Last week I received one of those emails that kick your thinking into a higher gear. It contained four simple statements:
• Uber - the world's largest taxi company owns no vehicles.
• FaceBook - the world's most popular media owner creates no content.
• Alibaba - the world's most valuable retailer has no inventory.
• AirBnB - the world's largest accommodation provider owns no real estate.
These four statements neatly capture one of the mega trends revolutionising the economy. Over the last 35 years the West has undergone a massive economic inversion.
Corporate balance sheets, once cluttered with tangible assets such as property, plant and equipment have been inverted. Airlines don't own aeroplanes anymore. Hotels don't own their buildings. Car manufacturers are now outsourcing production lines.
This of course begs the question: if all the heavy stuff, the tangible assets, are gone - what replaced it?
The answer is both profound and simple: balance sheets today are dominated by intangible assets: brand, content, data, know how, confidential information, design, inventions, code - in short intellectual property.
A recent survey by OceanTomo found roughly 80 per cent of the value of the S&P500 is now in intangible assets.
This makes sense on a micro level too: take a company such as Apple or IBM or Google and calculate the value of all their fixed assets (desks, chairs, lap tops and anything else you can physically touch) and it soon becomes clear that all the real value is somewhere else entirely.
It can been seen happening in value chains too: in a backstreet in Pakistan (or China or Indonesia) I can buy a t-shirt for $1. Sew on a Calvin Klein (or D&G or Chanel) label and it now costs $100. Same t-shirt. Where did the value come from? Brand (supported by content, design, innovation, marketing and distribution know how) - all intangible, all intellectual property).
Despite the enormous impact of this inversion the financial, legal, accounting and regulatory world is playing catch up. Seven hundred years of the pre-eminence of "real" assets in accounting and humans' innate tendency to focus on the tangible over the intangible means we still tend to concentrate on things we can stub our toes on.
For example in due diligence, audit or financing the counter party or investor typically focuses on what the fixed asset register looks like, yet in many cases it is now largely irrelevant. Traditional company accounts frequently fail to show where real company value now lies. Value, like the underside of the proverbial iceberg, is often hidden or blended together under the blunt rubric "goodwill".
This economic inversion (the movement from heavy (tangible) to light (intangible) balance sheets) presents enormous opportunities and risks and its effects are rippling, seen and unseen, through Western economies.
SHARE THIS QUOTE:
Corporate balance sheets contain both hidden, un-sweated assets that savvy management can leverage or insightful third parties can take advantage of.
Witness Carl Ichan's move to force AOL to monetise its patent portfolio. Analysts had valued the intellectual property at a few hundred million. When, under pressure from Icahn, AOL did sell the patents went for US$1.1 billion (NZ$1.4 billion), the approximate value of all of AOL at the time.
The stock surged 43 per cent, adding hundreds of millions to AOL's market cap even after it had divested the patents, the very asset that had driven the increase in the stock price. Icahn's position earned him a handsome profit.
Risks exist as well and can be identified once investors and management begin to investigate the previously unseen.
Many companies (and their investors) are exposed to currently un-priced or under-priced risk from infringement of third party intellectual property, failure to own or control intellectual property assets critical to delivery of major revenue streams, the loss of key intellectual property through theft or lack of management (data, content, confidential information) or are vulnerable to new technology and innovation coming on stream they do not influence that threatens core business.
The inversion's ripples don't just stop at operating companies, they affect financial institutions as well.
SHARE THIS QUOTE:
The inversion's ripples don't just stop at operating companies, they affect financial institutions as well. Banks for example have traditionally made loans to businesses secured against tangible assets (plant, equipment, real estate).
These assets are increasingly irrelevant to company performance. Over time banks face a stark choice: either don't bank a progressively large portion of the market (and watch your book shrink) or figure out how to ascribe value to the intangible assets of your customers.
The same assets that current thinking and accounting rules tell you to put a line through are ironically where the real value lies. Investors face similar challenges to banks: often modern company performance cannot be fully understood without also understanding the management, risks and opportunities baked into the investee's intangible assets.
The great economic inversion that began 35 years ago has profound implications: for management, for boards, for investors and financial institutions. There is no going back: in a knowledge economy intangible assets will only become more important.
As with any fundamental shift, those that see further and embrace the change are best prepared to profit from it.