Black and White brings you a part two of a two part interview and discussion about intangible assets with Dr. Nir Kossovsky of Steel City Re.

So why am I suggesting there’s a mispricing? Because the mechanism of accounting for the value has no relationship to the performance, utilization, or revenue generated by those underlying assets.

You state on your website, that the intangible assets are often mispriced. Why is that?
KOSSOVSKY: Well, we talked about Goodwill being a form of recorded intangible asset value. So when a company acquires a second company and there’s a difference between the book value and the acquisition cost, that difference, which represents the intangible assets, is recorded at that time as Goodwill, and then it’s depreciated over 40 years by a magic formula called take one-fortieth off every year. So why am I suggesting there’s a mispricing? Because the mechanism of accounting for the value has no relationship to the performance, utilization, or revenue generated by those underlying assets. Example. Time Warner’s acquisition of AOL. That was a hundred billion dollar acquisition and within day two of the deal there was a hundred billion dollar asset — Goodwill asset sitting on Time Warner’s books because there was no physical asset coming over in that deal. A hundred billion dollars of Goodwill.

But based on subscribers and market value?
KOSSOVSKY: No. Based on the price they paid for it. That’s the accounting rule. It’s a transactional base. How long did it take them to write down the hundred billion? Was it a year or two?
Close to that period of time.
KOSSOVSKY: Within a year or two, they had to write down a hundred billion on that. That’s a lot of money to lose in the course of a year or two.

Well, also the AOL executives didn’t have a lot of good things to say.
KOSSOVSKY: No. There were a lot of issues there, but you’re question was about mispricing, well, for a price to change over the course of year by a hundred billion dollars suggests that somewhere along the way the price was wrong.

I want to go back to globalization for a minute. Are U.S. companies paying more attention to their intangible assets because they are more frequently producing ideas and then sending production overseas? And so if companies did not start to pay attention to the intangible aspects of their business, would their market value fall?
KOSSOVSKY: What you are saying, corporate — no. In a sense, this is one of the mechanisms that we have clear evidence that intangibles are valuable, that companies market cap today tends to be about 2, 2.1, 2.2 times its book value. So, it’s not falling, it’s just that the…

Would it fall if they did not identify, manage, and insure their assets?
KOSSOVSKY: Yes, and that’s why you have your Jet Blue stories, you know, Mattel stories. These are very dramatic examples of acute loss of that value. How do you know what you’ve got? Well, it’s easy to figure what you got when you lose it, and you kind of realize what it is really worth. So, many companies take for granted that they have this, or have not really realized to the extent that those aspects have to be accurately managed. Many may be aware of the brand’s importance; intellectual property’s importance, human resources and things are important, but may not appreciate the degree to which they are the drivers of value. And they may not be able to know how to apply managerial tools to that. A managerial tool — the CFO, tell me, how is my account doing in this particular area? What is my return on this? How much did I invest in that? It’s very hard to answer that. What should I be investing in resources? Well, let’s kick it up an extra ten million. And what is our return on that? A new metric of measuring. So it’s exceedingly difficult for conventional management that’s been looking at the world in terms of management you can measure, to get their arms around the approach of this. And most difficult is that while the value accrues at the enterprise level, it’s overall corporate sales, or more corporate profitability, or overall enterprise value, earnings, multiple stock price stability, that’s an enterprise level value. Decisions are working there, where largely be manifestations of investing in intangibles, it would be cost. We have to pump in more money to include our safety practices. And that’s going to incur divisions for the bottom line even though the enterprise value maybe protected. That was clearly the thinking of Ford. That was the thinking of BP. We have to put more money into safety. We have to protect the tank or rebuild the gas tank. That’s cost. What’s the return on that cost? Hard to say.

I want to go back to top-down and bottom-up management. Virgin, for instance, which is known through Richard Branson, of being a bottom-up management style company. At least he alludes to that. Their hierarchy is apparently not so well defined. A lot of what happens in all of the companies that he is involved in very much happens at the individual business unit as opposed to a top-down management strategy. So with regards to your business and with regards to intangible assets, are companies who are undertaking best practices typically using a top-down management strategy?
KOSSOVSKY: No. I think the tactical aspects of this execution would have to come from the bottom where detail control is, but the philosophy and the importance of this — the emphasis has to come from the top. So the top sets a strategic lead, and emphasizes the strategic value, in a sense structures rewards systems, incentive systems for teams to encourage them to pursue the right track. Which means that incentives would have to include not just divisional or unit benefits, but they would also be responsive to enterprise-wide performance because the benefits — or the costs of screwing up are enterprise wide. Consider the banking industry. You have all these different verticals in a large bank. And the real estate groups got into some serious trouble between the SIVs and CDOs and what not. So you had banks that, through one particular division, got massively hammered and then lost huge amounts of value. Other divisions did pretty well. So the bank is writing bonus checks to other divisions, even though the banks have lost massive amounts. Previously, they would write big checks for the guys that lost all that amount. There was no mechanism; still is no mechanism for that value to be tied to enterprise related risks. So instead of compensating a banker for putting the bank into a high risk, high yield scenario that produces five years and then give it all back to the sixth, tie their bonus to long term performance so that they themselves are not tied to that risk. If I’m incentivized to gamble with your money, it’s really hard not to. And you’re telling me that if I gambled big, I’ll get a big check for doing that, I’ll swing.