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Understanding Intangible Assets
Intangible assets, in short, are those that cannot be physically seen or touched. Generally, these items include intellectual property, such as patents or trademarks, brand recognition, and trade secrets from which future economic benefits are expected to flow. Throughout the global economy, companies’ investments in intangibles are enormous, and rival those of tangible assets. Goodwill, the excess of the purchase price of an acquisition over its value, is also considered an intangible asset.
Investors should consider the amount of a company’s intangible assets, and how this number changes over time, in considering a company’s earnings potential. Note, though, that the value of these assets is difficult to determine and estimate due to their having no physical substance, companies’ lack of control over the benefits, no observable market prices, and their employment in combination with other resources. As such, they are tested annually for impairment.
Intangible assets on a company’s balance sheet can be categorized as follows: 1) Those purchased in a business combination, 2) Those purchased in situations other than business combinations, and 3) Those developed internally. Henceforth is a further description, and examples of, each type.
First, in terms of business combinations, goodwill is created when the purchase price of the acquisition exceeds the sum of the amounts that can be allocated to individual assets and liabilities. For instance, when thermal imaging products maker, FLIR Systems (FLIR) acquired Raymarine Holdings, a supplier to the recreational boating and light commercial marine markets, $85.5 million in goodwill was added to the purchase price. According to the company’s 10-Q filing, this total is to account for the ability of the combined companies “to grow through the combined businesses through the integration of each other’s products, market presence, distribution channels and domain knowledge.”
Intangible assets other than goodwill, including those that involve exclusive rights, may also be acquired in a merger. Items, such as Internet domain names, video and audiovisual material, and numerous others are also treated separately from goodwill. Furthermore, “in-process” R&D is an intangible item related to a particular project that is incomplete at the time of an acquisition.
Second, the intangibles on a company’s balance sheet may include those purchased in situations other than business combinations. These assets are more similar to long-lived tangible assets, as they are recorded at their fair value when acquired, an amount equivalent to the purchase price. Thus, no impairment is required. However, because the valuation of these assets can be somewhat arbitrary, investors should focus more on their type, rather than their stated value. For instance, Disney (DIS – Free Disney Stock Report) purchased the distribution rights for feature films The Avengers and Iron Man 3 from a third party studio and will pay certain fees to that studio associated with the performance of those films, subject to a minimum guarantee. These distribution rights are recorded as intangible assets.
Finally, companies often internally develop legal, as well as competitive, assets. These categories of intangibles are created through activities like Research & Development and advertising. Legal assets consist of those such as patents, copyrights, trademarks, brand names and franchises. As an example, the stated value of Microchip Technology’s (MCHP) “Developed technology” intangible assets rose substantially from March 2008 to September 2010. The company designs and develops semiconductors utilizing a proprietary architecture under the PIC brand name. Competitive intangibles, meantime, are less definable and include know-how, human capital, reputation, leveraging, and collaboration.
Definite intangible assets include those that last for a particular amount of time and their values are amortized. Indefinite ones exist for an unspecified amount of time, like a brand name that will continue on for as long as the company chooses to produce the product.
Investors may want to review the amount of a company’s intangible assets because of their possible considerable impact on book value per share. Legal and competitive intangibles can provide a firm with sizable advantages over its rivals. For instance, at the end of 2009, The Coca-Cola Company (KO – Free Coca-Cola Stock Report) owned indefinite-lived trademarks that amounted to 13% of its total asset value. Without these trademarks, the beverage giant would likely be unable to maintain pricing. Along those lines, investors might also be interested in the amount of intangibles amortization recorded, as this expense reduces net income. Additionally, investors should be aware of the potential for an intangible asset impairment, recorded as an expense and subtracted from the asset’s book/carrying value.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.