Few companies dispute the value of data to the business, but many flinch at the ongoing cost. If that investment could be reflected in an asset value, however, the whole nature of the discussion would change. David Reed looks into the issue of database valuation.
“It doesn’t matter if you include customer relationships in a valuation, but you need to demonstrate that they are in there. Accountants are more confident with the brand because it is bigger and you can see it.”
How do you value a social network? With LinkedIn already floated and Twitter working towards an initial public offering, financial analysts are puzzling over the question. Share prices for these networks appear to have broken free from the usual bounds of valuation - just one week after being floated, LinkedIn’s share price had soared to $120 from a launch price of $45.
That might reflect current enthusiasm for these new online businesses, but it is worrying for anybody trying to relate market value to actual value. In the case of LinkedIn, the disparity is worrying - at its current price, the company is valued at 30 times revenues and 135 times book value.
Multiples of that scale have not been seen for a decade. Since the latest wave of digital companies floated, in fact, leading to over-valuations and the dot.bomb. In their wake, it has to be wondered whether any real lessons have been learned?
Regulators have definitely been concerned to close the gap between what can be proven about a company’s value and how the stock exchange is viewing it. To give shareholders a better grip on the situation - and to avoid a repeat of the Enron and Worldcom meltdown’s - accounting rules have been tightened.
Specifically, there is a big push to reduce the use of good will in reports and accounts. Intangible assets have become a key tool for accountants to explain value, especially during an acquisition. Over the last few decades, brand valuations have gained credibility as part of this process.
But even the brand does not fully explain why some companies attract a huge premium far in excess of their current earning power. So other factors - such as “customer-related intangible assets” as they are called - are being looked to. Data may emerge as a core underpinning of the true value of emerging brands like social networks, if only accountants could work out how to do it.
The process is not an easy one, nor is it always followed. For example, ITV's £145m acquisition of Friends Reunited assigned just over one quarter of the value to intangible assets, including customer related ones, but lumped more than two-thirds of the deal price into goodwill. Yet, as Intangible Business points out, "the driving force behind the acquisition was the Friends Reunited brand and customers".
Julian Dailly, former director of valuations at Interbrand, says that private equity firms are leading the charge towards new valuation techniques. “The whole premise of their model is a combination of leverage and intangible assets. The bigger the gap to physical asset values, the bigger the risk and the higher the reward,” he says.
If intangible assets can be show to have a substantial value to a business, then it can be sold at a commanding premium. Brands have been used to generate high multiples for private equity in the past, even though Dailly believes these investors often “stop investing in the long-term sources of brand value because their exit strategy is three to five years.”
Brand valuations also have their own problems. When persuading accountants to agree a standard for including them in the balance sheet, Dailly believes a fundamental error was made. This is that the brand is considered to have an indefinite life, so the valuation at the point of acquisition is fixed. Instead of the cost being amortised across a number of years, it remains constant but is subject to an impairment charge. That creates a drag on future profits.
Valuing data as an intangible asset would therefore require a number of key issues to be universally agreed. Following the brand valuation process would not be credible, since it can not be argued that a database has an infinite life. Instead, a model would be required that permitted the value to go up or down and which could be properly amortised.
While technical accounting rules permit data (or “customer lists” as they are described) to be valued at the point of acquisition, the tools for doing this do not seem to reflect the real contribution this asset makes to a business. Three approaches have generally been used to value databases in the rare examples of this being done - these are based on cost, income or market value.
In the cost approach, the business simply adds together the overheads that have been incurred to create the database. Dailly points to Sainsbury’s statement that its Nectar scheme costs 2 per cent of sales as an example. Replacement costs for data are often considered in this model, but this tends to become confusing since demographic variables can be found on commercial sources, but relationship history and behaviour can not.
Market valuation considers what price the database might achieve if sold. This is often referred to by companies and marketers as the real value of a database. Yet accountants tend to look at pricing in a “fire sale” scenario where a company is forced to hive off assets, rather than when selling at the height of performance.
A far more complex approach involves looking at the income that can be attributed to the database once all other costs and assets have been accounted for. This is challenging, so royalty rate is sometimes used as a proxy measure by referring to income that might be generated if the data was licenced to a third party.
What all of these models suffer from is the difficulty of isolating the database and its contribution to the business. Even well-established measures of intangible assets struggle with the same problem. “The brand is not a simple asset,” points out Kelvyn King, director of BNP Paribas Business Assets Valuation and a leading authority in this area.
“It is a combination of customer intangibles and relationships that build the brand. If you maintain it, it goes on forever,” he says. “It doesn’t matter if you include customer relationships in the valuation, but you need to demonstrate that they are in there. Accountants are more confident with the brand because it is bigger and you can see it.”
King argues that “valuing the customer relationship is easier”. As proof, he points to business-to-business firms which often have limited brand value, but strong customer bases. “The whole value of their brand relates to customers and is an important contributory part of the brand. So if you are doing a B2B brand valuation, you start there.”
If that makes it sound as if companies are routinely including customer related intangible assets on their balance sheets when acquired, then do not be deceived. This practice is a long way from being commonplace, even though it is mandated by the accountancy practice itself.
The IPA’s Direct Marketing Committee, led by Mark Runacus, senior partner at Crayon, is working on an initiative to get the issue of database valuation discussed across the advertising industry. A number of outcomes are possible, from putting pressure on the accountancy profession to agree on a standard (something the IDM Data Council tried and failed to do six years ago) through to creating a league table of brands based on some form of database valuation.
For data practitioners, any additional noise about the value of data can only be a good thing as they seek to sustain board-level interest and investment levels. David Pandit, head of data at BBH, says: “I think some form of score would be amazing, for example ranking a company on its use of its database. That would help to create interest.”
Beyond that, challenges rapidly emerge, even when working on an in-house database, let alone trying to evaluate a third party. “To work out customer lifetime value can be taxing,” notes Pandit. “Saying that, relationships are very important in terms of data assets.”
As well as agreeing on the right measures and model to use, there is the underlying issue of data quality and completeness. These are unlikely to be visible outside of the company, yet have a significant impact on how effectively data is exploited. Some form of tracking (or even seeding) might be used to look at this dimension.
Regardless of the difficulties, there is common agreement that the time is right to look into valuing the database. “One of the biggest issues we tend to find among client-side marketers when trying to put up a proposal for investment into the database is that it is always seen just as a cost,” says Caroline Kimber, head of data planning at Stephens Francis Whitson. “We need to get them thinking from the other perspective - that the database provides an opportunity to make money.”
Thirty years ago, the advertising industry needed to persuade its clients to continue pouring millions of pounds into an activity that appeared to create no underlying value for them. A strategic move to get valuation of the brand accepted saw both parties happy with the outcome, despite certain limitations, and advertising enjoyed several more decades of unprecedented success.
Data is undoubtedly enjoying its own golden hour, but faces the same issue of how to sustain interest. Creating a valuation process - whether an accountacy-grade version or a more PR focused league table - looks like a smart move. The brand may be the diamond on a company’s finger, but data is the gold ring that keeps it there.