Brand Values Are Up
Should ABLs Lend More Against Brands?
Date october 2010
Featured in The Secured Lender
With decades of experience under their belts, asset-based lenders (ABLs) have a high degree of confidence in their ability to value and lend against assets such as inventory, machinery and equipment, real estate and accounts receivable.
Over the last decade, this confidence has extended to brands and other types of intellectual property (IP) as lenders push the limits on the collateral pool to win new business and retain clients. Initially, ABLs knew that brands had some value, but they lacked confidence in the methods used to discern how much value brands contained. However,as the decade progressed, ABLs became more comfortable with brand-valuation models and started to look toward brands as primary sources of collateral.
The Value of Brands as Collateral for ABLs
Many recent corporate bankruptcy auctions — such as Polaroid, The Sharper Image and, to a certain extent, Eddie Bauer — were driven primarily by brand value rather than hard assets. These auctions put brand valuations to the test, giving appraisers an opportunity to demonstrate the usefulness and accuracy of their valuation models in real-world situations.
These transactions not only provided support to the brand appraisals used by ABLs, they actually demonstrated that ABL loan-to-value (LTV) ratios for properly conducted net orderly liquidation value (NOLV) brand appraisals have been conservative. In some cases, auction results even exceeded valuations due to brand extendibility (both in product and geography), which is typically beyond the scope of the brand appraisal.
For example, a financial buyer maybe willing to include the potential of expanding the brand through negotiated licensing agreements in markets where the brand previously had little or no exposure. These brand extensions can significantly increase the bid for the brand but may have no precedent in the brand’s history and thus no value in the brand appraisal. In addition, the deal model may include assumptions about benefits from divesting certain licensing agreements and renegotiating others to obtain more favorable terms that would also improve the economic value of the brand.
As ABLs consider raising LTV ratios for brands, it’s also important to consider that the brands themselves are increasing in value. These rising values are not related to the individual brands in question, but rather to the basic principles of the “brand disposition market,” which is defined by supply, demand and risk. The supply of iconic brands is limited, but the interest in distressed brands has increased with more and more financial buyers willing to purchase just the brand itself. With a number of recent brand purchases predicated on extracting a brand from a broken operating business model and the subsequent successful conversion to a licensor-based brand-management company, the risk in such transactions continues to decrease as the business plans prove out. The bottom line? More bidders and longer track records equal lower risk, which equals higher value.
Will Bundling Brands with Hard Assets Enhance the Value of the Package?
ABLs have historically valued assets used as collateral on a stand-alone basis, with little or no consideration given to their value in connection with other assets. Even as ABLs add brands to the collateral pool, they have maintained a separation between hard assets and brand assets. With brands now a bigger part of the collateral pool, does that independence still hold true? Can brands actually enhance the value of other assets in the collateral pool? Does including IP in the collateral pool change the risk profile of a credit file enough that ABLs should lend more?
On the surface, it seems reasonable to assume that controlling both the IP and the hard assets would enhance the overall value. Consider a scenario where IP and hard assets are purchased separately: If the buyer of the inventory sells it through bargain basement discount channels, such action can easily degrade the value of the brand. On the other hand, a buyer that purchases the IP and the hard assets together can maintain or even enhance the value of the brand through a controlled sale of the inventory.
Eddie Bauer is an example of a recent auction that demonstrates the premium a buyer was willing to pay to control both the IP and the hard assets. In the end, a bid from Golden Gate Capital for the entire company as a going concern exceeded the individual bids for each asset.
Despite anecdotal evidence that suggests strategic buyers are willing to pay a premium for a blended package of IP and hard assets, we believe that ABLs should still resist the urge to assign extra value to an IP/hard-asset package, if they are doing so, because of the possibility that a strategic buyer might decide to pay a premium for the brand-inventory bundle. To assume the presence of a strategic buyer exposes ABLs to excessive risk and introduces the potential for over valuation. Instead, ABLs should assess each asset class separately in the context of a competing set of financial buyers (not strategic buyers) that are willing to pay a liquid market rate within the time constraints of a motivated seller. ABLs should, in other words, continue assigning independent asset values to independent assets, while acknowledging the potential for strategic upside, if IP and hard assets are purchased as a group.
The maturation of brand values and associated ABL appraisals are worthy of enthusiasm on their own. The fact remains that actual brand values are increasing in what is an otherwise declining market of asset values. ABLs should feel more confident using proven market-based, brand-valuation methods when underwriting, secure in the knowledge that recent dispositions have actually met or exceeded values that properly prepared valuations predicted. Brand value is no longer hypothetical — real facts and real transactions can reveal it.
That said, ABLs should not allow the maturation of the brand as collateral to affect their valuation expectations for other asset classes or the bundle. ABLs should maintain their discipline of independent assessments of both brands and hard assets.
Strategic buyers may pay a synergy premium to purchase a total package (inventory + fixtures + IP/brand), but ABLs cannot and should not base their valuations on such a possibility, because they have no way of knowing in advance whether a strategic buyer will actually appear in the event of a bankruptcy auction or whether just competing financial buyers will bid.
On the other hand, ABLs may want to adjust their LTV ratios to take into account recent transactions in which brands and associated IP sold for prices at or in excess of those that properly prepared valuation models predicted.
Consider this illustrative example:
Asset: Scenario #1
Scenario #2 Scenario #3 Inventory 100 100 100 Fixtures 10 10 10 Brand 30 30 40 Synergy - 10 - Total 140 150 15
Many ABLs use valuations shown in Scenario #1. It would be risky for ABLs to assume the presence of a strategic buyer willing to pay a synergy premium (Scenario #2), but ABLs can nonetheless arrive at a higher total valuation for collective assets once they increase their LTV ratios via proper brand valuations that reflect recent deals that validate appraisals (Scenario #3).