Why a brand valuation could tip the balance sheet

By David Haigh

Now that brands can carry a hard cash value under ISO 10668, they can be used more widely than ever, for anything from collateral for loans to bargaining in takeovers.

A brand new approach

In the past, brand valuation was often written off by Chief Finance Officers as a subjective “black art”. In future, CFOs are much more likely to take it seriously.

The new ISO 10668 standard on monetary brand valuation was released in September 2010 and has been promoted widely as a new dawn for the discipline of brand valuation. The new ISO standard requires that legal, market research and financial analysis must be completed in determining a brand’s value.

Certain brand valuation techniques have been specified by ISO (the International Organization for Standardization) to ensure that brand valuations are more transparent, reliable and reproducible.

There is no doubt that the new ISO will make a significant difference to the perception of brand valuation as a management discipline. However, although CFOs may now accept that brand valuation is a mature professional discipline, they still need to be convinced as to why a brand valuation is necessary. Conducting a robust brand valuation takes time, effort and money from both client and valuer – so there had better be a good commercial reason for commissioning one.

Why measure brand value?

The global standard mentions a diverse range of reasons for brand valuation. Common purposes include accounting, liquidation, legal transactions, licensing, litigation support, dispute resolution, taxation planning and compliance, fund raising, management information, strategic planning and value reporting.

In terms of accounting, every major acquisition now results in a brand value appearing in the accounts of the acquiring company. For example, when P&G acquired Gillette several brands were explicitly identified – Gillette, Braun, Oral B and Duracell being the main ones. P & G paid $ 64 b, nearly half of which was allocated to the acquired brands.

Since 2004, International Financial Reporting Standard (IFRS) 3 has required that on acquisition the purchase price paid must be allocated to the individual assets acquired for inclusion in the balance sheet of the acquirer at their fair values.

This applies to all traditional tangible assets such as plants and equipment, but also to intangible assets such as patents and brands.

As a result, the acquisition of British Airways and Iberia by the newly created International Airline Group (IAG) means that when IAG’s financial report is published in early 2011, the value of these two iconic airline brands will appear on a balance sheet for the first time.

It is arguable that the requirement to conduct brand valuations for financial compliance purposes has forced CFOs and financial regulators to take brand valuation seriously. Certainly it is a serious business for the Securities and Exchange Commission (SEC) in the US, which commissioned the International Valuation Standards Council (IVSC) to create guidelines for the valuation of all intangible assets.

IVSC Guidance Notes 4 and 16 on intangibles, together with ISO 10668 on brand, have created much greater clarity in the accounting treatment of intangibles generally and brands in particular.

One of the spin-offs for marketing people is that balance sheet valuations often highlight the growth opportunities of sub brands, enhancing the role and importance of brand management.

Brand bargains

Brands are generally valued on a “going concern” basis to the current owner, often referred to as “value in use”. But where companies have fallen into administration or liquidation it is sometimes necessary to value brands on a “potential use” basis to a new owner.

The recent financial crisis, which began in late 2007 and is only just beginning to end, has seen the demise of many well known and potentially valuable brands.

For example, in 2008 Woolworths stores went into administration and the brand was sold. The liquidator used brand valuation analysis as the basis for negotiating a sale. A typical report of this kind would include a trademark review, brand strength assessment and an estimation of the brand royalties that might be expected for licensing the brand into a new business vehicle.

On 2 February 2009 it was announced that the Woolworths brand in the UK had been bought by Shop Direct Group, The Times estimated that Shop Direct paid between  £ 5 m and  £ 10 m for it. Shop Direct Group re-launched the brand online. On 25 June 2009, Woolworths.co.uk reopened with more than half a million products on offer.

Having bought the Woolworths brand based on a conservative “potential use” basis it is likely that a revaluation on a “value in use” basis would show a significant gain in value for the Shop Direct Group.

Restructuring

There are many occasions where it is necessary to value brands for the purposes of legal restructuring. A good example of this involved the transfer of the EasyJet brand to EasyGroup limited in 2000 when EasyJet went public.

The “Easy” brand began as a low-cost airline. Prior to floatation of the airline, the founder,Stelios Haji-Ioannou, transferred the brand into EasyGroup so that it could be developed beyond the airline business. He subsequently developed EasyCar, EasyCruise, EasyBus, and EasyHotel.

Businesses outside the travel industry now include internet cafes, online price comparison, personal finance, cinema, male toiletries, online recruitment, pizza delivery, music downloads, mobile telephone, offices and wrist watches.

It was necessary to value the brand and set rates for its use by each subsidiary in the expanded group of companies, many of which involve third parties.

Licensing

When Ban Yan Tree extended from its traditional five star hotels and resorts business into fragrances, body care, clothing spas and accessories, it began with a detailed brand valuation that highlighted the brand value opportunities. This was then used as a route map to follow in realising the brand value potential.

The three areas of analysis required in an ISO compliant brand valuation are all vital ingredients in licensing negotiations.

Companies such as EasyGroup and Virgin need to fully understand the extent of their legal rights, the brand equity in new territories and classes of business and the likely financial gain from the use of their brands by potential licensees. This then provides the basis for the licensor brand owner to strike the highest price for the use of the subject brand.

Litigation

In 1984 Nestle acquired Carnation Foods, valued the brand portfolio and expatriated the trademarks from the US to Switzerland. Nestle has a policy of running all its brands from a “brandco” in Vevey, Switzerland.

Its brands are managed from there and are recharged internally to subsidiaries and externally to third parties. Moving the Carnation brands was standard operational practice at Nestle.

While accepting this principle, the US tax authority, the Internal Revenue Services (IRS), challenged the capital values placed on the Carnation brands. The IRS asserted that the brands had been overvalued to utilise unrecovered tax losses on exit from the US.

The brands were valued by experts on both sides using royalty relief and income split methods (two of the methods recommended by the new ISO standard) and the case was eventually settled out of court.

Dispute resolution

Arbitrators and mediators often require brand valuations to reach equitable decisions when resolving disputes. In 2006 British American Tobacco (BAT) was required to stop licensing its cigarette brands into non tobacco applications, which were deemed to be unacceptably promotional for cigarettes.

BAT had previously licensed the Pall Mall brand to a clothing company that had adopted the name Pall Mall Export Clothing Company (PMECC).

BAT was forced to break its licensing agreement and had to pay compensation to PMECC, which had developed a highly successful business. Brand valuation models were created that showed the “base case” value of the PMECC brand in clothing with the benefit of the Pall Mall brand. It was then flexed to show the probable revenue and cost impacts of rebranding, as the basis for a settlement.

Michael Leathes, the CEO of BATMark, used the resulting brand valuation in a ground breaking arbitration-mediation exercise. The valuation model was used by both sides to determine fair compensation for PMECC.

Taxation

It has become common practice for major brand owners to set up offshore “brandcos” to more efficiently and effectively manage and run their brands. Shell Brands International in Switzerland and Vodafone in Dublin are good examples of brands that have migrated from the UK.

In both cases the primary reason to move was to enhance the operation of the brand by better managing brand strategy, brand communications, and internal and external licensing. But in each case the location chosen to operate the brand from was also highly tax efficient. More and more brand managers are getting used to working out of exotic tax havens such as Switzerland, Singapore, Dubai and Cayman Islands.

Fund raising

It is increasingly common for banks to ask for a brand due diligence report when they lend or renew borrowing facilities to strongly branded businesses. This is particularly so in the private equity areas. For example, private equity firm Doughty Hanson borrowed heavily to fund the purchase of food manufacturing group RHM. The brand portfolio was an important intangible asset to support the borrowing.

Similarly brands have been used by Disney to raise finance through bond issues supported by royalties, paid by theme park operators in Japan and elsewhere.

Even football club brands are being used as collateral for borrowing to fund highly geared debt structures.

Management information

It has been said that if Cadbury had more widely disseminated its internal brands valuation results prior to last year’s take over approach by Kraft, it might have enhanced its share price and avoided takeover.

Companies with large complex brand portfolios need management information reporting frameworks to support decision making and resource allocation.

Diageo is a good example of a company that has regularly conducted brand valuations of its many drinks brands to support its value based marketing approach. The valuations have historically been used for internal purposes only and not for detailed reporting to investors. Interestingly, Cadbury did the same with its many confectionery brands.

In the marketing services world brand valuation techniques are also being included in the assessment criteria for campaign effectiveness when rewarding advertising agencies. For example, VCCP, the advertising agency of the highly successful online website comparethemarket.com, benefits from an increase in brand value due to the creative work that has gone into the promotion of that site.

Strategic planning

Perhaps the most important single application of brand valuation for marketers is its use in strategic planning. Brand valuation frameworks, often wrapped up in brand scorecards, are becoming common tools for managing brands on a comparable basis from brand to brand and time to time.

Unilever, Heineken, BAT, Diageo, Castrol and Nestle are just a few of the brand owners that are using brand valuations in one form or another to determine brand acquisition, investment, extension and divestment strategies.

Value reporting

Prior to 1988, brand values were never shown in balance sheets. In 1988 Hovis chose to value its brand and to include it in the balance sheet as part of a takeover defence. The board argued that an unsolicited bid undervalued the company. In the end the bid was defeated, but the accounting authorities disapproved of the practice.

The Hovis defence sparked a 20-year debate. First the accounting and financial reporting professions produced new accounting standards (FRS 10, FAS 141 and IFRS 3) to account for acquired brands. But home-grown or self-generated brands are still nowhere to be found on balance sheets. The view among accountants is that it is imprudent to set these up in the formal balance sheet. So in formal accounts home-grown brands do not appear.

However, increasingly major brand owners are producing valuations of all their brands on a periodic basis and presenting the resulting valuations to investment analysts so that they can better understand the value of the company.

A good example of this is Club Med, which has valued its brand and presented the results to investment analysts several times in recent years. The intention is to explain and justify why the Club Med business is strong and valuable despite the depression in the travel and tourism market.

A new era for brand managers

As noted in the ISO standard there are many technical and commercial reasons why companies are valuing their brands. Gone are the days when brand managers were logo cops making ads and briefing PR firms. Nowadays they are more likely to be rubbing shoulders with tax advisers and investment bankers.

Brand managers need to be aware of how to value brands, but also why and when. Brands have become big business and managing them has become a branch of high finance.

(David Haigh – Managing Director of Brand Finance Plc – is founder and Chief Executive of Brand Finance and a CIM Fellow. This article was published in The Marketer magazine UK of February 2011.)