Valuation & Financial Opinions                                                                            Trends in the Al...
Valuation & Financial Opinionsand customer backlogs. These intangibles comprised 12.7% of the                             ...
Valuation & Financial Opinions                                                                       ...
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Trends In The Allocation Of Intangible Assets For Purchase Accounting Article


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Trends In The Allocation Of Intangible Assets For Purchase Accounting Article

  1. 1. Valuation & Financial Opinions Trends in the Allocation of Intangible Assets for Purchase Accounting By Jason M. Muraco, CFA – jmuraco@srr.comIn the fifth year of our intangible asset allocation study, we noted 2002 to 61.0% in 2006. The downward trend is consistent with oursome interesting trends in the allocation of the “Intangible Gap” expectations given the general “push” for an increase in the allocation(defined as total assets over the net of the amounts assigned to of purchase price to identifiable intangible assets since the releasetangible assets). Our current look focused on transactions that of SFAS 141, Business Combinations in June 2001.closed during the calendar year ended December 31, 2006.Transactions in the Financial Institutional market (i.e., banking, Marketing-Related Intangiblesinsurance, etc.) were excluded from our analysis as the economics Relatively unchanged from 2005, marketing-related intangiblesand typical assets within this market are unique (e.g., a large (e.g., trademarks, trade names, etc.) accounted for 6.2% of thepercentage of financial instruments and a low percentage of Intangible Gap in 2006. The most notable change in the capitalizationidentifiable intangible assets) and therefore are not necessarily of marketing-related intangibles was in the Computer Software,comparable to transactions in other industries. Further, the statistics Supplies and Services industry, which accounted for 5.4% of thediscussed in this article are based on an equally-weighted analysis Intangible Gap, more than double 2005 levels. The Communicationsas opposed to dollar-weighted results. The equally-weighted results and the Drugs, Medical Supplies and Equipment industries showedof our 2006 study are summarized in the following chart. downward trends in marketing-related intangibles over the past three years. Total (Excluding Financial Institutions) [a] Technology-Based Intangibles 2006 2005 2004 2003 2002 Number of Transactions 215 557 274 353 398 After goodwill, technology-based intangibles accounted for the Goodwill largest portion of the Intangible Gap in 2006, representing 13.5% Percentage of Intangible Gap 61.0% 62.4% 67.3% 61.0% 69.7% Marketing-Related Intangibles on average. The Drugs, Medical Supplies and Equipment industry Percentage of Intangible Gap 6.2% 6.3% 5.0% 6.0% 4.4% exhibited the largest increase in the allocation of technology-based Technology-Based Intangibles Percentage of Intangible Gap 13.5% 11.3% 11.8% 18.0% 13.8% intangibles over the past three years, with recognition increasing Customer-Related Intangibles from 23.9% to 53.0% of all transactions. The upward trend in Percentage of Intangible Gap 12.7% 14.4% 9.9% 8.9% 5.7% technology-based intangibles within this industry is primarily Contract-Based Intangibles Percentage of Intangible Gap 4.6% 4.6% 3.5% 3.7% 5.1% attributable to in-process research and development assets, which Miscellaneous Intangibles accounted for 60.7% of total technology-based intangibles in Percentage of Intangible Gap 2.0% 1.0% 2.5% 2.3% 1.4% 2006 (up from 42.9% in 2004). Overall, in-process research and Source: SEC filings of companies identified in Mergerstat Review . development was the second most common technology-based All percentage calculations are based on a straight average. [a] Excludes the following industries: banking and finance; insurance; and brokerage, asset recognized across all industries in 2006, following patented investment & management consulting. and unpatented technology. Patented and unpatented technology was recognized in 78 of the 215 transactions analyzed (or 36%).Goodwill Customer-Related IntangiblesAs illustrated in the chart, goodwill still represents the largest The largest year-over-year change in booked intangible assets overpercentage of the Intangible Gap (61.0% in 2006). There is an evident the five-year history of our study was recorded in customer-relateddownward trend in this percentage, albeit at a relatively slow pace, intangibles. Customer-related intangible assets include customeras the amount allocated to goodwill has declined from 69.7% in relationships, customer contracts, customer lists, customer orders,Patrick A. Brown Gregory A. O’HaraDirector Managing Director216.373.2993
  2. 2. Valuation & Financial Opinionsand customer backlogs. These intangibles comprised 12.7% of the deferred tax liability is a dollar-for-dollar increase to goodwill. SinceIntangible Gap in 2006, which is materially higher than the 5.7% this adjustment (which has already been accounted for in theaverage in our 2002 study. The Manufacturing and the Communi- allocations reviewed in this article) is typically made after valuationcations industries exhibited the highest increases of the top five firms perform the purchase price allocation work, the initialindustries in customer-related intangibles over the past three years. allocation percentage to goodwill implied by the valuation firm’s work could be lower than the final allocation percentage after anyCustomer relationships were by far the most commonly-recorded adjustment for deferred tax liabilities (which could be material).customer-based intangible in the 2006 study, as they were bookedin 130 of the 215 transactions analyzed. The FASB’s dissemination To illustrate this theory, we compared the allocation percentageof Emerging Issues Task Force (“EITF”) Issue No. 02-17 “Recognition to goodwill both with and without the inclusion of deferred taxof Customer Relationship Intangible Assets Acquired in a Business liabilities. The following chart summarizes the results of our studyCombination” was referenced in a previous study as a potential for the top five industries (in terms of number of deals in 2006)reason for the trend towards an increase in the recording of over the past three years.customer relationships.EITF Issue No. 02-17 Computer Software, Supplies Drugs, Medical Supplies and(which was released in Banking and Finance 2006 2005 2004 2006 Manufacturing [b] 2005 2004 2006 and Services 2005 2004 2006 Communications 2005 2004 2006 Equipment 2005 20042002) attempted to Number of Transactions 126 105 128 35 77 31 31 142 75 23 31 9 20 32 25 Goodwillclarify the definition of Percentage of Intangible Gap 85.5% 85.0% 85.6% 60.2% 64.8% 66.3% 67.0% 67.0% 68.2% 70.5% 60.7% 80.2% 37.0% 49.0% 62.6% Marketing-Related Intangiblescustomer relationships Percentage of Intangible Gap 0.2% 0.3% 0.1% 3.0% 5.8% 6.4% 5.4% 1.9% 2.2% 0.5% 3.2% 3.7% 1.9% 3.7% 5.3% Technology-Based Intangiblesin the context of Percentage of Intangible Gap 0.0% 0.1% 0.0% 15.2% 13.4% 15.1% 12.1% 13.7% 12.2% 2.1% 7.5% 0.0% 53.0% 32.0% 23.9%recognizing this asset in Customer-Related Intangibles Percentage of Intangible Gap 14.3% 14.1% 12.9% 18.9% 13.2% 11.2% 10.2% 13.6% 12.5% 19.2% 17.3% 11.8% 2.3% 10.2% 3.8%a business combination. Contract-Based Intangibles Percentage of Intangible Gap 0.1% 0.2% 0.9% 0.7% 1.3% 0.6% 3.1% 3.2% 1.3% 7.6% 11.1% 4.2% 5.7% 5.0% 1.6%It certainly appears that Miscellaneous Intangibles Percentage of Intangible Gap 0.1% 0.3% 0.5% 2.1% 1.5% 0.4% 2.2% 0.6% 3.6% 0.1% 0.2% 0.1% 0.1% 0.1% 2.9%the EITF had an impact Source: SEC filings of companies identified in Mergerstat Review .on the recognition of All percentage calculations are based on a straight average. [a] The manufacturing industry includes companies classified in the following industries: automotive products & accessories; autos & trucks; electrical equipment; electronics; fabricated metalcustomer relationships, products; industrial farm equipment & machinery; miscellaneous manufacturing; plastics & rubber; primary metal processing; and valves, pumps, & the averagepercentage of the total Intangible Gap allocated to customer The average allocation to goodwill for the Manufacturing industryrelationships increased from 1.6% in 2002 to 11.0% in 2006. was 60.2% in 2006. Removing the impact of deferred tax liabilities (for those deals that disclosed such detail) decreases the averageContract-Based Intangibles goodwill allocation to 53.9%, nearly a 10% reduction. As such,The booking of contract-based intangibles was unchanged from deferred tax liabilities appear to have a meaningful impact on the2005, accounting for 4.6% of the Intangible Gap in 2006. Consistent allocation of the Intangible Gap to goodwill. Further, removing thewith past results, non-competition agreements were the most deferred tax liability offset (i.e., increased goodwill) from thefrequently recorded contract-based intangible in the 2006 study, as Intangible Gap calculation would also have the impact of increasingthey were a recognized intangible asset in 40 of the 215 transactions the relative percentages of recognized intangible assets.analyzed (or 19%). Looking ForwardAdditional Thoughts Increases in customer-related intangibles (particularly customerIn general, goodwill (as a percentage of the Intangible Gap) has relationships) have accounted for the largest portion of reallocateddeclined over the five-year history of our study. However, the goodwill amounts over the history of our study. We anticipate thisdecline is modest and the total allocation percentage to goodwill is trend to continue for those transactions that closed in calendar yearstill relatively high. One potential reason for the discrepancy could 2007 given the overall push by accounting firms and regulatorsbe related to the timing of the work performed by valuation firms. for companies to allocate larger portions of the Intangible GapGenerally, valuation firms utilize a target company’s preliminary to identifiable intangibles (such as customer relationships). Foropening balance sheet that does not incorporate all post-transaction transactions closing in 2008 and beyond, we look forward toaccounting adjustments (e.g., deferred tax liabilities). Acquisitions analyzing what type of impact more recent regulations (such as thein the form of stock transactions (which tend to be more prevalent revision of SFAS 141, Business Combinations and the release ofthan asset transactions) often book a deferred tax liability since SFAS 157, Fair Value Measurements) may have on the allocationthe acquired assets are usually written-up for book purposes but of the Intangible Gap.not for tax purposes (i.e., an acquirer does not get the full taxdeductibility benefit of acquired assets in a stock transaction, onlythe carry-over benefit). The offsetting adjustment to booking a
  3. 3. www.srr.comWE SUPPORT YOUR WORLDWIDEFINANCIAL REPORTING VALUATION NEEDSWE ARE INVOLVED IN ALL ASPECTS OFFINANCIAL REPORTING VALUATIONS INCLUDING : ■■■ Purchase price allocations (SFAS 141, IFRS 3, IAS 38) ■■■ Goodwill impairment testing (SFAS 142, IAS 36, IAS 38) ■■■ Long-lived asset impairment (SFAS 144, IAS 36) ■■■ Employee stock options and restricted stock (SFAS 123R, IFRS 2) ■■■ Fresh start accounting (SOP 90-7) ■■■ Fair value of financial investments (SFAS 107, IAS 32) ■■■ Fair value measurements (SFAS 157)
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