The Ascent of Intangibles
How do investors know how much a company is really worth and how do they make sure that their capital is well spent?
For centuries the combined value of a company’s physical assets was roughly equal to its market value. Financial statements normally gave an accurate account of all assets contributing to the company’s value. Today this is no longer the case, as intangibles have replaced physical assets as the principal factor of production. Unsurprisingly, investors find it increasingly difficult to understand what lurks beneath the glossy veneer of corporate reports.
Intangibles have no physical substance. These assets - intellectual property, research and development, customer relationships, staff and managerial expertise – are the building blocks of 21st-century companies.
Research by Ocean Tomo, a merchant bank, found that more than 84 % of the value of the S&P500 consists of intangible assets, an increase of 4 % over the last decade and 52 % since 1985. Firms now invest as much or more in intellectual assets as they do in physical capital such as machinery, equipment and buildings.
Traditional productivity and business performance measures have not kept up with this transformation, and many companies underreport their intangible assets. Chicago economist Simcha Barkai estimates that the unobserved intangible capital in the US now amounts to a staggering USD 48 trillion, exceeding the total value of physical assets. Instead, companies should identify these hidden assets and unlock their real value.
The absence of intangibles on corporate balance sheets prevents investors from properly gauging risks. Nor can they carry out meaningful comparisons between companies.
In the case of non-traditional investments, the situation is even more challenging. The actual performance of the venture capital industry is notoriously hard to understand. Investors have to spend time and treasure to identify the top performers. The opaqueness is often attributed to the complexity of venture capital investments and the lack of transparency on the part of most managers about their results. But a simpler explanation might be that venture capital firms struggle to properly capture the value of intangibles. What assets could a startup possibly possess besides cash raised from friends, family or investors? Without a valuation method that includes intangibles the industry is bound to remain murky.
Investors in private equity face a similar problem. A recent survey by Augentius, a private equity manager, finds that existing valuation practices and pinpointing suitable investments are the chief concerns among investors. Private equity assets being illiquid, their fair value is calculated using estimates which are often biased and rarely subject to outside scrutiny. As a result, investors find it increasingly difficult and time consuming to navigate the market for unquoted assets. Needless to say, there is an increasing demand for more transparency.
It has long been recognised that the performance of a company – and by extension its market value – flows from how efficiently its entire capital is employed. This basic truth also applies to intangibles.
Intangibles are born out of investment. For accounting purposes, that expenditure is not capitalised in the balance sheet and is only written off as an expense in the income statement. Nevertheless, these intangible investments are in principle recognised and can be treated as assets under international accounting standards. Such capitalised intangibles are then adjustable under normal accounting rules and practice, making a company’s value, performance and market position visible.
More bang for your buck
Apollonian, a new investment firm, aims to shed light on intangibles. Its novel approach to company evaluation allows Apollonian to identify, measure and value all intellectual capital and knowledge based-assets. By analysing these assets the firm can identify untapped investment opportunities and accurately assess a company’s underlying value, risk exposure and potential for growth.
Armed with more than 70 unique algorithms based on 900 indicators, Apollonian assesses all assets underlying a company’s value. In so doing, it is able to determine a company’s current and future value.
Building on this novel approach to assessing companies, the firm has also launched Apollonian Innovation Growth Fund, a private equity fund focusing on intangibles. The Fund invests in unquoted innovative companies planning to scale up their businesses. Its strategic objective is long-term value creation through active management of intangibles. By combining quarterly redemption rights with quarterly reporting, this open-ended Fund offers both flexibility and transparency to clients.
With its twin approach, comprising value investment and active business development, Apollonian is well positioned to offer investors an alternative to opaque and illiquid venture capital structures.