32)."


Accounting data also are jam-packed with information. But there are some things these data can't tell you. To continue with the metaphor I introduced in my narrated power point presentation on Chapter 1 "A Bridge to Tomorrow,” accounting data can't tell you the value of "clouds in the sky" because there's no way to hold legal title to them. And "assets" are things to which you hold legal title, otherwise you can't buy and sell them.


To find out the market value of tangible assets traded in a "thick" market, like gold or common stocks, all you need to do is look up their price online. The market value of a common stock is it's closing price times the number of shares outstanding. Calculating the market value of a public company is the first step in estimating its intangible market value.


Two other two general categories of assets (plant/equipment and inventories) are less liquid, but they have accounting values: depreciated book value and replacement cost. The depreciated book value of technologically outdated assets may be a poor measure of their replacement cost. Estimating the replacement cost of such an asset is tricky because of the need to impute the value of improved technology. If you want to dig into the details of how to do this, check out the Lindenberg and Ross paper I cited above. For relatively new assets, like digital images, it's reasonable to assume depreciated book value is a fair estimate of their market value. This also is true for old assets with a very long life, like oil refineries. In either of these cases, the second step in estimating the market value of intangibles is to look up the net book value of tangible and intangible assets on a companies balance sheet.


Which brings me back around to the OIL vs. IMAGES story I posted last time. For those of you just joining me, that story was about Getty Oil and Getty Images. The biggest deal in US history up to July 11, 1984 closed when the Federal Trade Commission approved by a vote of 4-to-1 the purchase of Getty Oil by Texaco for $10.1 billion. On December 31, 1983 the closing price of a single share of Getty Oil common stock (ticker GET.1) was $98.125. The number of shares outstanding on that date was 79,135. This made the total market value of the company $7,765.1 million. In its final SEC filing Getty Oil declared the book value of intangibles was $0.00. MARKET & ACCOUNTING DATA The total market value of a company (v) equals the value of its tangible assets (v1) plus the value of its intangible assets (v2). Now with a little arithmetic we can combine these accounting and financial market data to estimate what Getty Oil was worth just before the merger. Here's the equation: v = v1 + v2, or $10,385.1 = $10,385.1 + $0.00. paid $10,100 million for Getty.


The intangible market value of Getty Images can be estimated using a combination of accounting data and total market value. In case you missed the first story, Mark Getty is the founder and CEO. But while his grandfather's oil company was very 19th century, Getty Images is sooooooo 21st century. The common stock of Getty Images closed at $89.27 on December 31, 2005. With 62,295 common shares outstanding the market value of the company was $5,558.4 million. The balance sheet reported the book value of total assets as $1,663.1 million. The book value of intangibles was reported on the balance sheet as $885.1 million. Subtracting the one from the other we estimate the book value of tangible assets was $808.1 million. Rearranging the terms and combining the accounting data with the financial market data we can estimate the intangible market value of Getty Images: v2 = v – v1 $4,750.3 = $5,558.4 - $808.1 Notice, the book value of intangibles under-estimated the market value of those assets by 83%. That's because accountants can't agree how (or even if) these intangibles should be reported on the balance sheet. So, now you know how to calculate the value of "clouds in the sky." But remember my cautionary note about the assumption that the book value of tangible assets is a reasonable estimate of their replacement cost. When you apply this logic to your own company, ask accounting for their estimate of the replacement cost of tangible assets (they have one) and compare that with reported book value.


Why all this fuss over market and accounting data? Because if you don't know how much intangible market value your business is creating, you can't possibly figure out how much of that value is due to enterprise marketing. And you can’ find that out in the company’s financial statement because intangible book value underestimates intangible market value. On average by about 63%! When you figure out your company’s intangible market value, the next step is to begin pinning down how it’s created and what it costs … the price of value. Stay tuned.