Valuation of Intangibles

1. “Valuation of
Intangibles”
16th Dec, 2020
International Management Institute
Business Valuation Course
Chander Sawhney
FCA, FCS, Registered Valuer (IBBI)

2. Agenda VALUATION OF INTANGIBLES
-Interbrand Best Global Brands 2020 report
-Identification of Intangible Assets / Ind AS 38
-Types of Intangible Assets
-Valuation Approaches
-Guidance on Valuation of Intangible Assets / IVS 210
-Relief From Royalty Method
-Brand Earning Multiple / Discounting Method
-Assembled Workforce Method
-Multi Period Excess Earning Method (MPEEM)
-Purchase Price Allocation

3. Interbrand Best Global Brands
2020 report

4. Top Global Brands 2020*
*Interbrand Best Global Brands 2020 report

5. New Entrants Top 100 Brands 2020*
*Interbrand Best Global Brands 2020 report
Social media and communication brands -have fared exceptionally well in the past
12 months, with Instagram (#19), YouTube (#30) and Zoom (#100) entering the
rankings for the first time.
Zoom’s market capitalization has risen 389% in 12 months. Its revenue is up 270% in
the first half of the year and its brand has enjoyed enormous growth thanks to the
accelerating digital transformation in consumers working lives.
Instagram and Youtube have entered the rank this year thanks to improved financial
reporting from Facebook and Alphabet.
Tesla has also re-entered the rankings at #40, having last appeared in the Best Global
Brands table in 2017. Tesla’s market capitalization has risen 769% in 12 months, its
revenue has risen 10% in six months and the production launch of the futuristic
Cybertruck, as well as the launch of connected services and plans to roll out a “Tesla
Network” of self-driving “robotaxis,” has cemented the brand with its core customer
group.
Johnnie Walker also re-enters in 2020. Though its market capitalization was affected
by COVID-19 it remains a highly distinctive brand, with a newly updated visual
identity

6. Valuation of Intangibles

7. Intangible assets do not have any physical identity. These represent a company’s right or claim to future benefits arising
from their use. Intangibles result in excess profits to the company and lead to high growth in business, thereby increasing
the ROCE resulting in enhanced profitability and better cash flows.
As per Ind AS 38 Intangible assets are defined as “An identifiable non-monetary asset without physical substance”
Guidance under Ind AS 38 on Intangible Assets
Identifiability
Para 11. The definition of an intangible asset requires an intangible asset to be identifiable to distinguish it from goodwill.
Goodwill recognised in a business combination is an asset representing the future economic benefits arising from other
assets acquired in a business combination that are not individually identified and separately recognized. The future
economic benefits may result from synergy between the identifiable assets acquired or from assets that, individually, do not
qualify for recognition in the financial statements.
Para 12 states that an asset is identifiable if it either:
(a) Is separable, i.e., is capable of being separated or divided from the entity and sold, transferred, licensed, rented
or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the
entity intends to do so; or
(b) Arises from contractual or other legal rights, regardless of whether those rights are transferable or separable
from the entity or from other rights and obligations.
Identification of Intangible Assets

8. Control
Para 13 states that an entity controls an asset if the entity has the power to obtain the future economic benefits flowing
from the underlying resource and to restrict the access of others to those benefits. The capacity of an entity to control
the future economic benefits from an intangible asset would normally stem from legal rights that are enforceable in a court
of law. In the absence of legal rights, it is more difficult to demonstrate control. However, legal enforceability of a right is
not a necessary condition for control because an entity may be able to control the future economic benefits in some other
way
Para 14. Market and technical knowledge may give rise to future economic benefits. An entity controls those benefits if,
for example, the knowledge is protected by legal rights such as copyrights, a restraint of trade agreement (where
permitted) or by a legal duty on employees to maintain confidentiality.
Future economic benefits
Para 17 states that the future economic benefits flowing from an intangible asset may include revenue from the sale of
products or services, cost savings, or other benefits resulting from the use of the asset by the entity. For example, the use
of intellectual property in a production process may reduce future production costs rather than increase future revenues.
Identification of Intangible Assets

9. There are five major types of intangible assets and valuation methodologies vary for each of these assets. The remaining
amount which cannot be apportioned to the respective Tangible and Intangible Assets forms part of Goodwill.
Types of Intangible Assets
S. No. Nature of Intangible
Asset
Major Constituents
1 Marketing-related Brand, Trademarks, Trade names, Internet domain
names, Non-Compete Agreements
2 Customer-related Customer lists, Backlog, Customer contracts
3 Artistic-related Plays, books, films and music, etc
4 Contract-related Licensing and royalty agreements, Service or supply
contracts, Lease agreements, Permits, Broadcast
rights, Servicing contracts, Employment contracts
and Non-Compete agreements and Natural Resource
rights
5 Technology-based Patented technology, Computer Softwares,
unpatented technology, Databases

10. Valuation
Approaches
Valuation approaches and methodologies for intangible assets
As in any valuation, income, market and cost approaches or a combination of these approaches are
used to value intangible assets. Different intangibles may be valued using different valuation
approaches.
• Cost approach
The cost approach values intangible assets by accumulating costs that would currently be required to
replace the asset. However, by its nature, the intangible cannot be valued based on cost approach as it
fails to incorporate the competitive advantage, business operations and incremental profits. Further,
not all costs are incurred efficiently and may or may not have any value today. However, as in other
cases, it can form a base of value as a reference check.
• Market approach
The market approach values intangible assets by comparing prices paid in similar transactions. However,
the market approach is often difficult to apply in case of valuation of intangible assets as no
meaningful comparable can be found in practice. Often business transactions take place in lump-sum
and intangibles are not separately valued leading to difficulty in benchmarking. However, where such
information is available and transaction for some intangibles have taken place, this approach may be
applied.
• Income approach
The income approach is the right approach for deriving true value of intangibles as essentially an
intangible leads to excess profits, incremental cash flows leading to growth in business and better
ROCE.

11. Guidance on
Valuation of
Intangible Assets
under IVS 210
Para 60.4. The income approach is the most common method applied to the valuation of
intangible assets and is frequently used to value intangible assets including the following:
(a) Technology;
(b) Customer-related intangibles (eg, backlog, contracts, relationships);
(c) Tradenames/trademarks/brands;
(d) Operating licenses (eg, franchise agreements, gaming licenses, broadcast
spectrum);
(e) Non-competition agreements.
Para 70.3. The cost approach is commonly used for intangible assets such as the following:
(a) Acquired third-party software;
(b) Internally-developed and internally-used, non-marketable software; and
(c) Assembled workforce.

12.  Factors considered in Discounted Cash Flow Methodology:
o Financial Analysis and Normalisation Adjustments
o Understanding Industry Characteristics and Trends
o Forecasting and reviewing Company Performance
o Detailing of Future Cash Flows and deeper understanding of Value drivers, Competitive advantages,
Geographical Location of Business and underlying assumptions of business model
o Prospective Financial Information to cover “Known or Knowable” on Valuation Date
o Review of Cost of Capital (Historical v. Estimated)
o Incremental Risk Premium /CSRP / Alpha
o Deeper penetration into Revenue, Cost, Working Capital, Leverage
o Cash Flows of Intangible are discounted at “Cost of Equity as they are rarely funded by Debt
o Sensitivity / Scenario Analysis
Key Factors considered in Income Approach

13. Relief from
Royalty method
Relief from royalty method (which is based on the royalty rate as a percentage of revenue
that the company would be required to pay to a hypothetical third-party licensor for use of
that intangible asset) is often applied to value marketing-related intangibles like Brand or
Trade Names.
The principle behind Royalty Relief Model is that the value of the intangible asset is equal to
the present value of the after-tax royalty savings attributable to owning the intangible asset.
The valuation analysis in the Royalty Relief Method involves the following steps:
- Determine an earnings measure to estimate a royalty* payment stream;
- Assess the trademark's remaining economic life;
- Select an arm's length royalty rate to apply to that earnings measure;
- Deduct income tax from the net royalty stream;
- Select and apply an appropriate discount rate to the after-tax royalty stream; and
- Add tax amortization benefit
The royalty rate applied in the valuation is determined after an in-depth analysis of available
data from licensing arrangements for comparable brands and an appropriate split of brand
earnings between licensor and licensee. The Royalty Relief method is widely used because it
is grounded in commercial reality and can be benchmarked against real world transactions.
*Source : Databases, Annual Reports of Industry Leaders
Alternative Industry Benchmark Royalty Rate for Royalty Relief Method - 25% of EBIT

14. Relief from
Royalty method
(Case Study)
All Amount INR Million
Particulars Year 1 Year 2 Year 3 Year 4 Year 5
Total Revenue 1,000.00 1,050.00 1,102.50 1,157.63 1,215.51
Trade Name Royalty 25.00 26.25 27.56 28.94 30.39
Taxes 7.00 7.35 7.72 8.10 8.51
Royalty Cash Flows (post Tax) 18.00 18.90 19.85 20.84 21.88
PV Factor 0.92 0.79 0.68 0.58 0.50
Present Value of Cash Flows 16.65 14.95 13.43 12.07 10.84
Terminal Value 74.22
Sum of the present value of
cash flows (including terminal
value)
142.16
Tax Amortization Benefit
Factor *
1.121
Tax amortization Benefit 17.20
Fair Value of Trade Name 159.36
*Tax amortisation benefit (TAB) refers to the net present value of income tax savings
resulting from the amortisation of intangible assets. Tax amortization benefit is based
upon life and discount rate used to value Intangible Assets.

15. Brand Earning
Multiple
Method
Brand Earning Multiple Method
The valuation analysis in the Brand Earning Multiple Method involves the following steps:
- Determination of Stable Brand Profits after excluding the Non Brand Profits
- Determination of #Brand Score / Earning Multiple
#Brand Score is based on evaluation of several factors on a scorecard of 0-100. Factors such
as Leadership, Stability, Market, Global Reach, Support and Protection etc. are evaluated.
- Brand Value is then determined based on multiplication of Brand Profits with Brand Score
Note – There is inherent subjectivity in evaluation of Brand Earning Multiple but leading
companies like Interbrand are using this methodology to rank Brands.
As per Interbrand report, there are three key components in their valuation methodologies:
• an analysis of the financial performance of the branded products or services,
• the role the brand plays in purchase decisions and
• the brand’s competitive strength.

16. Brand Strength Factors*
*Interbrand Best Global Brands 2020 report

17. Brand Earning
Multiple
Method
(Case Study)
The following is the extracts of Brand Valuation disclosure made by Infosys Limited in its
Annual Report 2012 by way of additional disclosure by following ‘Brand Earning Multiple
Method.

18. Brand Earning
Discounting
Method
Brand Earning Discounting Method
The valuation analysis in the Brand Earning Discounting Method involves the following
steps:
- Assess the Brand's economic life;
- Estimate Brand Cash Flows*;
- Deduct income tax from the Brand Cash Flows;
- Select and apply an appropriate discount rate to the after-tax Brand Cash Flows;
and
- Add tax amortization benefit
*Real challenge in intangible valuation lies in determining how much portion of value is
attributable to a number of tangible and intangible assets. A layman’s perspective is to
determine the cash flows with and without that intangible and address this issue. The
estimated annual cash flows of such intangibles are then converted to present value by
applying a suitable rate of return appropriate to the risk of the asset.

19. Multi-Period
Excess Earning
Method
(MPEEM)
Multi-Period Excess Earning Method (MPEEM)
The principle behind this method is that the value of the intangible asset is equal to the
present value of the after-tax cash flows attributable to the intangible asset only.
Valuation analysis in MPEEM involves the following steps:
- Forecast revenues attributable solely to the intangible asset;
- Apply an appropriate margin to forecast sales (EBIT adjusted for non asset-related
cost);
- Apply an appropriate tax charge to estimate post-tax cash flows;
- Apply post-tax contributory asset charges (net working capital, fixed assets, brand
charge, assembled workforce, etc) to reflect the return required on other assets
that contribute to the generation of the forecast cash flows; and
- Discount the resulting net post-tax cash flows, using an appropriate discount rate
which reflects the risk associated with the intangible asset relative to the overall
business operations of the Company, to arrive at the net present value.
- Add tax amortization benefit.

20. Multi-Period
Excess Earning
Method
(MPEEM)
(Case Study)
All Amount INR Million
Particulars Year 1 Year 2 Year 3 Year 4 Year 5
Total Revenue 1,000.00 1,050.00 1,102.50 1,157.63 1,215.51
Revenue from Existing Customers 800.00 840.00 882.00 926.10 972.41
80% Revenue attributed to Customer Relationship (Basis Attrition rate of the customers for last 5 years, Addition of new
customer every year and Revenue attributed to the customers out of total revenue)
Cost of services for surviving customers 600.00 630.00 661.50 694.58 729.30
COGS, operating costs and depreciation assumed to attribute to existing customer revenues on a pro rata basis with new
customer revenues.
Total OPEX 600.00 630.00 661.50 694.58 729.30
EBITDA 200.00 210.00 220.50 231.53 243.10
Less: Depreciation 1.05 0.83 0.66 0.52 0.41
EBIT 198.95 209.17 219.84 231.01 242.69
Trade Name Royalty* 49.74 52.29 54.96 57.75 60.67
*Assumed Trade name royalty is 25% of EBIT as per general industry practice
Adjusted EBIT 149.21 156.88 164.88 173.26 182.02
Taxes 41.78 43.93 46.17 48.51 50.97
DFNI (Debt Free Net Income) 107.43 112.95 118.72 124.74 131.05
Add: Depreciation 1.05 0.83 0.66 0.52 0.41
Less: Return on Net Working Capital# 24.16 26.07 27.37 28.74 30.18
Return on Fixed Assets# 1.05 0.83 0.66 0.52 0.41
Return on Assembled Workforce# 23.14 24.30 25.51 26.79 28.13
Contributory Assets 48.35 51.20 53.54 56.05 58.71
Excess Earnings 60.13 62.59 65.83 69.22 72.75
PV Factor 0.93 0.80 0.69 0.60 0.51
PV Excess Earnings 55.86 50.16 45.53 41.30 37.46
Total Present Value of Excess Earnings 230.31
Tax Amortization Benefit Factor* 1.127
Tax amortization Benefit 29.25
Fair Value of Customer Relationship 259.56

21. Assembled
Workforce
method
Assembled Workforce
The technique used to estimate the fair value of the assembled workforce is the replacement
cost method, which represents the cost to hire and train a comparable assembled
workforce.
The valuation analysis in assembled workforce method involves the following steps:
- Determine the cost associated with hire such as:
-Internal and external recruiting cost;
-Training upon hire; and
-Opportunity cost of start-up phase due to reduced efficiency and time lost to
training upon hire.
- Determine total cost avoided associated with having the workforce in place based on
Replacement Cost method.
It is worth mentioning that the assembled workforce is not a separately identifiable
intangible asset and forms part of goodwill.

22. Purchase Price
Allocation
Intangible valuations are required mainly for financial reporting purposes.
Under Ind AS 103, now all business combinations (except group consolidation) are
considered in the nature of purchase and require the acquirer to apportion the consideration
paid among tangible and intangible assets. Intangibles need to be separable and identified
based on their unique characteristics.
As per para 18 (measurement principle) of Ind AS 103, the acquirer shall measure the
identifiable assets acquired and the liabilities assumed at their acquisition-date fair values.
The difference amount, if any, between the consideration paid and assets acquired goes to
goodwill. It is also known as Purchase Price Allocation (PPA).

23. Purchase Price
Allocation
(Case Study)
Acquisition and PPA from the 2016-17 Annual Report of Infosys Limited
Transaction Details
On 5 March 2015, Infosys acquired 100% of the voting interests in Panaya Inc. (Panaya), a
Delaware Corporation in the United States. Panaya is a leading provider of automation
technology for large-scale enterprise and software management.
The business acquisition was conducted by entering into a share purchase agreement for
cash consideration of Rs 1,398 crore. Panaya’s Cloud Quality™ suite positions Infosys to bring
automation to several of its service lines via an agile SaaS model, and helps mitigate risk,
reduce costs and shorten time to market for clients. The excess of the purchase consideration
paid over the fair value of net assets acquired has been attributed to goodwill.
The purchase price has been allocated based on the Management’s estimates and
independent appraisal of fair values as follows:
Notes-
(1) Includes cash and cash equivalents acquired of Rs 116 crore.
The goodwill is not tax-deductible.
The gross amount of trade receivables acquired and its fair value is Rs 58 crore and the
amounts have been largely collected.
The fair value of total cash consideration as at the acquisition date was Rs 1,398 crore.
The transaction costs of Rs 22 crore related to the acquisition have been included under
consultancy and professional charges and employee benefit costs in the Statement of Profit
and Loss for the year ended 31 March 2015.

24. Purchase Price
Allocation
(Case Study)

25. Chander Sawhney
Chartered Accountant & Registered Valuer (IBBI)
FCA, FCS, B.Com (H)
M: +91 9810557353
E: chandersawhney@gmail.com