By P.J. Patel, Senior Vice President, Valuation Research Corporation
Recently, many well-known consumer product brands have been acquired.
Recent transactions involving global consumer product companies include Kraft Foods’ $19 billion acquisition of Cadbury, and the Sanofi-Aventis $1.9 billion acquisition of Chattem , maker of brands such as Icy-Hot and Gold Bond. And recent news surrounding the purchase or sale of brands like Tommy Hilfiger, Circuit City, Linens ‘n Things, Nestle’s acquisition of Kraft’s pizza business and Heineken’s acquisition of the FEMSA (in Mexico) brand suggest that more transactions, involving consumer product companies and their brands, will be completed in the future.
Tempered optimism regarding the economy, strengthening stock markets and record private equity “dry powder” capital levels are reviving deal activity. In addition, many operating companies are sitting on cash, and those anticipating an improving economy may be opportunistic in acquiring well known brands at attractive prices, where values may still be reduced due to depressed earnings, reduced multiples or general market uncertainty. For strategic buyers, acquisition rationales may include strengthening product portfolios, growing market share, entering new markets, improving sourcing or manufacturing capabilities, or a combination thereof. Given the strength, importance and expected use of the brands, many of the acquired brands will have an indefinite life for accounting purposes, and as such, many of the transactions will be accretive to earnings regardless of how the deal is financed – another powerful incentive to be acquisitive.
Target companies have seen many of the same market trends, but may have also experienced increased volatility and downshifting by consumers to private labels in a tough economy. For target companies, selling a brand or the business may be an opportunity to strengthen balance sheets, re-adjust product portfolios or cash out.
While opportunities abound, determining whether or not to add a brand to your product portfolio requires careful consideration. We’ll consider the methods and approaches commonly used to value consumer product brands in an M&A transaction.
For many consumer product companies, their brands are the most significant asset. A strong brand influences the choices of customers and can lead to loyal and durable followers. In reviewing public filings, brand values can account for 70% or more of the purchase price.
Unlike fixed assets, a brand is an intangible asset and its value is often more nebulous than the value of tangible assets. The value drivers of a brand, such as market perception and customer loyalty, can be difficult to estimate and even more difficult to translate into value. In valuing brands, cost and market- based approaches are generally less effective methods. Because brand development is often unpredictable and difficult to replicate, a cost approach (often utilizing replacement cost estimates) is subjective and not necessarily reflective of the asset’s future value. Market transactions involving truly comparable brands may be rare, making specific comparable market metrics on brands largely unreliable. As such, brands are often best valued using an income or cash flow-based approach.
To value a brand, the valuer must consider a variety of quantitative and qualitative characteristics. The value is often a reflection of the current and/or future economic benefits that can be derived through the brand ownership and exploitation of its ownership rights.
Key quantitative characteristics to consider include:
- historical and projected growth rate
- market share
- pricing premiums received by the brand
- required advertising and promotion expense
Key qualitative characteristics to consider include:
- history, heritage and longevity of the brand
- perceived product quality
- brand recognition in the marketplace
- potential to extend the brand into adjoining areas
- ability to protect the integrity of the brand
- brand’s breadth of distribution
Some brands are valued using the relief from royalty method. This method is based on the theory that if the company did not own the brand, it could license the brand name from a third party in exchange for a royalty payment. Royalties are generally calculated by applying a royalty rate to revenue. The hypothetical royalty fee is then tax-adjusted, projected over the remaining economic life of the brand and discounted to present value to arrive at the value of the brand.
A second method, the excess earnings method, considers the cash flow generated by a brand net of taxes and charges for use of contributory assets. Cash flows are projected over the expected economic life of the brand and discounted to present value.
Accounting Treatment of Intangible Brands
In a business combination, the fair value of the acquired brands will be reflected on the acquiring company’s balance sheet. This value becomes the book value going forward and is either amortized over the asset’s useful life, if determined to have a finite life, or tested for impairment, if determined to have an indefinite life. ASC 350 provides guidance for determining useful life. Factors to be considered include legal rights, regulatory or contractual provisions or limitations, external economic factors and the required maintenance.
Many well known consumer product brands would be deemed to have an indefinite life, and thus would not be subject to amortization. Indefinite lived assets are tested for impairment annually or more frequently if events would suggest that the asset may be impaired. Factors cited in ASC360 include an adverse change in the asset or market and current or projected losses, among others.
Evaluating a purchase
In evaluating the acquisition of a brand, or collection thereof, the acquiring company should consider the following:
- Price – Is the potential purchase price reasonable?
- Brand Portfolio – Does the acquisition make sense as part of the brand portfolio? Recent successful deals seem to bring together like products or allow a company to divest assets in order to focus their core brand portfolio. For example, as part of InBev’s acquisition of Anheuser Busch it acquired the rights to the Budweiser brand.
- Synergies – Does the acquisition result in synergies that can add to sales and reduce costs? Synergies can be a result of cross-selling opportunities, added distribution capabilities, sourcing or manufacturing advantages, or exposure to new customer audiences. Can you expand the brand to new products and reduce barriers to entry to establish the new product lines? Depending on the industry and the brand, some successful deals have added to earnings in the first year due to the synergies achieved in the transaction.
- Strength of the Brand – How strong is the brand? A brand with significant market share can become even stronger. In the case of InBev’s purchase of Anheuser Busch, Anheuser Busch had more than a 50% market share. Notice the name change–InBev became Anheuser Busch InBev. Or, as in the case of Kraft’s acquisition of Cadbury, a strong portfolio of brands may provide access to worldwide markets.
- Financing - How will the deal be financed? Acquirers need strong balance sheets and plenty of cash since lending is tight. But properly structuring an acquisition can have a meaningful impact on the economics and ultimately the success of the transaction.
- Taxes - Are there tax benefits? This could be a good time for buyers to take advantage of net operating losses of businesses they’re considering acquiring.
- Life – Will the brands be determined to have an indefinite life for accounting purposes or will the brands have a finite life and need to be amortized?
Maximizing the value of brands
Before making a purchase, acquirers will make sure a plan is in place to maximize the value of the acquired brand. These plans include a careful financial forecast of the earnings that can be derived from the newly acquired brand, a projection of potential demand for the product and market share growth, a competitive analysis of similar brands, and a projection of any brand extensions or new market strategies. This analysis is part and parcel of your brand value calculation. But it is also important as the acquiring company will define the roadmap for the strategic use of the acquired brand.
P.J. Patel specializes in the valuation of businesses and intangible assets, including brands, in-process R & D, software, and patents for financial reporting purposes at Valuation Research Corporation. VRC provides valuation services for mergers and acquisitions and financial reporting purposes. Contact Robert Schulte at (617)342-7366.